史賽克 (SYK) 2008 Q2 法說會逐字稿

Good day, ladies and gentlemen. Welcome to the Stryker conference call. My name is Katie, and I will be your coordinator for today. At this time, all participants will be in listen-only mode. We will be conducting a question-and-answer session towards the end of this conference. (OPERATOR INSTRUCTIONS).

The Company has asked that I read the following statement. Certain statements made in today's conference call may constitute forward-looking statements. They will be based on management's current expectations and will be subject to various risks and uncertainties, that can 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 product, regulatory actions, unanticipated issues arising in connection with clinical studies, and otherwise that affect the United States Food and Drug Administration approval of new products. Change in reimbursement levels from the third-party payers, a significant increase in the product liability claims, change in economic conditions that adversely affect the level of demand for the Company's products, change in foreign exchange market, and change in financial markets, and change in the competitive environment.

Additional information concerning these and other factors are contained in the Company's filings with the Securities and Exchange Commission, included in the Company's Annual Report on Form 10-K, and the quarterly report on Form 10-Q. Today's conference call will also include a discussion of adjusted net earnings from continuing operations for the comparative quarter, and six months ended June 30th, 2007. Further discussion in the non-GAAP financial measures including GAAP reconciliation, and the the Company's Form 8-K filed today with the United States Securities and Exchange Commission, which may be accessed from the For Investors page on the Company's website at www.stryker.com.

I would like to now turn the call over to your host for today, Mr. Stephen P. MacMillan, President and Chief Executive Officer. Sir, you may proceed.

Thank you, Katie. Welcome to Stryker's second 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.

We had a few challenges in the quarter, and as always there will be a few things to poke at, but our unique set of businesses delivered strong results once again. Posting our 30th straight quarter of double-digit sales growth. While a favorable calendar and currency helped, in the quarter by adding over 4 points of growth to our top line, overall reported sales growth was 17%, and earnings were again up over 20%. With strong performances from our international businesses, our growth was remarkably balanced on a geographic basis, with both the U.S. and international businesses up about 12.5% operationally in the quarter.

This represents significant upticks in our European, Pacific, and Latin America businesses, and total reported international growth was up 25% in the quarter. Internationally, all five of our orthopedic implant businesses, hips, knees, spine, trauma, and CMS, delivered accelerating growth rates, and exceeded 20% combined sales growth on a reported basis. MedSurg also had another impressive quarter, posting over 20% reported growth, and up 18% operationally.

Our international expansion efforts continue to pay off, as reported MedSurg growth was up a remarkable 37% in the quarter, and 25% operationally. Our U.S. businesses also continue to be strong, up over 15% in the quarter. Thus, we continue to be optimistic about our long-term prospects for growth in MedSurg.

We will now turn to an update on quality and compliance. We have been actively engaged in discussions with FDA, as we work to remediate our existing warning letters. But also to harmonize and strengthen our compliance systems across the corporation. While our highly decentralized organization helps drive exceptional commercial success over the years, it has also made it more difficult to deliver the consistent company-wide compliance systems which FDA expects.

The magnitude of the effort ahead of us is big, and earlier this year we began a major revamping of our approach to our quality and compliance systems, and it will take time, money, and management focus throughout the organization. We would expect costs of this effort to be at least $50 million per year for the next few years, and will likely result in the addition of several hundred new people around the world.

So what should you make of all this? It is pretty simple. We have a lot of work to do, but we are channeling our can-do spirit to the area of compliance, and attacking it like we attack all challenges, with focus and energy, and from a position of financial strength, which should allow us to continue to deliver while also getting stronger.

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

Thanks, Steve. I would like to start with the impact of foreign currency on our sales in the quarter. As in the first quarter, foreign currency was very favorable this quarter. The weakening of the U.S. dollar added $65 million to international sales, and increased the Company's overall sales growth by 4.4%.

In the second quarter, the dollar weakened approximately 16% against the euro, and about 13% against the yen when compared to the prior year. If currency rates hold near June 30th levels, we expect the impact of foreign currency will increase third quarter 2008 sales by about 2.5 to 3% versus the prior year.

Now I will spend a moment on the impacts of price and volume mix on the top line. Selling prices were up about 0.5% on a worldwide basis in the quarter, with domestic prices up 1%, and international prices declining slightly, as a result of the April 1st, 2008 government reimbursement cuts in Japan. Japanese pricing was off 7% in the quarter. Volume mix growth was 12% in the second quarter. Domestic volume mix growth checked in at 11% in the quarter, and the international volume is mix growth was a robust 13% on the heels of a soft first quarter.

Now I will turn to our business segments. Orthopedic implants represents 59% of our sales, and sales of orthopedic implants increased 15% in the second quarter on a reported basis, and 9% operationally. The orthopedic implant business received a slight benefit from one additional comparative selling day in the quarter, and as we go through the growth rates by product line, which are shown in our press release, I will reference the rates as I provide more detail on performance needs product category.

Hips were up 7% in dollars, and 2% in constant currency in the second quarter. As was the case in the first quarter, our overall hips business was negatively impacted by the Trident hip recall. Trident supply has now been restored to reasonable levels, and our sales forces can turn their attention to getting this franchise back on an improved growth track. U.S. hip sales grew 3% in the quarter, led by incremental Cormet hip resurfacing sales, and growth in restoration module hip revision, X3 polyethylene, and Accolade cementless product. Declines in Trident sales have offset a portion of the gains from these products.

European hip sales posted mid-single digit local currency growth, with ABG-II, X3 polyethylene, and Accolade leading the way. Trident and Exeter registered modest unit growth in Europe. In Japan, constant currency hip sales declined at low single-digit levels as a result of the MHLW imposed price reductions. Volume gains reached mid-single digits, led by our Secur-Fit products. Local currency hip sales in the remaining international markets were basically flat, rebounding from a 10% decline in the first quarter, as Trident supply came back on line.

Now turning to knees, they were up 18% in dollars, and 13% in local currency in this quarter. Our overall knee business had a nice quarter with consistent growth around the world. In the U.S., knee growth of 13% provided our 34th consecutive quarter of domestic double-digit growth in this category. Primary knees posted low double-digit growth with X3 polyethylene and Triathlon leading the way. Revision knees grew by over 30% for a second straight quarter, paced by our new Triathlon PS revision product.

In Europe operational knee growth checked in at healthy mid-teen levels, with Triathlon and X3 the key drivers. Japanese constant currency knee sales grew at mid to high-single digit rates, translating to mid-teens volume growth after considering the price reduction in the pact. Scorpio NRG is our leading knee product in this market. Pacific, Canada, and Latin America all posted low double-digit local currency knee growth, with Triathlon leading the way in Pacific and Canada, and Scorpio in Latin America.

Now turning to trauma, that was up 22% in dollars, and 13% on an operational basis in the second quarter. Our trauma business had a very solid all-around quarter with the U.S. slowing a bit, and growth overseas accelerating. Domestic sales grew 13% in the second quarter, and this percentage is unaltered by the exclusion of military sales. U.S. trauma growth was led by Gamma 3 hip fracture, VariAx Distal Radius, and foot plating system products.

International trauma sales accelerated to 13% growth on an operational basis. Europe had had another nice quarter, posting mid-teens local currency growth. In Japan trauma product sales were flat in constant currency. The remaining international markets for trauma were all exceptionally strong, registering collective growth above 40% on a relatively small base. Similar to the U.S., international trauma growth was paced by upper extremity and foot and ankle products.

Now turning to spine it was up 21% in dollars, and 17% in local currency in the quarter. Our spine business had another excellent quarter. U.S. spine sales were up 22%, against an extremely tough prior year comparable. This growth was very consistent with the major product categories we track, all up at least 20%, led by Interbody devices.

International spine sales posted 7% operational growth in the second quarter. Thoracolumbar products generated the bulk of our international spine growth. And Pacific and Europe were the geographic leaders, with each of these market posting low double-digit constant currency growth.

CMS, the last of the products in this category was up 22% in dollars, and 18% in local currency in the quarter. Our CMS business had another excellent quarter, with balanced growth between the domestic and international businesses. Neuro and HydroSet injectable bone substitute products again drove the U.S. growth, as they did overseas. CMS growth outside the U.S. was particularly strong in Pacific, and Europe had a very solid quarter.

Now turning to our MedSurg group this represents the other 41% of our sales. MedSurg had an excellent quarter. Instruments had an exceptional quarter in the U.S., and all three businesses posted excellent sales results overseas. As a reminder, MedSurg is comprised of three significant product categories, with Instruments making up 18% of total company sales, Endoscopy 14, and Medical 9%. MedSurg group sales were up within 21% for the quarter in U.S. dollars, and 18% on an operational basis.

Now turning to the individual product sales for our instruments product line were up 26% in the quarter on a reported basis, and grew 22% in local currency. Instruments had an exceptional quarter with operational growth over 20% in both the U.S. and international markets. To be fair, the business received a bit of a boost in the quarter from the bolus of demand for certain products, that a competitor pulled from the market in the near term.

Domestic sales were led by exceptional growth from our cordless driver 3 micro powered tools, and Neptune waste management product, as well as growth from our irrigation and cement mixing products. Sales of heavy-duty power tools were solid in the quarter.

Our international instruments business had had an outstanding quarter, growing 38% on a reported basis, and 25% in constant currency. Overseas growth was led by heavy-duty and micro-powered tools, along with irrigation and interventional pain products. On a geographic basis, Pacific, Japan, and Latin America, all registered operational growth above 30% in the quarter.

Endoscopy grew 16% in the quarter as reported, and 13% in constant currency. Endoscopy had a quarter very much like their first quarter, reporting solid growth paced by the international markets. Domestic sales were led by communications and general surgery products. International sales grew 21% operationally, with general surgery and video products leading the way. Pacific and Canada registered exceptional growth, and Europe also had a nice quarter.

Now turning to Medical, our Medical business was up 18% in the quarter as reported, and 16% on an operational basis. Medical posted another strong quarter with our international business leading the way. Domestic growth of 13% was led by EMS products with beds and stretchers registering solid double-digit growth. Overseas the key product categories all registered constant currency growth above 20%, with geographic growth led by Latin America and Pacific.

Now I will provide some comments on the remainder of the income statement beginning with gross margins. Gross margins in the quarter were down 70 basis points compared to last year. As anticipated, the cost of some of our quality initiatives began to ramp up in the second quarter, which unfavorably impacted our margins. Higher excess and obsolete inventory costs associated with the implant businesses and increased shipping costs, also lowered comparative margins.

As a result of certain increased costs, including those associated with our ongoing quality initiatives, and higher raw material and freight costs, we now project annual gross margins will be down 20 to 40 basis points compared to the prior year. Spending on Research & Development was down 2% in the quarter. Back in January when we gave our 2008 guidance, we indicated that we planned a slower pace of R&D spending during this year.

This plan should be understood in the context of the previous four years, where R&D spending grew well above our top-line growth rate, and increased meaningfully as a percent of sales as we increased our pipeline of products across the divisions. We expect to see a more normalized level of R&D spending on a go forward basis, recognizing that given the timing of certain projects, the spend level will vary from quarter to quarter as it did in the second quarter.

In addition, the focus of R&D resources on quality has slowed down a few R&D projects, and reduced spending that may have normally been directed by our teams through outside contractors. We are still comfortable in our R&D pipeline as we look ahead, given the level of work we have done in this area over the past several years.

SG&A costs increased by 17% 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 reflected in the legal fees that almost tripled in the quarter. Selling costs include compensation and instrument amortization costs, and grew somewhat below the rate of sales growth, as instrument amortization has begun to slow down.

The second quarter of 2007 included a pretax impairment charge of $19.8 million to write off patents associated with the spinal interbody fusion cage products, obtained in the 2002 Surgical Dynamics acquisition. Excluding the impact of that impairment charge, operating income increased 20% in the second quarter, and operating margins increased to 23.4% of sales.

Now I will provide a breakdown of other income and expense for the quarter. That number which totaled $19.2 million was made up of investment income of $26.4 million, offset by interest expense of $7.3 million, and then supplemented by a small foreign currency transaction gain of $0.1 million. The Company's effective income tax rates were 27.2% and 27.6% for the second quarter and first half of 2008 respectively, as compared to effective income tax rates for the second quarter and first half and year ended December 31st, 2007, of 27.6%, 27.9%, and 28.0% respectively.

Our balance sheet continues to be in excellent shape, and I will touch on the key asset management areas. First, Accounts Receivable. Accounts Receivable days ended the quarter at 59 days, down 1 day sequentially, and up 1 day from a year ago. We continue to believe this represents very good performance for our industry and geographic footprint.

Inventory days finished the quarter at 162 days, in-line with the first quarter, and up 13 days versus the prior year. This metric is impacted by foreign currency translation and new product introduction, but also reflects inventory we expect will be better utilized, as we strive to accelerate growth in our hip franchise around the world.

And lastly on the balance sheet at June 30th, 2008, we have just $24 million of debt outstanding. Now I will finish with a brief look at our cash flow statement, where we are pleased with the performance so far this year. Cash flow from operations in the first half was up 19% to $431 million, and our cash and marketable securities balances have topped 2.5 billion.

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

Thanks, Dean. So as we summarize the quarter it looks like this. Strong sales, earnings, and cash flow growth. Admittedly helped by the calendar, currency, and a little help from our instruments franchise from supply issues at a competitor.

These positives allowed us to overcome our own shortfalls in our hip franchise, and enabled us to invest significantly in quality and compliance initiatives. These investments dinged our gross margins a bit, and have delayed some R&D projects as we mentioned, but we remain confident in our overall pipeline. The strength of the euro also dented gross margins narrowly, but an improved tax rate helped.

All-in we had a few moving parts for and against us as always, but our broad-based set of businesses once again allowed us to deliver on the commitments we established at the start of the year. Looking forward, we continue to feel good about our ability to deliver in the second half, while continuing to strengthen our quality and compliance systems.

With that, we will now open it up for questions and remind everyone that we will take one question from each person with one follow-up. So back to you, Katie.

Ladies and gentlemen, (OPERATOR INSTRUCTIONS).

Your first question comes from the line of David Roman from Morgan Stanley. Please proceed. David, your line is open. You may proceed with your question.

Thank you. Good evening, everyone. Couple of quick questions. First, on the hip side, can you give us an update on the Cormet launch, where we are with training courses, and when we can expect a full rollout?

Sure. The training course has been happening through the second quarter. I would tell you, to be quite candid, our organization shifted from playing offense to defense the first half of the year, as we reeled from the hip recall, and I think we will expect a steady uptick here in the third quarter and beyond. This one continues to go certainly slower than we would have planned at the start of the year.

Okay. And then on the gross margin, Dean, can you quantify maybe the components of that 20 to 40 basis point year-over-year decline, what the positives and negatives are in there?

Well primarily, David, it is the quality initiatives kicking in. I also mentioned the fact that, as you know, and we have talked about it before it, we have a few components of higher raw material costs.

Some of that relates to the price of some of the commodities that we are purchasing, the metals that go into some of the products, as well as to some degree a little bit of a ding from the impact of foreign currency in that category, and then also we have some higher shipping costs that are going into that, but the from a magnitude standpoint, it is primarily the quality initiatives that are going to impact that year-over-year change.

And again, if you think about where we would have maybe anticipated this to be in a normal year, we would have expected our margins maybe to be up 30 to 50 basis points. So all-in we are taking a pretty good whack as we roll in the cost of this quality, which will have some ongoing impact, but should leave us in a better place as a company as we go forward.

Your next question comes from the line of Mike Weinstein from JPMorgan. Please proceed

Thank you. Good evening guys.

Hey, Mike.

Let me follow up on that last question. It probably would be helpful, Dean, if we think about what has been moved from plus 30 to 50 to down 20 on the gross margin guidance, or initial thoughts today, can you give us a sense of how much of that is the quality initiative, versus increased material costs, increased shipping costs, and the dollar?

Well again, most of it is quality, and we have outlined the number there of at least $50 million, so --

And that 50 --

Pardon?

And that full 50 shows up in the cost of goods sold line?

Not completely, but the majority of it does.

Okay. Let me just come back to the FDA. You spent a little bit of time on it. I was hoping you could update us on the timing of the reinspections of Cork and Mahwah?

It is still no timing planned, and Mike again, I know from an investment community standpoint, we would love to get those behind us. I will tell you we are still more focused on making sure that we have those facilities in great shape, and are preparing that way. So there is no timing yet established.

Your next question comes from the line of Raj Denhoy of Thomas Weisel Partners. Please proceed.

Good afternoon, guys. Wonder if I could ask about the hip business in general. You have mentioned that the inventories have now been restored in the marketplace, but that growth rate, particularly on the domestic side, is still pretty anemic. Could you just maybe give us a little bit of clarity, as to when you expect that to accelerate, and how you expect to overcome some of the competitive hits you have taken there, to get back some of that business?

We think we will get it going by about 2015 at the rate we are going. No, it's going to be probably slow coming back here in the second half of the year. The sales forces took a hit, and you don't get that business back, and that momentum back. I think to be quite honest, we are also very caught up in our incredible growth in our knee business right now. It is easy to go to hips. I would remind everybody that our other seven franchises all grew in excess of 15%.

There is a lot of momentum in knees right now. If you look at that time knee marketplace, we think it's a much more dynamic marketplace right now, in terms of surgery schedules and everything else. And candidly, with the success of Triathlon, with the PKR, and our partial knee resurfacing, and our Triathlon revision systems, it is a little easier for our sales force to be focused on knees right now, and it is going to take a little bit of time before they get fully back, and excited about hips again.

Sure. The knee business for sure isn't lost. But it is interesting, because I guess we don't necessarily seem like there is going to be a lot of competitive change quarter in and quarter out in orthopedics, but it sounds from some of your comments, that you maybe actually have lost some competitive share in hips, and it is not just the one-off procedures, but surgeons may have moved to other competitors and devices in order to satisfy their needs. Is that in fact the case and what has happened?

Yes, I think if certainly the J&J numbers, they had a great hip quarter. I think we have lost a little bit of business to them. It is going to take a little bit of effort to get back. So I think that is a very fair observation. We are not thrilled about it. I think we are taking market share in seven of the eight categories we compete in, which I think just about any company would take, but we have lost a little bit in that one. But we will get it back eventually.

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

Good afternoon. Steve, I was intrigued by your comment about knees. Do you believe that knee volumes are up close to the 10% we saw for a while in the United States?

It certainly seems, if you look at the hip market and the knee market right now, Bruce, the knee market certainly seems to be a lot more vibrant. And I would say both in the U.S. and globally. And that is where, we are disappointed with our hip business, but frankly, given the growth in the knee category right now, we would rather be succeeding and winning in knees, which we are. So it does seem pretty vibrant.

With regards to the warning letter at Analyst Day, the potential for a corporate warning letter, at the Analyst Day, you were guardedly more optimistic that it could be avoided. Could you comment on your sense of how things are going, and also to the extent that worst comes to worst, is that $50 million the number that will pretty much stay in place, in terms of incremental spend?

As we said at the Analyst Day, we are essentially operating the Company as if we received a corporate warning letter, when you look at the magnitude of the effort that we are putting into our quality and compliance issues. I would tell if you you draw a continuum between, hey, we are completely out of the woods on one extreme, and on the verge of getting a corporate warning letter on the other extreme, I would say we are probably closer to the middle, but if anything, we would be on the wrong side of that middle still.

We still have got work to do. But we feel we have made a lot of progress in a short period of time, but we still have a lot of work to do.

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

Hi, thanks for taking the call. Apologies if you already addressed this, but obviously with the first quarter with Easter, there has been a lot of talk on what that impact was in the first quarter. Any sense on what you might have seen from a year-over-year comparison, given that Easter was in the second quarter a year ago? And then if you could just touch on the instruments, can you just specify what were the issues there, and to what degree you expect to benefit from your competitors issue going forward?

Sure. On the Easter, you essential had an extra day this quarter versus a day short. Probably all-in it was a few percentage points. Whether it is between 1.5 to 3 points is probably, Dean, I think what we would factor in.

I think that is fair. Certainly we saw Europe particularly on the international businesses, be stronger in the reconstructive and implant parts of the business, and this quarter, which is where we got hit last quarter, and would have anticipated that bounce-back.

On instruments, I think Dean mentioned there were a couple product lines, in terms of some of the irrigation stuff, that probably benefited a little bit more from some shortages in the market. Again, we always want to be as honest as we can, because that may not repeat in this quarter next year, and as you know, we try to be as critical as we can, instead of blowing a bunch of smoke, tell where you we did get a little lucky.

Can you quantify exactly how much you think it impacted the growth rate there?

In the grand scheme, pretty minor, truthfully.

Yes, I think that is fair. They did have an exceptional quarter, and I think as I said, there was probably a little bit of a bolus of that demand for those products. So while those products are going to probably remain off the market for a while from our competitor, I think this quarter is probably getting the most benefit.

Maybe a percent or two of growth for that business?

Maybe a little bit more than that.

A few percentage points, Kristen, on the instruments franchise for the total corporation. Clearly less than a percent.

Your next question comes from the line of Michael Matson from Wachovia Capital Markets.

Hi. I was kind of interested in the comment that you made earlier in the call, or that Steve made earlier in the call about the 50 million per year may need to continue for the next few years, and this year you are tapering down your R&D spending, and I understand that was sort of by design. That was something you intended to do heading into the year. But just looking out for the next few years, if you are spending this 50 million a year, how are you going to continue to be able to deliver some nice margin expansion? And are there other things that will start to roll off next year, such as the monitoring fees and things like that?

The first part of the answer is we are going to continue to grow really fast on the top line, which I think we have been proving our ability to be pretty good at, and simply put, that 50 million next year off of a much bigger base, you will get some automatic leverage there. And regarding, as we continue to go forward, there should be some costs, particularly Dean mentioned some of the legal costs, and everything else, being up significantly higher, we would certainly hope that some of those do start to roll off.

Okay. And then I was wondering if you could give us a little more detail on your hip resurfacing product. I guess Coren put out an announcement that you weren't taking any more orders from them until the end of the year or something. I just wanted to know is that reflective of a further slowdown in the sales there, or less uptake than you expected, or is that just a reflection of the delay in the training heading into the year?

It is delayed training, but overall, we are just slower out of the gate. It has not been as easy for us when the sales force has been so far distracted, I think we would be wiser to keep expectations lower here, rather than faster, Mike.

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

Good afternoon.

Hi, Doug.

Even adjusting for FX, it actually looks like your O-US hip number rebounded, I would say almost materially more than did it in the US. Any unique supply dynamics specific to Trident or surgeon management approaches that you took, that may have helped you get business back more so O-U.S than domestically?

Great question, Doug. I would tell you probably in some of our key markets outside the US, we did a better job of shielding the surgeons from supply issues throughout. I will tell you we made some prioritization calls, and shifted around certain countries to make sure that we protected our higher volume surgeons internationally, and frankly our more profitable surgeons in some of the international markets.

And I give our international leaders a lot of credit. They made some tougher choices than what they would have done historically, and I think it did allow to us bounce back a little bit quicker.

Great. And just one follow-up. In Q1 you suggested that the Trident challenges you were facing may have actually hindered what was a pretty strong knee number in Q1. I think that was attributed to just the fact that, as you have talked about on today's call, it is a distraction to the sales force. Any thoughts on how this dynamic played out in Q2?

I think in Q2, as we started to get at least supply back on the hips, it allowed the sales reps to at least not be spending all of their time as logistics coordinators, and allowed them to get probably back into surgeries, and with the uptake in the launches of the Triathlon PKR and the revision system, they probably started to put a little more of their time and energy back into selling those products, but I think it is less of a problem on hips, and they went back to knees, which they were having a lot of fun with, but still they are not yet having fun selling hips again.

I do think we do suspect, Doug, that it may have hurt our trauma business in the US a little bit, with some of the folks that have in that their bags as full-line reps, potentially some of that focus issue, but we certainly think we are in good shape as we go into the third quarter now.

Yes, great additional point.

Ladies and gentlemen, as a reminder, please limit your questions to one question with one follow-up. Your next question comes from the line of Michael Jungling from Merrill Lynch.

Thank you for taking my questions. I have two questions. First on gross margin. Given the investments you are making in quality control, the measures there, will the gross margin be bound to below 70% over the intermediate term? And I am not just referring to the next two quarters but perhaps a little bit more beyond that? And then secondly, on trauma what is the constant currency trauma growth rate, if you exclude military sales, and also while we are out in three quarters of deceleration in positive currency sales growth? Thank you.

Sure, Michael. I lost the first one.

The first question, Michael, I am not sure I fully understood.

The gross margins. Yes, they probably will stay under 70.

Just under 70%? Yes, they will be.

And that is also for next year?

Yes, because a lot of these costs will roll through.

Last year our gross margin for the year was 68.9, and we are now projecting that to be down 20 to 40 basis points, and with that 50 million, or components of it built into gross margin going forward, even if we get a normal expansion we are still going to be below 70.

We haven't ever really been a 70 company. We have been constantly marching up over time, and now that march up is going plateau here for a little bit.

Regarding trauma, Michael, we have had just unbelievable growth in the United States for a number of quarters. That's finally, the comparables of 25, 28% on top of each other, we are probably starting to see some of the slow down, combined with what Dean said. Some of our full-line people that do trauma and recon were a little distracted. We certainly saw the slowdown in the US. Internationally our trauma business the last couple of quarters had been good.

But the overall global rate slows down because the US has slowed down a little bit. I would remind you by the way, 13% trauma growth in the US is still not too shabby.

And the military sales had no impact on that number. It is the same with and without.

Thank you.

Great.

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

Thank you. First question has to do with tax rate. 27.2% is that the rate we should think about for the the remainder of the year, and then on a go forward basis?

I think the tax rate is going to have a little bit of volatility. We are at 27.6% through six months, I think we are comfortable with rates anywhere in the range of 27.5 to 28%, as we look at the remaining quarters of the year.

Okay. And it looks like did you not repurchase any shares in the quarter. Is that the right read, and if so, why not?

Yes, that is the right read, and we had, as you know, to put one of these programs in place, you can't have material inside information. We have had certain things that we were looking at and going on, and we are not in a position to initiate that buyback yet.

Okay. So many questions that could come off of that. I will wrap it up then with sources of, sorry, uses of cash. We are still looking at acquisitions then ?

Acquisitions and initiating the buyback.

And initiating the buy back, okay. Thank you very much.

Sure, thanks, Joanne.

Your next question comes from the line of Rick Wise from Leerink and Swann. Please proceed.

Good afternoon, Steve. Hi, Dean.

Hey, Rick.

Couple of questions. You had particularly outstanding international MedSurg results, if I am seeing it correctly, second quarter growth rate is accelerating over first quarter year-over-year numbers. Maybe you can give us a little more color on what is happening there, and some of the initiatives that are driving that, and the sustainability?

Sure. It has largely been just greater focus in a lot of our key countries outside the US, Rick, where we have been putting more dedicated sales people in, particularly really for our instruments and endoscopy businesses. What we have always recognized, we have good products there. We just frankly haven't had many sales people on the ground in some of the markets, and it has been starting to build that out. It is where we continue to think there is some nice runway ahead of us there.

Back to the U.S., I have had some hospital supply manager discussions lately, that quite pleasantly have been indicating that Stryker beds seem to be gaining share. Had some folks who were total Hill-Rom hospitals, they have built a new wing and they are putting in Stryker. Can you help me with any perspective? Is something new affecting dynamics there, and maybe just as part of that update us on the perpetual question these days about capital equipment spending in general?

Sure. We continue to feel great about our medical business, pure and simple. We have we think a great team of people there, and a great, steady flow of new products. And a lot of the new products that they may have mentioned to you, a lot of what we are focusing on are beds and stretchers that can be easier for the OR staff, and frankly help productivity in the hospitals, with some greater software componentry to them, and everything else. We have a new bed that we are just launching right now that is being very well received, so we continue to feel very good about that ability of that business to grow well above the market rate. We are very proud of that division.

And next question comes from the line of [Matt Miksic] from Piper Jaffray. Please proceed.

Hi Steve, hi Dean, thanks for taking the question. One question just on the sequential differences from Q1 to Q2 with all of the expectation around Easter having some kind of positive impact on Q2 and the negative impact on Q1, you had the recall in Q1, it looked like some of your businesses, and I guess I am looking at knees, even though they are still great, they did come down from Q1. I looked at a couple of your other businesses, like even beds or some of the others, which are strong, but they are all kind of down, and I am just wondering with the billing date difference, are some of those moving in ways that you didn't expect quarter to quarter? And is there anything out there that gets you worried about the environment?

There is nothing out there that has us worried about the environment. Our instruments business in the U.S. grew faster in the quarter. I think our medical business grew faster in the quarter as well.

Our knee business grew faster in the quarter, too. So I think a lot of the businesses actually did pick up.

In the US?

Largely what you have, we have been saying for a while, that trauma and spine would eventually be slowing down. Spine is going against a 30% growth quarter last year. So we have been modeling all year long, frankly that trauma and spine would slow down a little bit, knees would hopefully maintain, and hips would pick up a little bit. Obviously the recall on hips has pushed us back there. And that MedSurg would continue to truck along.

I think all-in, that is very much what we feel like we have had.

So you still feel pretty strongly coming into the second quarter here. You talked, I heard the comment earlier about knees. It sounds like you are just seeing a lot of positive procedure activity out there in your major markets.

We are. I think certainly in knees we have expanded the Triathlon franchise here adding the TS Revision System obviously has had great results in the first quarter, and now the PKR is starting to pick up as well. So we certainly feel good about those two additions helping to continue the nice momentum that we have had in knees for long time.

Your next question comes from the line of Lawrence Keusch from Goldman Sachs. Please proceed.

Good afternoon, guys.

Hey, Larry.

Just so, Steve, two questions. I will just ask them, and then you can fire back. Obviously everybody is trying to understand what is going on with surgical volumes, and it feels like things are fine, but if you look across, let's keep it to the US, across the US, are you seeing any changes in any of the geographic areas, either accelerating, because people are afraid of losing their jobs, and are trying to get procedures done, or decelerating in any way? Just trying to get a feel if that is tracking any differently, as you work through the quarters here?

And then the second question, I don't want to put words in your mouth, and that is why I want to make sure I do in understand this. From your prior comments regarding where you are with the FDA and the inspections, and sort of the challenges in front of you on that, it almost feels like you are not quite as optimistic as you were at the Analyst Day, and so I just want to make sure that something didn't happen since that meeting, that makes you feel a little bit less positive on getting this resolved quickly, or am I just reading way too much into that? I just wanted to ask that as well.

Sure. Let me answer the first one on the geographic within the US, we have not noticed any significant things, Larry. We could always follow up, but that level, there has been nothing that has jumped out at our level on that.

Regarding the second part, I think, as you think about FDA, where I was feeling certainly that we made progress when we saw you all in May, and I continue to feel that, is I feel better than I did in January. But I also don't want that to be perceived as, hey, everything is hunky dory, we are completely out of the woods. There is probably a slight nuance there that I might have thought that people might have read maybe a touch more positive business in May. But we continue to feel we are working it. We feel like we have made a lot of progress. We feel we have impressed the FDA that we have made a lot of progress. But the ball is still ultimately in their court, and there is a lot of work to be done.

I think what we have wanted to be clear about, and as we have peeled back the onion more and more, realized there is a lot that we have to do, and I just don't want people to kind of declare victory and go home.

Right. So tap the brakes a little bit here.

So hopefully that frames it. Not very different, but the perception of where it might have been was potentially, if anything, just a touch more positive probably even as we saw the stock run-up after the Analyst Meeting, I realize it was probably a touch more optimistic than we might have been feeling, but we do feel very good about the progress, but know it is a journey.

But no events that occurred. Again have just --

Nothing has changed to knock me back.

Terrific. Thank you for that clarification.

I would love to have something to knock me completely to the other end of the spectrum, and I just can't give that you yet.

Got you, thanks very much, Steve.

Thanks, Larry.

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

A quick clarification first. The 20 to 40 basis points that you talked about on the gross margin, Dean, is that the looking at full year '08 versus '07, or is that just looking at the back half, quarter-over-quarter, or year-over-year on the back half quarterly?

That is intended to talk about the full-year impact.

So looking at '08 --

Comparing it to the 68.9% that was our full-year gross margin for last year.

So bring that down 20 to 40 when we get to the full-year '08 in our models.

Yes.

Okay. In terms of the FDA, how close are you to being comfortable in calling them into either Cork or Mahwah? Are we talking three months' time? Six months' time? Or have you already done that?

We just would rather stay away from specific months, because the FDA works to their timetable. We don't want to overpromise and overcommit. We are working it, we know it is an overhang for some people. We are still better off make sure we have it right. I would rather that delay out a little bit longer, and get it right, than we come back too soon.

The classic mistake companies make in these situations, because of the pressure they feel from the outside community, they can try to rush things along and not be ready. So we have the financial strength, we have the commitment, and we would rather make sure that when they come back in, we are in as great a shape as we can be, even if that means we have an overhang from other key markets.

Just on the pricing front, specifically hips and knees, post-DOJ settlement in the quarter, any changes there, or are things pretty much status quo?

Nothing dramatic.

Your next question comes from the line of Bill Plovanic of Canaccord Adams.

Hi, Bill.

Couple of questions for you guys. Just in terms of the restriction on the stock buyback, is that still in place?

We have not yet initiated it.

But is it still in place? I mean, can you start initiating once we are through quiet period for the conference call?

I think we would prefer not to comment on that, Bill.

Okay. That is all right. Then in turn, one of the comments you mentioned on the onset was that with everything going on for compliance in the systems needed, that it was taking time, money, and management effort. Can you quantify that, in terms of how much is it kind of taking a way from your daily business?

It is clearly is on the minds of a lot of our managers. It is core to a lot of our operational folks. But it is also something that will make us better. So it is also not going to hurt us running the business. It is part of what we need to do, and part of what we are doing.

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

Good evening, guys. Thanks for taking the call.

Hi, Jeff.

Couple of things here. Steve, I apologize in advance. You have answered this about six different ways already, but you ended your comment a few second ago about this overhang may be remaining for a few more months. Is it a fair read then, that at least sometime in '08 is still somewhat on the table for having maybe Cork reinspected?

Maybe, but I don't know. This is where, Jeff, when you guys keep trying to pin for specific answers, the answer is we don't know.

Understood. It is somewhat of an unfair question given your previous comments, but you did end it with 'another few months.'

Months, could be three months, months could be seven months. We are not in control.

Fair enough. Steve, going back to your comments regarding tone coming out of the Analyst Meeting, it also seemed you guys had had pretty high conviction there the next few years, EPS-wise, still looked doable at the 20% level, yet today we are talking about the 50 million maybe continuing at that level the next few years. Do you still have high conviction, or should we at all maybe change our thinking on your tone at the Analyst Meeting regarding that aspect?

You know what, we still feel good about the fundamentals of the business. We also know what is ahead of us now, in terms of probably this road, and barring anything unforeseen, over and above we have been able to absorb some pretty big body blows this year, and not walk away from our guidance in a market when a lot of other folks have had to do that. So I think we continue to feel good. But we also want to communicate it puts more pressure on the organization, there is no doubt.

Fair enough. That is all I have got, guys.

Sure, thanks, Jeff.

you have a follow-up question from the line of Mike Weinstein from JPMorgan. Please proceed.

Hey, Mike, welcome back.

Thanks. I didn't know we were going to get back in queue. I guess that is a gift.

There you go.

For the early cut-off. Steve, I think some of the reaction that we are already getting to the call and the quarter is, one, people a little concerned that you sound a little bit less enthusiastic than maybe did you at the Analyst Meeting, or on the last call, about the state of the business because you are having to deal with the quality systems issues. How do you want people to walk away from here, as to your outlook for the business and the sustainability of the growth?

Sure. The outlook for the business, we continue to feel great. If you look through the number of questions we have gotten today, virtually all of them have been on hips, and they have ignored the most of them the seven franchises that grew at over 15%. We continue to think, if you look at our reported growth, this was just 12.5% local currency growth in the quarter. I don't think there are a lot of companies putting numbers up that are that good. And we feel very good, we feel great about our organizations. We feel great about the fundamental businesses. We have a challenge with the FDA, and we are trying to moderate and manage the expectations of that.

I would say, Mike, back to your point, and I tried to make it earlier, I think some people might have perceived us as being potentially further clear coming out of the Analyst Meeting than maybe we fully intended. And I want to make sure that, as you know, with us, we don't like surprising people, and we don't like, just being out, we are not out pumping our stock we are out running the business. Just want to be careful that people aren't running around saying, hey, they are completely clear, because we are not.

Again, we feel great about where we are headed. Certainly feel better than we did at the start of the year, but know we have a lot of work ahead of us. So hopefully that clears it up a little bit.

Let me just ask you one last one, because unfortunately this is going to get more attention than you intended tomorrow.

Yes.

All of the little back and forths on, you guys haven't repurchased stocks and it is because you had some things you have been considering, the whole discussion on that is going to prompt everybody to walk away from here, wondering whether you guys are about to execute some transaction of significance. Maybe you want to spend just 30 seconds on how you guys view M&A, and what criteria you put in place to think about any deal?

Sure. Let's try to be as honest as we can here. We looked at a couple of things in the quarter that in all likelihood we walked away from, but they were significant enough that it might have kept us from wanting to initiate the buyback, or being able to do the buyback. But nothing you shouldn't expect that we are about to go out and do some major acquisition or anything.

But there were some pretty obvious properties on the market in the quarter, that you can probably surmise that we might have been taking a peek at. But, yes, it shouldn't be, hey, Stryker is about to go do a big deal.

And your final question comes from the line of Michael Matson from Wachovia Capital Markets.

Hi, thanks for letting me get on with the follow-up question. I apologize. It is another hip question.

We have had enough of them, Mike!

I guess just in general, with your hip business, aside from the recall and everything, how much of the problems have been execution versus product related, and is it safe to assume that you have got things in the pipeline, new products in the hip area, that could maybe reignite the growth aside from resurfacing? And then just your thoughts on metal on metal, because some of the competitors, like DePuy and so forth, that are doing well, I think that is part of the reason.

Mike, those are great questions, and actually probably the first hip question I am glad got asked tonight. The quickest way we could accelerate growth in our hip franchise is to go metal on metal. I would tell you, we are still not completely comfortable with the science there, and we may have our heads in the sand. I think it is important for people to remember, we try to run this company for the long haul, and we are not going to just take the easy way out sometimes to accelerate our growth.

We are looking at, as you also know this can be our fifth straight year of single-digit hip growth. It will also be our fifth straight year of very strong overall top-line growth for the corporation as a whole. You can expect that we have other things in the pipeline. I would tell you there are some things that we probably would have hoped would have come out this year, that because of the distraction from the hip recall, it probably shifted into 2009. It is a bit of a bummer. We clearly were finally rebuilding momentum at the end of last year.

As you recall, we finally got back to double-digit growth in the fourth quarter, but this has clearly been a self-inflicted wound, but we do have some things that are in the pipeline, but for all the reasons of things get delayed and pushed back, and that is again why we don't like to talk too much about what is coming, and when they might be coming, lest we, because our track record is delivering is never perfect, relative to our internal expectations, but I think continues to be certainly strong enough to keep our total company growing at very, very healthy rates.

Okay. Then just one quick follow-up on that. Do you have a sense for what the global hip market is growing at on an underlying basis?

We think it is a lot slower than knees right now. But I think until the other folks report, we are probably not as completely, we feel it is definitely growing slower than knees, and it has probably slowed down a touch.

Thanks.

But again, we have got some self-inflicted stuff, so we never want to blame the market, but we feel good about knees, and good about the knee market.

All right, thanks.

Great. Is that it, Katie?

That is it, sir.

All right, great. I will just close by reminding everybody that again we do feel very good about the fundamentals of our business. We have got a lot of good things going. There are always a few things, as we mentioned to poke at.

We are working with FDA and working within our organization to continue to get stronger there, and just want to remind people there is work to be done there. But again, nothing like other challenges that we haven't always faced, and we will rise to that occasion. But don't expect it to be resolved in the next 30 days, is kind of I think what we are saying.

Our conference call for our third quarter 2008 operating results will be held on October 16th, and Dean and Katherine will lead that call. I will be back on in the January time period, when we report full year results and provide our guidance for 2009. So Dean and Katherine will handle that one. Thank you all very much.

Thank you for your participation in today's conference. You may now disconnect. Have a wonderful day.