史賽克 (SYK) 2008 Q4 法說會逐字稿

Good day, ladies and gentlemen. Welcome to the fourth quarter 2008 Stryker earnings conference call. At this time, all participants are in a listen-only mode. We will conduct a question and answer session at the end of this conference. (Operator Instructions).

Certain statements made in today's conference call may constitute forward-looking statements. They will be based upon management's current expectations and will be subject to various risks and uncertainties that could cause the company's actual results to differ materially from those expressed or implied in such statements, in addition to factors that may be discussed in this call. Such factors include, but are not limited to, further weakening of economic conditions that could adversely affect the level of demand for the company's products, pricing pressures generally including cost containment measures that could adversely affect the price of or demand for the company's products, changes in foreign exchange markets, 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, changes in reimbursement levels from third party payers, a significant increase in product liability claims, changes in financial markets, and changes in the competitive environment.

Additional information concerning these and other factors are contained in the company's filing with the United States Securities and Exchange Commission including the company's annual report on Form 10-K and quarterly reports on Form 10-Q.

Today's conference call will also include a discussion of adjusted net earnings from continuing operations for the fourth quarter and year ended December 31st, 2008 and the comparative year ended December 31, 2007. A discussion of these non GAAP financial measures, including GAAP reconciliation appears on the company's Form 8-K filed today with the United States Securities and Exchange Commission which may be accessed on the investor's page on the company's web site at www.stryker.com.

I would now like to turn the presentation over to your host for today's call, President and CEO of Stryker, Mr. Stephen MacMillan. Please proceed, sir.

Thank you. Good afternoon and welcome to Stryker's fourth quarter 2008 earnings report. With me today are Dean Bergy, our Vice President and Chief Financial Officer, Curt Hartman, Vice President of Finance, and Katherine Owen, Vice President of Strategy and Investor Relations.

As you are aware, Dean will be stepping down from his role as CFO at the end of Q1 '09, though we will continue to benefit from his considerable insights as he will remain as an adviser to our team. I would like to take this opportunity to publicly thank Dean for all of his support and leadership over the years. His contribution to Stryker has been considerable. We would also like to formally introduce Curt Hartman to the investor community. As many of you know, Curt is a long time veteran of the organization, having most recently run our very successful instruments division, and his operational expertise will play a critical role as we look to drive continued margin improvements and operational excellence going forward.

Turning to the review of our quarterly results, it's clear that 2008 presented us with unprecedented internal and external challenges, including a global economy that contracted sharply in Q4, the considerable and rapid strengthening of the US dollar, the Trident hip recall early in the year, $50 million to $55 million of incremental investment in compliance, and the Department of Justice monitoring costs. Despite these significant challenges, as an organization, we still delivered top tier results with our eighth consecutive year of double digit sales growth at 10.5% in constant currency, reflecting the depth and breadth of our diversified sales base that resulted in six of our eight key franchises achieving sales growth above 10% for the year.

Although our earnings per share growth for 2008 was below our original target, at an increase of 18%, we demonstrated our ability to consistently deliver robust earnings growth that compares favorably to our med-tech peer group even during an exceptionally turbulent environment, both internally and externally.

On a geographic basis, growth was again reasonably balanced with the US posting an 11% increase for the year, while international was up 13% reported and 9% operationally. Looking at Q4, US sales were up 7%, while international was up a solid 9% operationally, though it was down 2% as reported due to the substantial strengthening of the dollar.

Our diversified footprint remains a key competitive advantage as it limits the overall impact from a slowdown in specific divisions. During the fourth quarter, five of our eight key franchises posted double digit constant currency worldwide growth led by our stellar spinal franchise which was up 17% globally and a robust 20% in the US, despite very difficult year over year comparisons. Spine continues its multi-year track record of 20% or greater growth.

Globally, our knee franchise continued to gain share with 15% growth operationally while hips were flat operationally, recognizing the tough year-over-year comparisons. CMF and trauma were also strong contributors in the quarter, both up 12% operationally. In total, our orthopedic implant business was up 4% reported in the fourth quarter and 9% operationally.

As we detailed in our earlier press releases, the challenging economic environment placed considerable pressure on hospital capital budgets during Q4, which translated into slower growth for two of our MedSurg businesses. Though even here, the increasing strength of our diversified product line and geographic makeup came through. Specifically, while our endoscopy and medical businesses both declined modestly in the United States, east achieved double digit operational growth outside the US, thereby cushioning the impact of the US softness. Meanwhile, the biggest leg of our MedSurg business, our instruments franchise, achieved stellar US growth of 18%, but was actually soft overseas.

Overall, we believe our fourth quarter and full-year results speak to the strength of our unique footprint, which helps drive consistency in our sales and earnings growth by limiting the impact from a slowdown in a specific division while providing opportunities to enter adjacent markets. As a company, we have a history of delivering a steady flow of new products that both expand markets and drive share gains. Lastly, we continue to see opportunities for geographic expansion in all of our businesses, with particular opportunities for our MedSurg businesses outside the US.

With that, I'll turn the call over to Katherine.

Thanks, Steve. I'd like to provide updates on our compliance initiatives and (inaudible) new product launch in OP-1, all of which are topical items in our wheel house. As many of you are aware, we currently have three warning letters which drove our decision to undertake a comprehensive approach to compliance. These efforts, which include implementing a common set of quality standard throughout our company allow us to not only address the issues raised in the warning letters but are also galvanizing the organization around moving towards excellence in compliance. We invested an incremental $50 million to 55 million in 2008 in compliance versus 2007, and expect a 2009 incremental investment versus '07 to be in the $60 million to $90 million range.

During 2008, we had twice as many FDA inspections of our facilities compared to the prior year, and we' think we are demonstrating meaningful progress. However, we still have work to do as evidenced by the Q4 recall of one of our CMS products. This product was manufactured and supplied to us by a vendor that recently received an FDA warning letter underscoring the importance of our compliance effort which includes validating our vendors in order to improve product quality. 2009 represents year two of a three-year intensive compliance initiative, recognizing we expect to make ongoing investments beyond that time frame. Our goal for 2009 is to have successful reinspections of our facilities with warning letters and to achieve a compliance model that will drive greater operating efficiencies in 2010 and beyond. As is our policy, we will not get into any specifics regarding possible reinspection dates or confirm whether or not anything has been scheduled. Rather we'll report back to you in a timely manner pending receipt of tangible results from the FDA regarding our compliance program.

On the new product front, we wanted to highlight the recent launch of endoscopy's new 1288 HD 3-chip camera which was rolled out to our sales force in just the past few weeks. As those of who you have followed our company for some time are aware, fluctuation in endoscopy sales growth is primarily a function of new product launches, particularly when we introduce a next generation camera. The 1288 is able to capture images at a higher resolution via a 1920 by 1080p resolution which we believe yields a picture quality that is unmet by our competitors. In addition to the camera, we are launching our 26 inch HDTV wide wireless monitor which, in conjunction with the 1288, is the first HDTV wireless system in the surgical marketplace. The system delivers HDTV 1080p resolution in an untethered manner throughout the operating room.

Finally, endoscopy is rolling out its L9000 light source which is the industry's first surgical LED light source. The L9000 provides unmatched light output but it is cooler than xenon. In addition, it's eco-friendly and cost-effective in that the bulb never needs to be changed. Although we expect the current capital spending environment to limit the initial uptake for these new product launches, as we enter the second half of '09 and move towards 2010, we believe this exciting new portfolio of endoscopy offerings will be an important growth driver for the division.

For those of you attending next month's American Academy of Orthopedic Surgeons meeting in Las Vegas, we will be hosting booth tours where you can see new product launches including endoscopy's 1288 camera and related offerings.

Recording OP-1, on our last call we informed you that our PMA submission, including the additional prospective data we collected, would be reviewed by the FDA Orthopedic and Rehabilitation Devices Panel on February 3rd. Owing to scheduling conflicts, the FDA has since informed us that the panel will be rescheduled to March 31st, 2009 in order to ensure the appropriate personnel can be in attendance. Although there is still uncertainty recording both the outcome of the panel and the FDA's ultimate decision regarding the PMA submission, we remain encouraged that we will have an opportunity to present the broad data package. As has been our policy it would not be appropriate to discuss the specifics of the trial, including our decision to collect additional prospective data ahead of the upcoming panel, and therefore will not be making any additional comments regarding OP-1.

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

Thanks, Katherine. I'll start by discussing the considerable unfavorable impact that foreign currency had on our fourth quarter sales. The strengthening of the US dollar in the majority of our overseas markets reduced international sales by $68 million in the quarter, and reduced the company's overall sales growth by 4.1%. In the fourth quarter, the dollar strengthened approximately 10% against the euro, and weakened approximately 15% against the yen when compared to the prior year rates. Significant unfavorable currency impacts were also experienced in the UK, Australia and Canada. If currency rates hold near current levels, we expect the impact of foreign currency will decrease the first quarter 2009 sales by about 4.5% to 5.5% compared to 2008.

Now I'll spend a moment on the impact of price and volume mix on the top line. Selling prices were flat on a worldwide bases in the quarter, with domestic prices up slightly and international prices declining as a result of the April 1st, 2008 government reimbursement cuts in Japan. Japanese pricing declined 4% in the quarter. Volume mix growth was 8% in the fourth quarter which had one less selling day compared to the prior year. Volume mix was generally as expected for orthopedic implant products but volumes were off considerably for our endoscopy and medical business, particularly in the US. Overall, our domestic volume mix growth was 7% in the quarter and international volume mix growth came in at 10%.

Now I'll turn to our product categories, starting with orthopedic implants which represent 59% of our sales. Sales of orthopedic implants grew by 4% in the fourth quarter on a reported basis and 9% in constant currency. Keep in mind that the fourth quarter includes one less selling day versus 2007, so on a sequential basis, constant currency growth of 9% compared well with 10% growth last quarter, a period that included one additional selling day.

We provide the sales growth rates by product line in our press release and I'll reference those as I provide more detail on our product performance. Starting with hips, they were down 6% in dollars and flat operationally in the fourth quarter. Hips slowed a bit this quarter, but this was expected given one less selling day compared to last year and a tough comparable of 10% US and 8% worldwide constant currency growth in the prior year period. US hip sales were flat in the fourth quarter. Incremental Cormet hip resurfacing sales, as well as growth in restoration modular hip revision products, were offset by declines in other hip products. Year-over-year, Trident sales were flat in the quarter compared to declines in previous quarter.

On a sequential basis, US hip sales were up mid single digits versus third quarter levels. European constant currency hip sales declined slightly in the quarter. Accolade X3 polyethylene and restoration modular hip revision products each had solid growth, which was offset by declines in other hip products. In Japan, hip sales declined at mid single digit levels on an operational basis due to the government price cuts and the impact of one less selling day. Volume gains were in the low to mid-single digit range led by Exeter. Local currency sales in the remaining international markets increased mid-single digits in the quarter with specific posting the best results in these markets.

Turning to knees, they grew 9% in dollars and 15% in constant currency in the quarter. Knees had an excellent quarter with our domestic business again leading the way. US knee sales growth came in at 16%, the 36th consecutive quarter of double digit knee growth domestically. Primary knees posted low double digit level growth led by Triathlon. Revision knee growth, paced by our Triathlon TS revision product, was again extremely strong and we continued to benefit from building sales of the Triathlon PKR product.

European knee sales were down slightly operationally, partially as a result of one less selling day. Growth in Triathlon products was offset by declines in other knee systems. Japan posted mid-single digit operational declines in knees after considering the impact of the price reduction. Our Pacific knee business posted sound results in the quarter, led by Scorpio, and Canada and Latin America and knee sales increased mid-single digits on an operational business with growth led by Triathlon of Canada and Scorpio in Latin America.

Turning to trauma, that was up 9% in dollars and 12% in local currency this quarter. Our trauma business had a very solid quarter led by the US. Domestic sales growth was 18% and would have been 14% if military sales were excluded. This was an excellent performance when considered against last year's 24% fourth quarter growth. Sales of Gamma3 Hip Fracture, Hoffman II External Fixator, VariAx Distal Radius and Foot Plating system products led our US trauma growth.

International trauma sales were up 8% operationally in the quarter. Europe posted constant currency growth just shy of double digits. In Japan, local currency trama sales in the mid single digits. Pacific led the remaining international trauma businesses, posting growth above 30% operationally. On a product line basis, international trauma sales were again paced by growth in upper extremity and foot and ankle products.

Spine grew 15% in dollar and 17% on an operational basis in the quarter. Spine franchise had another excellent quarter with the US again leading the way, and the international operational growth reaching double digits for the second straight quarter. US spine sales grew 20% against an exceedingly difficult prior year comparable of 32% growth. Domestic spine growth was led by inner body and Thoracolumbar products.

International spine posted operational growth of 10% led by Thoracolumbar products. On a geographic basis, Europe grew at mid teens levels on a constant currency basis while Pacific and Japan grew at mid-single digit levels operationally. Then last on this product set, our CMF business was up 8% in dollars and 12% in constant currency in the quarter, and CMF had a very solid quarter. Domestic growth of 13% was based by sales of maxillofacial and neural products. And international local currency sales growth came in at 11% but benefited from a very easy prior year comparable.

Now turning to our MedSurg group. As you know, this represents 41% of our sales comprised of three significant product categories -- instruments comprising 18% of total company sales, endoscopy 14%, and medical 9% to come up with that total of 41%. As has been well publicized by now, our MedSurg group had a mixed quarter. On the plus side, instruments had an excellent quarter in the US, and endoscopy and medical did well internationally. However, these performances could not offset the impact that US hospital belt tightening had on our domestic endoscopy and medical franchises, as well as softer instruments quarter outside the US. MedSurg sales growth was 3% for the quarter on a reported basis and 6% on an operational basis.

Touching briefly on the product categories here, sales for our instruments product line were up 9% for the quarter on a reported basis, and 13% operationally. Instruments had a very strong quarter in the US with sales up 18%. International sales growth was softer as a result of the ramp up of shipments of our System 6 heavy duty power tools to overseas markets following a late third quarter voluntary recall of that product. Endoscopy's fourth quarter sales were down 5% in US dollars and 2% in constant currency. Endoscopy was hurt by both the significant falloff in capital demand and the state of its own product cycle with the new 1288 HD camera and related video products launching in recent weeks.

Domestic sales declined 7%, with video down significantly. International sales with 15% operational growth did not experience the same slowdown, albeit on a smaller base. And then our medical business grew 4% in the quarter as reported, and 7% in constant currency. Medical declined 2% in the US but had an excellent quarter overseas. Domestic sales saw modest growth in EMS products offset by declining net sales. The international business for medical grew over 50% operationally on a small base.

Now I'll turn to the remainder of the income statement beginning with gross margins. Fourth quarter gross margins declined 80 basis points compared to 2007, primarily as a result of the costs for internal and external resources working out our compliance initiatives. Margins were also negatively impacted by higher freight costs. Research and development spending was down 2% in the quarter. It was up 8% on a sequential basis to reach 5.8% of sales in the quarter, a high watermark for the year, and in line with our budget on a gross spending basis.

Selling, general, and administrative costs decreased 2% in the quarter primarily as a result of reduced discretionary spending partially offset by increases in sales-related costs. Selling costs include compensation and instrument amortization costs, and again grew below the rate of sales growth due to slowing instrument amortization. During the fourth quarter, we decided to simplify the structure of our Japanese distribution business and to substantially reduce development efforts associated with Sightline Product Technologies acquired in 2006. As a result, we recorded a $35 million pretax restructuring charge in the quarter which reduced net earnings by $22 million or $0.05 a share. Excluding the impact of this restructuring charge, adjusted operating income increased 12% in the fourth quarter, and adjusted operating margins increased 23.6% of sales.

I'll provide a quick breakdown of other income and expense for the quarter. That was made up of investment income of $19.9 million offset by interest expense of $8.3 million and a foreign currency transaction loss of $1.8 million to get to the total other income of $9.8 million in the quarter.

The company's effective income tax rate was 26.9% for the fourth quarter 2008, and 27.4% for the year, in line with the rates of the third quarter. With the restructuring charges excluded, the effective income tax for the fourth quarter was 27.9%, and the annual rate was 27.6%.

As indicated in our press release, we initiated and completed the previously announced share repurchase programs. In total, we repurchased 17.4 million shares for $1 billion.

Turning to the balance sheet, our balance sheet continues to be very strong and I'll briefly discuss certain key asset management areas. Accounts receivable days ended the year at 59 days. This represents an increase of three days compared to the prior year. This metric has been 59 or 60 days all year, and we believe this represents excellent performance given our geographic footprint. Inventory days finished 2008 at 155 days, down nine days sequentially but up 18 days versus the prior year. A number of factors including our compliance initiatives and the fourth quarter sales slowdown have left this metric a bit higher than we would like.

Then, last I'll end with some brief commentary on cash flow. All in, we had another very strong cash flow year. Cash flow from operations for the year grow 14% to $1.176 billion, and free cash flow was up 22% from $841 million to $1.029 billion, slightly above the amount used to repurchase shares during the year.

With that I'll turn it back over to Steve.

Thanks, Dean. Before we open it up for Q & A, we'll touch here on our outlook. As we look at 2009, we are facing both challenges as well as opportunities. We are assuming hospital capital budget pressures will continue and foreign currency remains volatile, clearly creating more uncertainty than at any time in recent memory. In addition, elective procedures may see some slowdown and we'll continue to make ongoing investments in compliance.

We know many are wondering how certain we can be in developing our plans and guidance for the year. And the truth is, it is hard to have a high degree of conviction given the environment. Against this uncertain backdrop, we are focused on what we can control, especially our costs. On the positive side, we continue to see strong momentum in many of our businesses knees, as knees, spine, trauma, as well as our CMF implant businesses are well poised to maintain their above market growth. And although MedSurg will see pressure in 2009, we remain confident in the strength of the core portfolio of products, as well as our opportunities to leverage these franchises outside the US. Additionally, our hip franchise, after under-performing throughout 2008, is set to deliver improved growth, helped by new products, while our endoscopy franchise is entering a major new product cycle.

We are also extremely focused as an organization on leveraging our P&L via cost controls. Combined, all of these factors were key considerations as we developed our budget for 2009. As stated, we expect to deliver 6% to 9% constant currency sales growth in 2009 and 10% to 14% EPS gains to $3.12 to $3.22 per share as a range.

Speaking candidly, we've had a number of comments from investors over the past two weeks who feel we are overly optimistic in establishing these goals. Maybe so, but those of you who know us well understand that our DNA is wired to set the bar high and achieve results that do stand out over time. So once again, we are setting aggressive goals, but we will be closely tracking the environment and our actions to deliver against these goals. We're not simply going to take a pass on 2009 because it's a challenging time.

It's important to recognize that results will be stronger in the second half, as the hospital capital environment, the impact of currency, our investment in compliance and the lower investment returns are expected to limit per-share earnings growth in the first two quarters to the mid-single digit range.

Despite the currently challenging and uncertain economic environment, we believe we are well positioned to deliver meaningful growth in 2009 and beyond. As we move past 2009, we'll continue to make significant investments in compliance but we'll benefit from P&L leverage and decreasing one-time costs. We also expect to begin to realize the benefit from efficiency initiatives, including vendor consolidation, streamlining back office functions, and procurement. And although FX is always an unknown, we would expect that the swings in currency will be more in line with historic norms versus what we have experienced in recent months, and for hospital capital spending to eventually normalize, leading the hopefully even stronger results.

We'll now open it up for Q&A, and hand it back to you.

(Operator Instructions). Participants are asked to limit their questions to one question and one follow-up. Your first question comes from the line of pob Hopkins of Banc of America Securities. Please proceed.

Hi, thanks. Can you hear me okay?

Yes, Bob.

Great. Good afternoon. First, just on that comment that you made around guidance in the philosophy and the DNA of Stryker, I'm just curious, couldn't you have higher goals internally than the guidance that you give to Wall Street?

Well, Bob, we've always tried to have internal and external goals that align. Frankly, a lot of it comes down to we set our sales targets, our aggressive targets for our people, and we want to maintain ourselves to the same standards. We like having the same goals internally and externally.

Okay, just an IR question there.

We could probably be more conservative but it's just not us.

So if I look at the guidance that you gave for '09, it looks like you're assuming mid to high single digit growth for MedSurg. Number one, is that right? And number two, since you gave that guidance, maybe roughly three, four weeks ago, have the trends you're seeing at hospitals stayed the same, gotten a little better, gotten a little worse?

Overall, we haven't seen any real change in the trends over just the last few weeks. We're obviously staying very close to them and I think ultimately, we'll know a lot more I think after the first quarter comes through.

Am I right about what you're assuming for MedSurg somewhere in the single mid to high range for that overall MedSurg business?

As you know, we don't give too much specific guidance to that effect but I think that's in the range.

Bob, just as a follow-up, keep in mind, given that the year is back end loaded, part of that is going to be more of a MedSurg phenomenon.

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

Thank you. I have ten questions. I'll try and narrow it down here. First off, thank you for the candid comments, Steve. They were all appreciated. Let me do follow up, though, on some of the questions that Bob was asking, and I think we're interested in the way the macro environment is evolving and impacting businesses. Your orthopedic business held up very well, at least the industry held up very well. And your knee business held up very well in the fourth quarter. Are we seeing any drop off in procedure volumes in your mind in the first quarter? It's obviously just a few weeks into it, but any thoughts that maybe procedures were pulled into the fourth quarter, people were trying to use up their FSAs and trying to take advantage of their deductibles if they hadn't worked through them already?

You know it looks over the last few years like that's increasingly happened, and I know you've been looking at the seasonality of that. We're assuming some of that, but again it is pretty early in the quarter. I think overall, for all the talk that's out there about procedural slowdown, you certainly see some pockets, I don't think we see anything dropping off the face of the earth here.

I would just add there's two things going on. The slowdown and the capital spending cycle is very real and we've got a lot of data points obviously to bake that into our expectations. The elective procedure side is more something that we considered in our budgeting as a possibility as opposed to anything that's showing up in any clear way right now that you could draw any trend. So so far, Q4 was very much in line with historic norms recognizing a little bit tougher comps and one less selling day.

Let me ask two other questions. One, Katherine, you described the compliance initiative as being in year two of a three-year initiative. I don't think I've heard you guys describe it that way before where this is a three-year playout and we're now entering year two of it. I want to make sure we're thinking about the spend levels as we go from 2009 to 2010 correctly. Obviously it's still early in that process but I want to make sure we're thinking about that right.

And then second, I want to come back to the question of use of cash. You said you guys bought back $1 billion worth of stock which is obviously a very sizable amount. When we talk about use of cash from here, do you have an authorization in place to repurchase additional stock if you chose to do so? Thanks.

That was sort of two questions --

That was more than two. I tried.

A good process, I'll give you that. I guess a couple of points. On the first one, we did talk a couple weeks ago about the compliance program that 2009 was year two of a three-year cycle or a three-year process. It's going to go on beyond three years, but the primary key investments, the major investments we're making across the organization we have laid out in a three-year plan. And so year two was really the peak investment year spend of that three-year. We'll have more costs next year, but in terms of incremental investment, the hope would be they would not be above 2009 levels. Then beyond that we'll have ongoing investments with these kind of one-time costs that are captured in this three-year time frame. That's what we're talking about in a two out of three-year initiative.

On a cash, Mike, we do not have an additional authorization in place. Certainly, it's something that could be used. Our preferred use of cash would continue to be acquisitions first and obviously we've got a number of things that we could potentially look at there.

Thank you, guys.

Thanks, Mike.

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

Raj?

Sorry about that. Had the phone on mute. I was curious if I could ask a little bit about the Department of Justice. My understanding is the monitoring initiatives are going to end here at the end of the first quarter or early in the second quarter. How should we think about that? Are you expecting a major change in anything should that monitoring come to a close? And is there also a possibility that it won't end then and might it get extended further?

I don't think we have much evidence that would suggest it's going to continue on, but I think there has been a fundamental shift in this industry. I would expect not significant changes afterwards. I know there's some investors out there that think okay, gee, all of a sudden it's going to be the Wild West come April 1st. I think we've all learned that that would not behoove us to be going in and changing. I think most of the companies have really put in much more rigorous systems in terms of needs assessments and everything else. There probably won't be much change.

Okay, and then if I could just ask one on the SG&A. The margin in the quarter was quite good, I think it's the best we've seen for a couple of years. I think you in the past talked about there being a lot more margin there still. 38.2%, are we looking at that number declining significantly again here in '09? Or just thoughts on where that number could actually get to over time?

Sure. We probably don't necessarily have a target of going down. I would say the way we're thinking about it right now is in the good times when we were really generating clearly solid double digit growth, we kept saying we may be making additional investments, additional sales force expansions, other things. I would say what you saw in the fourth quarter is we got wind, particularly that last week of October, when we saw orders not typically come in, we reined things in pretty tightly. We've got enough resources on the ground that continue to drive us here for awhile but our typical head count expansions and some of that stuff we've really reined in. So I think the fourth quarter is probably a signal of more things to come here in the first few quarters until things pick back up.

If I could just add to that briefly. I think obviously, we said there could continue to be some gross margin pressure. So I think it's fair to say for the year that you could see SG&A still down. We've still got some room there. As Steve said, we also want to be sensitive to where the business is. Keep in mind on a quarterly basis, usually the first quarter is a higher SG&A quarter ,and although I would expect it to be down year-over-year, I would not use the fourth quarter as a proxy for what you're going to see in the first quarter in terms of percentage of sales spending.

Your next question comes from the line of David Roman with Morgan Stanley. Please proceed.

Thank you for taking the question. Just, Steve, looking across the different businesses, there were several areas where you posted growth way above market rates. Can you talk a little bit about what's happening in either the knee market or the instruments market about what's driving the outside growth? Is it volume, mix, share gain, et cetera?

Sure. I think within knees it's all of the above. Clearly our Triathlon knee has, I think, by all standards, turned out to be a great, great knee. And we continue to gain new customers on that even well -- we're into what? the fourth year of the product life cycle, and the accolades on that continue to be very strong. So I think we're feeling great about that.

I think our instruments business continues to bring new products out and expand essentially our share of the operating room. I think it's why we continue to be underlying -- have a lot of bullish feelings despite the current challenges, that there is still so much opportunity and so much underlying momentum in a number of our businesses that even if the markets slow down a few points, we should still be able to post half decent growth. It won't be up to our historic norms but it'll still be solid by probably most people's measures.

Okay, then on the $60 million to $90 million spending for next year or that you're on quality, could you give us some sense how that flows through the P&L, maybe some trajectory on gross margins and SG&A for next year?

Sure. Dean, you want to take that?

Sure. Yes. The majority of those costs will go through the cost of sales line. So again, as I said, I think that on margins, we would expect them to be flattish to down slightly as a percentage of sales for the year, although obviously for the first quarter, they're going to be down from what was a very, very strong first quarter in gross margin in 2008. In SG&A, as I said, I think we do have some room to continue to see that come down as a percentage of sales, maybe in the 50 to 100 basis point range year-over-year for the year.

Again, we ask that participants limit their questions to one question and one follow-up. Your next question comes from the line of Bruce Nudell of UBS. Please proceed.

Thanks. Steve or Dean, could you speak just generally to the differential performance in the MedSurg categories? Is it just the size of the CapEx expenditure that hospitals have to make that explains the differential performance? And looking out into '09, because this is a tough to model space, could you just, at least qualitatively, contrast what we've seen this quarter, at least relatively amongst the groups? Will that extend, in the MedSurg groups, will that extend to 2009?

I guess a couple of points, Bruce. You are correct in that certain of the businesses, medical being the most, instruments being the least, are more capital intensive than others, with the overall split still being in that 60/40 range. So that certainly has an impact. I'd also layer on top of that, though, endoscopy which actually saw the greatest pressure, was also coming towards the tail end of product life cycle. As we showed before that you see most of the volatility in endoscopy's growth has historically been tied less to capital budgets, more so right now given the environment we're in. But it's very much impacted by new product launches. And when we launch a new camera, like we just did a few weeks ago, that has a bigger impact traditionally. So it really had two factors weighing on it, one throughout most of the year and then certainly in the fourth quarter, compounded by capital budgets.

Specifically looking at endoscopy, which was down 2% operationally, and patient handling, which was 7%, are those representative of the run rates we might see in this extraordinary period? Or would you expect improvement in endoscopy at least towards mid-single digits or even higher?

We're not going to get into line item detail in terms of the projection for the full year. We did make comment that you should expect ortho to be stronger obviously than MedSurg. MedSurg will be more back end loaded. We do expect growth within the MedSurg business throughout the year. I wouldn't necessarily read too much into the fourth quarter. There's differences quarter to quarter in terms of year end capital budgets, seasonality, timing of product cycles, year-over-year comparisons, all of which will have an impact on the growth rates.

We would expect endoscopy to be more back end loaded partly because of the capital budgets but also because of the comp that will happen in the fourth quarter 2009 and the gradual benefit it will realize from the product cycle launch with the endoscopy 1288 camera and the related products. Beyond that we're not going to get into too much granularity. I think the good news is we're able to track what's going on with capital budgets a lot better. We've got a lot more information from our key customers. We get that on a weekly basis now. Things have not continued to deteriorate rapidly but it's obviously not at a point where capital budgets are improving. That's the environment we're in. But I would not necessarily extrapolate Q4 rates into Q1.

Your next question comes from the line of Ed Shenkan with Needham & Company. Please proceed.

Thank you. Just wanted to ask you, your comment that you said elective procedures may see a slowdown. What areas might you expect to see the slowdown first? Would it be domestically, internationally? Would it be hips, knees, or spine?

The short answer is don't know. We're talking about something we're not sure is going to happen. I don't think there's a big difference between hip and knee procedures in terms if you're going to make a decision to delay a procedure, I'm not sure it's different whether it's a hip or knee or spine. They're all elective to a degree. But the reality is patients with this kind of debilitating pain really have to have the procedure done. So, could we see a quarter or two where there's a slowdown in any one of these three buckets because people are concerned about co-pays or taking time off work? It's entirely possible. We think it's prudent to assume that in some of our budgeting which is why we did come out with a range, and you could make assumptions as to what's at the lower end of that sales range.

The US versus overseas, there are some differences, obviously nationalized healthcare and what some of the spending will do. I think the bigger issue is probably domestic but I wouldn't assume it's completely different. Beyond that, it's hard to give you granularity as to which procedure may see a slowdown before a different one.

Does the average age for the procedures, do you think that would make the impact compared to if it's a Medicare procedure, maybe it's less at risk?

It really depends. If you're a Medicare patient, you're going to have anything from nothing to a couple thousand dollars of out-of-pocket expenses depending on what type of additional coverage, Medi-gap coverage, you have, or whether or not you have already had a procedure done during the year that's going to eat up that. On the private side, which is probably another big chunk, obviously, not the majority, it's really going to depend whether you are inside your provider network, outside of it. The magnitude of co-pays vary dramatically. Do you opt to have this procedure done if you are one of the two million people out of work right now before your COBRA goes away. There's a lot of compounding factors right now that I don't think you can make a big determination whether or not, if the slowdown happens, if it will be Medicare or non-Medicare specific.

Last, is it then in your guidance that there would be a slowdown, or is that not part of the guidance?

What we've tried to reflect in the 6% to 9% revenue range is assumptions at the low end, which obviously assume a tougher capital environment, and have taken some appropriate cautious guidance around elective procedures. And then there's the high end of the range. We've made assumptions into both that's captured in that 6% to 9%.

The simple perspective here is, look, we just grew 11% local currency in 2008. We're saying the low is 6%, almost half that in 2009. So hopefully that should frame in. Our 6% to 9%, remember, is a significant haircut from what we've been doing over the last few years. The additional uncertainty. There's uncertainly. We can't tell you exactly by quarter which business is going to do exactly what. And, by the way, even in our best years, remember, when we go back and look at our final results for a year, it doesn't exactly mimic by quarter what we predicted for every business, but collectively our diverse footprint always seems to come through. Some of the businesses come in higher, some are a little lower. Again, I think we're trying to manage it as we can here.

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

Thank you. Could you tell us what you're assuming for foreign exchange headwinds in 2009?

It's going to be all over the places.

I mean in your guidance, though, in the 6% to 9%.

It's in the press release.

The 6% to 9%, Joanne, is constant currency.

That's constant currency.

Understood. Is it 300 basis points of FX headwinds, 300 basis points? That's really what I'm asking.

There's an unfavorable impact of 3.5% to 4.5% that we would assume would be a headwind given the current rates. And, again,. that's a reduction of that 6% to 9% constant currency growth.

Okay. When you take a look at your spine business, it's growing above the market growth rate. Could you give us an idea of what is driving that growth, and could you also give us an update on artificial disks. Thank you.

What's driving it is great product and great salespeople. We think we've quietly built an incredibly strong sales organization and we've fed them a lot of new product innovations over the last few years. We really rounded out the bag. It's a dynamic team that we have there with a lot of momentum. We expect that to continue.

On the artificial disks, we're essentially waiting for the the FlexiCore. We're in the process of hopefully having that on the market, potentially later this year. It's in with FDA going through some of the inspections and other stuff. ServiCore I think we're still thinking is later on in 2010.

Yes.

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

Good afternoon. A quick question on the capex changes that you're seeing. When you have the dialogue with the hospitals, what are they saying is causing them to delay the purchase? And what are they waiting to see to reconnect and purchase a new suite or some new products on the Cap Ex side?

It varies all over the place. There are some hospitals that had their bond offerings go through, and, frankly, they're in pretty good shape from a capital standpoint. Our job is to find more of those. There are other ones, what's really happened in a lot of cases is really in that October time frame, a lot of the CEO were looking around, whether it was their endowments or their capital budgets in general, and just starting to put in either arbitrary cuts or arbitrary holds, and it literally is all over the map. We're getting weekly updates from our teams in the field, particularly in the US and they just are all over the place in terms of how long they expect them to continue, what level they're at in terms of how far down they're going. I think just in general we're assuming there's going to be less capital spent certainly in 2009 than what people would have been planning six months ago.

Having said that there's still going to be money spent. I think our job is, if you look, if you look, I think six out of our eight businesses, probably seven out of our eight businesses, we've been growing at faster than the market last year. Our charge to our teams is there's still going to be money spent. We've got to get more than our fair share going forward.

But no single event or anything we're waiting for?

I think in general, too many people are looking for single events. I think it's going to ultimately, let's face it, housing will come back. Jobs are going to continue to get worse. It's just a hard time to plan. I know we'd love to give you more definitive answers on a lot of this stuff. Anybody that's giving you definitive answers I don't think knows what they're talking about.

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

Hi. I had yet another question on the hip business. Steve, I think you mentioned that you're watching some new products there. I was wondering if you could tell us what those products are? And if not, I guess one of them that we're aware of is the Tritanium Cups. Just wondering on the timing of that launch and if there's any additional instruments that will have to be placed in the field? In other words, how quickly can that really ramp up?

Tritanium is really ramping up now. That is what we're talking about particularly, and that was a fourth quarter launch rolling out and starting to get some traction. I would also tell you I think our sales force has been so focused on knees because we've been having so much success there, I think part of our hip business has lagged a little bit from that. But I think Tritanium will get folks talking about hips again a little bit. We're not going to generate the kind of growth that we'll have on knees this years, but it should certainly start to pick up.

Okay. And then just with regards to the guidance range for EPS, how much would currency have to move before it would push you out of that range?

Dean, beyond what we put in the release, largely would you say?

Yes. Obviously, we've gauged our guidance around the FX numbers that we've put in the release, and so I think you can naturally assume that movements outside of that could potentially impact it, but there's a lot of factors that go into that. Right now, we've assumed the negative impact on our FX for the full year would be the $0.10 to $0.15 range generally.

The only thing I'd add onto that is I wouldn't make any huge conclusion if currency rates move demonstrably outside of that range if that happens because this is a big company with a lot of items that are fluctuating whether it's commodity prices or legal costs, or whatever it is. These things can't really be isolated, and assume that movement and isolation you can draw down and that means extra earnings.

Yes, and I think the other thing that's fair to say in that regard is there's a lot of currencies that are moving here. I referenced, the British pound, the Australian dollar, the Canadian dollars are all currencies that are also moving around here. When you look at all the cross currency impacts, it's actually very complex in trying to put your arms around it.

All right. Appreciate the clarification. Thanks.

Your next question comes from the line of Matt Miksic with Piper Jaffray. Please proceed.

Hi, everybody. Thanks for taking the questions. I have two and I do have a clarification I'd love to try to squeeze in here, Dean, on one of your comments during the call. The first going back to the stop, Steve, you had talked about guidance and having some conversations with some folks on the street who don't think that you're going to be able to hit your guidance, or feel that you're maybe being overly optimistic. Can you talk a little bit about where are you being optimistic that the street is not, do you think, or investors aren't, or where do you think that the strength is going to be potentially, areas of upside that maybe we're not understanding?

Sure. I think to me the big picture comment is people saying, "Hey, everybody's writing off 2009, why don't you guys do the same?" Again, it comes back to the fact I think we've got a lot of positive momentum. The biggest piece is I'd give you this. Think about our MedSurg businesses. Yes, we're going to hit some capital hiccups here in the United States. We've been making efforts to expand that business outside the United States. And frankly, those businesses are still roughly, three-quarters of those businesses today are in the US. We have very low market shares outside the US. Now is the year that we hope that some of what we've been doing over the last couple of years will help us to effectively cushion some of the downside.

I think you saw that in the fourth quarter. When we put out our, I think when we put out in mid-December our update on the numbers for the fourth quarter, I think everybody thought MedSurg was going to fall completely apart. And if you looked at it, yes, we had two businesses that were negative in the US in the quarter but they both had double digit growth outside the US. So it gets back to, in any given quarter, we always have a few things that surprise us on the upside, either geographically or by franchise, and invariably we have a few things that disappoint us. But collectively, the numbers still seem to come through pretty well that we're growing at or above our markets in virtually every area.

Okay. That's helpful. Second question, and again, I do have one clarification I'd like to sneak in. The second question is that on this hospital spending front, Katherine, you mentioned a lot of data points, a lot of people recognized there's pressure there. I'm trying to understand, and it'd be helpful if you could shed some light on, to what degree is, there's a certain amount of belt tightening and cash conservation that's going on at hospitals. But then there's also this element of just new hospital construction that has been put on hold or stopped or significantly curtailed. So I'd love to understand to what degree those drive your business and then also to what degree maybe they are a factor going forward, US as well.

Matt this is Curt Hartman. Let me try to take a stab at that question, just stepping out of an operating business. Certainly at the street level we are focused on existing hospitals as well as new construction opportunities. Given the current environment, some of those new construction opportunities have obviously slowed down. But you have to keep in mind that the procedure volume that's out there that creates the wear and tear on equipment has not fundamentally disappeared. It may slow slightly, depending on elective procedure trends, but that use of equipment, that constant cycling of equipment does place an emphasis on new equipment replacement and purchases. Certainly we're going to pursue that as aggressively as possible even if new construction segments of the market do slow down.

And on the OUS side of this, to Steve's point, right now, I recognize you're building out that side of your business, particularly in beds, for example, is that at risk down the road? Are we concerned at all that the US has a capital spending problem now and that may go overseas in the next six to 12 months?

I don't think we would say it couldn't go overseas. I think what we would say, based on Steve's comment was, our percentage of MedSurg that's outside the US is fairly small at this time so any slowdown there should not have an overly meaningful impact on our results. And frankly, we see more opportunity there because we have so much opportunity to go capture market share.

There may be penetration that's in your favor there. The last point just to clarify, Dean, you made a comment during your talking through the P&L about slowing instrument amortization expense easing on the SG&A line. Could you just explain that?

Yes. The instruments are basically, the instruments that we buy and provide to generally hospitals to support orthopedic implant procedures, and the timing of our spend there just tends to revolve around not only the cost of the instruments but also the timing of launches of products. Just given where we've been, when we had the Triathlon launch, we had a significant bolus of instruments that went into the field, and that was a huge launch. In relative terms, we've been able to control the level of instruments that went into the field at a slower pace in the last couple of years and therefore that rate of amortization on that number started to slow down.

Great.

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

Afternoon, everybody. A big picture question and then an operating question. On the acquisition front, Steve, should we think, given the greater availability and possibly more attractive pricing that acquisitions or an acquisition is more likely this year, or is it less likely given all of the challenges you're facing and preferring to focus internally?

Probably more likely, Rick, because we like where valuations are coming. Having said that, we continue to be in a real good position of strength with our underlying business so we're not going to race out and just jump into something. We like where the valuations are moving, frankly, and like having the cash that we have right now.

And, back to MedSurg, on the OUS instrument front, I'm not sure I picked up -- if you mentioned it, I apologize if you did -- OUS was down, I think 8%, reported or operationally. Just can you remind us what's going on there and what and when you might turn that around?

I think it's a one-quarter blip it looks like. Our European business had a great fourth quarter '07. And I think they fell asleep at the end of fourth quarter of '08. We also did have, as I think Dean mentioned, a recall on System 6 that affected us at the start of the quarter. So we didn't quite make that back up. But we're back in business there. So nothing I think to be too concerned about.

So back to more normal performance?

Yes.

Thank you.

Thanks, Rick.

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

Thank you. Good evening. Steve or Dean, wondering if you could talk qualitatively just on flexibility on the expense side of your model. How low could constant currency growth go before you'd really start sweating out maybe the lower end of your EPS guidance? And I don't expect a direct answer there but maybe just qualitatively if you could frame that for us?

I'll let Dean handle that one. I sweat over everything.

Well, obviously, we've given you ranges, and we feel comfortable with those, but we know that there's probably as fluid a market as we've ever been in. We're going to have to manage our business. But as Steve said throughout his comments, we take our objectives and go over it very very seriously in this company. I think you should assume that's going to be the case and obviously going to be managing the business as we go through the air.

Fair enough.

We're more focused on cost than we've ever been yet it's a fine line because we still have a lot of growth. We don't want to choke off additional growth. So what we're trying to do is stay very close to our key leaders around the company in terms of managing our costs but also investing where we still have the opportunities to grow. But really paying much close attention to details right now.

Understood, Steve. My question is more, is there anything in the bag where we could cut this back if we absolutely have to but right now we're not going to necessarily unless we need a few more pennies to bottom line, something like that?

I would say from a big picture perspective, no. If the environment continues to worsen dramatically, I think you'll see a whole host of companies re-evaluating priorities and costs. Right now, we feel good that based on everything we know, recognizing there's uncertainty, the 6% to 9% range marries up pretty well with 312 to the 322 that we've outlined.

Fair enough. And then just a clarification, Dean. Shipping rates, commodity costs coming down on that, is that more of a back end of the year type benefit that we might start to expect to see a little bit?

It's always possible. Freight rates, as I mentioned in my overall comments, stayed pretty high in the fourth quarter and we hope that, shipping costs and commodity are things that we can start to squeeze down in appropriate reaction as we go throughout the year, but probably not necessarily starting the year there. People tend to try to hold on to increases that they've gotten there and it's our job to work them down.

Understood. Thanks, guys.

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

Good afternoon. It looks like things like the Sunshine Act and some other government initiatives to increase price transparency and in general control healthcare costs are maybe gaining a little bit more momentum heading into the year. There's also been some new data points, albeit somewhat anecdotal, suggesting that hospital administrators are gaining some traction in managing implants and vendor selection. I was just curious if you have any thoughts on any of these dynamics and specifically what pricing assumptions for recon are incorporated into your guidance?

Doug, we're facing these pressures all the time. They've been building over the last few years. We continue to deal with them on a daily basis as we go through things. The Sunshine Act, remember. is focused more on disclosure of physician payments as opposed to pricing. There's obviously a link back. We certainly see the hospitals more focused here. We continue to try to bring value to the game. And the last couple years, we've effectively had 0% price increases around the world, and see that continuing to be pressured.

Okay. And a second question. And it may seem a bit silly given what we know is going on in terms of the hospital capital spending environment. You did mention that endoscopy also struggled in part in the fourth quarter because maybe anticipation of the launch of the new product line. If so, is there any chance there may be at least a smidge of pent-up demand for some of those products heading into the first quarter?

It's a very good question. There's probably a smidge. I think in any other year, I would tell you any other year with the product line we just launched in our endoscopy business, our endo business would grow 20% this year. But there is such wide variation right now that even if there is a little pent up, we're being cautious in assuming it's going to be really slow coming out of the gates.

Thanks for taking the questions.

Thanks.

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

Hi, good afternoon, thanks for taking the question. I just wanted to clarify to, on the warning letters, did you say you expect to have them resolved in 2009, or just your facilities ready for inspection in 2009?

The goal would be to have them resolved in 2009.

And then just more big picture. I think your 2010 and beyond goals that you outlined a couple weeks ago, were for about 10% cost cost in currency, and 15% (inaudible). Do you feel like you have the right mix of business right now? How important will acquisitions be to furthering those goals? And what gives you confidence that what we're seeing in the market with pressures from Cap Ex will be more of a one-year phenomena?

I think we do feel good about our mix of businesses today that we'll be able to deliver that in more normative times. The hospital CapEx stuff, it's going to come back. The other part is, even with hospital capital expenditures slower, there's still a lot of spending going into healthcare. And we still have very low market shares. There's still significant opportunities for us to, frankly, take share in every market we compete in. I think that's what has us feel good.

Having said that, to your acquisition question, Kristin, I think we'll continue to look for additional businesses, particularly ones that are in our wheelhouse, and continue to try to build out our platform and probably broaden it in the years ahead.

On the acquisition front, are you still looking more on the smaller side or would you be willing to do a bigger deal that establishes some sort of new franchise, and down with one area in the past when you typically look at acquisitions, are you looking out several years to maybe recovery?

We'd consider some things that could bring new platforms to us, which would be bigger by some standards but we're not going to do any absolute game changer that puts us into a heavy debt position or anything like that.

And your tolerance for (inaudible) in the past, I think you characterized whether it was reasonably low?

Ultimately it's going to come down to return on capital and how we think about stuff. Certainly a year one dilution we'd be willing to do if it's the right thing, and probably even into year two if it made sense. We want to avoid huge long-term dilutions. But ultimately it's going to come down to also just the return on capital. We continue to be very disciplined, as you know.

Your last question comes from the line of Bill Plovanic with Canaccord Adams. Please proceed.

Great, thank you. I seem to be last in most of these lately. Simple question. On the monitoring cost, as those roll off in April, as those costs go away, one, can you quantify that? And, two, does that spending just get shifted to the COGS line for your compliance programs?

Bill, I'll take that one. The reality is, as Steve talked about, we, along with other companies have changed, at least on the inside, a lot of what we've done to manage our business here, and there's a lot of those costs that have an ongoing impact. So I wouldn't say there's going to be a significant amount of costs that are going to roll off. Obviously there's some external costs that will probably help us a bit. But I think in terms if you look at our overall cost of compliance with that included in there, we're not looking at that as being a real savings opportunity going forward at this point.

And are there any closing costs associated with that one-time charges, or a big check that you have to cut when that monitor rolls off?

No.

We hope not. Unless they hit us with a final bill.

Yes, office decorations maybe.

Great. Thanks, Bill, for that final question. And with that, our conference call for our first quarter 2009 operating results will be held on April 20th, 2009. We'll ask everyone to also hold a place on your calendars for our 2009 analyst meeting which will be held on May 20 in New York City. Thank you, everyone.

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