史賽克 (SYK) 2009 Q3 法說會逐字稿

Good day, ladies and gentlemen, and welcome to the third quarter 2009 Stryker conference call. I'll be your operator for today. At this time, all participants are in listen-only mode. We will conduct a question-and-answer session towards 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 material 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 product, pricing pressures, generally including cost containment measures that could adversely affect the price of or demand for the Company's product, changes in foreign exchange market, legislative and regulatory action, and anticipated issues arising in connection with clinical studies and otherwise that affect United States Food and Drug Administration's approval of new products, changes in reimbursement levels from third-party payors, a significant increase in product liability claims and favorable resolution of tax audits, changes in financial markets, and changes in the competitive environment.

Additional information concerning these and other factors are contained in an Company's filings with the United States Securities and Exchange Commission, including the annual report on Form 10-K and quarterly report on Form 10-Q. Today's conference call will also include a discussion of constant currency sales performance and adjusted diluted net earnings per share for the third quarter in nine months periods ending September 30, 2009, and for the year ended December 31st, 2008. Further discussion of these non-GAAP financial measures, including GAAP reconciliation, appear in the Company's Form 8-K, filed today with the United States Securities and Exchange Commission, which may be accessed for the four Investors page on the Company's website at www.stryker.com.

I would now like to turn the call over to Mr. Stephen MacMillan, President and CEO. Please proceed.

Thank you, Louisa. Good afternoon, everyone. Welcome to Stryker's third quarter 2009 earnings report. With me today are Curt Hartman, our Vice President and Chief Financial Officer, and Katherine Owen, Vice President and Strategy and Investor Relations.

With three-quarters of the year now under our belt it's clear that 2009 has been one of the most challenging periods our Company, and many others, have faced. However, we are pleased that we have delivered on quarterly commitments and that we are well positioned to achieve our targeted top and bottom line goals for the full year. Although there continues to be a great deal of uncertainty, both as it relates to the world economy as well as the underlying the growth rates for some of our businesses, we believe the actions we proactively undertook to control our cost structure have us well positioned going forward.

Furthermore, the combination of the economic slowdown as well as our own learnings stemming from our quality journey have prompted us to also take a deeper look at our cost structure going forward, resulting in some restructuring charges in the quarter. Turning to the third quarter, we delivered solid results in a challenging period with sales up 1% on a constant currency basis, the $1.7 billion, while also up modestly on a sequential basis, and it's worth noting that in the face of a difficult economic environment, which resulted in significant weakness in our MedSurg businesses, we were still able to post both year-over-year and sequential revenue growth.

Against that backdrop, a few highlights from this quarter include all of our implant businesses, including both hips and knees, delivered accelerated revenue growth, even though Q3 is seasonally the weakest quarter of the year, which we believe underscores both our strong competitive position as well as the underlying strengths of our target markets. And, spine continued continued its track record, delivering double-digit constant currency revenue growth. Overall our US orthopedic implant businesses continue to post solid growth up 8% collectively in the quarter.

Despite restricted hospital capital budgets, both our endoscopy and medical franchises reported a sequential dollar increase in sales. Our ongoing focus on leveraging our infrastructure to drive greater operating efficiencies fueled an 80 basis point increase in huge re-operating income, which is particularly noteworthy, given the relatively modest top line increase. Finally we continue to deliver strong cash flow generation with cash and equivalents totaling $2.9 billion, which provides us with considerable flexibility to pursue potential acquisitions, share buybacks and dividends.

As you all know, we've also been intently focused on a major transformation and implementations of corporate-wide quality systems. As we've stated throughout this year we feel we are making significant progress, yet we still have a great deal of work ahead of us. At this point, we are pleased to report that the biotech warning letter which we received in April of 2008, post an FDA inspection in 2007, has been resolved, following a productive re-inspection of our biotech facilities earlier this year. We view this as an important first step in our goal of resolving all of the outstanding warning letters and look forward to providing you with further updates as we receive tangible results from additional FDA activity. Our compliance initiative involves the collective efforts of our entire organization and the magnitude of these actions can't be overstated.

Against this backdrop, the resolution of a warning letter is a key milestone for us as we continue on our journey toward achieving a world-class compliance system, but again, much work remains. The results of the quarter confirm that we are able to deliver on our commitments by focusing on our customers, while at the same time making the necessary investments in our business and compliance systems to be able to deliver top-tier results over the long term.

With that I will turn the call over to Katherine.

Thanks, Steve.

My comments today will focus on Hospital Capital Budgets, Pricing, and Op-1. Starting with Hospital Capital Budgets, the environment remains difficult, although we continue to believe our results as well as the insights we're able to glean from our key customers, reinforces the view that the capital spending cycle is bottoming and is unlikely to deteriorate meaningfully from current levels. During the third quarter we saw a slight decrease in percentage of hospital customers with the capital freeze in place, with the corresponding modest uptick in the percentage now reporting a more affluent approach to capital purchases.

We view this as encouraging, but we would underscore that the shifts have been minor and the real key lies with the timing and magnitude of the actual recovery in capital spending. On that score, there remains a great deal of uncertainty. However, we'll continue to focus on controlling our cost structure to drive ongoing operating leverage.

With respect to pricing, the trend remains essentially unchanged from Q2, with our global total Company pricing flat year-over-year. We also saw stability as it relates to orthopedic implant pricing, which was down in the low single digits, consistent with trends we have seen throughout 2009. We continue to see low single digit decline in pricing for our hip and knee implants, partly offset by a more favorable pricing environment for some of our other implant businesses.

Shifting to the status of OP-1 in our R&D efforts, not surprisingly we've received numerous inquiries regarding the plan for this program going forward, following a disappointing FDA panel outcome earlier in the year. Given the extensive development work we have done today and potential applications for OP-1 in other indications, such as soft tissue, we are undergoing an intense review of our various strategic options. As many of you are aware we have an existing customer base that's an important consideration and we have a major state of the art manufacturing facility, located in Lebanon, New Hampshire, that is also a factor in our analysis. We expect to complete our strategic review in the coming months and look to report back to the investment community in early 2010 regarding our plans going forward.

With that, I will now turn the call over to Curt.

Thanks, Katherine.

On many fronts our third quarter results demonstrated positive gains relative to a tough market as well as against our own internal challenges. In kicking off the third quarter review, I think it is safe to say we're encouraged by our results, as evidenced by our domestic implant performance, quarterly increases in MedSurg sales, and the lifting of one of the FDA warning letters. Although we still have significant work to do, these are important achievements for our organization that underscore the fact that no one at Stryker is comfortable with parity to the broader market, both now and in the future.

Jumping to the business results, I'll begin with a quick review of the impact that foreign currency had on our sales. Consistent with recent quarters, currency contribution -- currency contributed to reduction in top line sales by approximately $20 million and the Company's overall sales growth was impacted by 1.2%. This was slightly below the bottom end of our expected range of 1.5% to 2.5% anticipated in the quarter. Through the first nine months, sales have been reduced by $183 million, which has impacted growth by 3.7%.

Looking to the fourth quarter, currency will now move to a positive for us, and if currency rates hold near current levels, we would expect fourth quarter sales to be impacted by approximately 3.2% to 4.2%, when compared to 2008. At these rates, the full year currency impact would be a decrease in the range of 1.6% to 2.0% when compared to 2008.

Next, I'll spend a moment on the impact of price and volume mix on the top line. In the quarter, selling prices consistent with both the first and second quarters we're essentially flat on a worldwide basis. This broke down into a slight international price gain of less than 1%, which was offset by domestic price loss of 1%. Volume and mix was generally as expected for our orthopedic implant products and consistent with the last three quarters, volumes were off across the MedSurg categories. In the quarter, selling days were consistent with the prior year.

Now, I will turn to the franchise segments. As evidenced by the details provided in our press release, we had encouraging results across several categories, paced by our domestic implants in the quarter. On that note, orthopedic implants, which represented 61% of our sales in the quarter, registered a nice gain, posting a 6% increase on a reported basis and 7% growth in constant currency.

Our hip franchise was up 4% as reported in dollars and up 6% operationally in the quarter. The Accolade, Trident, X3, and restoration products paced our growth on a global basis. In the US, hip sales were up 7% continuing the favorable trends from the second quarter. Trident, Accolade, and X3 all delivered solid gains, and we are encouraged by the uptake in our Tritanium Cup offerings.

Internationally, hip sales were up 5% operationally in the quarter. All international markets posted positive gains with the strongest results coming from our Canada, Japan, Pacific, and Latin-American markets. Top brands included Trident, Accolade, and X3.

Our global knee franchise recorded 5% sales growth in dollars and a 7% increase on a constant currency basis during the quarter. The US knee business had another strong quarter, reporting growth of 10% against a stiff prior year gain of 18%. Growth was driven by the continued strength in the Triathlon line with strong primary growth being supported by high market acceptance in the revision line. Internationally, knees were up 1% on an operational basis. Strength in our Japan, Pacific, and Canadian businesses was offset by small decline in Europe. Triathlon, again, recorded a nice gains in global market acceptance.

The global trauma business recorded a 5% increase in dollars and a 6% increase operationally. These results are below our average and our analysis would indicate that the trauma market softness is partially a reflection of a decline in driven miles as well as the decline in heavy construction starts, both of which drive a portion of traumatic injury admissions. Our US trauma franchise reported 6% growth, slowing from first half rates; sales of the foot and ankle, hip fracture and upper extremities products paced our trauma growth. International trauma sales were up 6% operationally in the quarter, with sizable gains being recorded in Canada and Latin America. This was offset by softer performance in Japan owing to a reduction in hip fracture device sales and pressure associated with the first half reimbursement reductions. On a product line basis international trauma sales were paced by growth in hip fracture and extremity products.

Our global spine business recorded its best quarter of the year, posting 14%growth in dollars and 14% on an operational basis, despite facing the most challenging year-over-year comparisons. US spine sales grew 13%, consistent with first half results. Domestic spine growth was again paced by our Interbody/Vertebral Lumbar offerings. Internationally, spine sales posted operation growth of 16%, our best result since Q1 2007. Interbody/Vertebral Lumbar devices paced our growth with our Europe and specific markets delivering strong gains in the quarter.

Next I will turn to the MedSurg group which represented 39% of our sales in the quarter. As a reminder, MedSurg is comprised of three businesses that historically generate about 60% of sales from capital equipment. Clearly reduced hospital capital spending continues to impact the MedSurg business results, though as Steve mentioned, our medical and (inaudible) businesses did record the highest absolute dollar sales volumes of the year in the third quarter, while instruments returned to positive growth. Against that, total Medsurg sales declined 8% as recorded and were off 7% at a constant currency basis representing slight improvement from the 8% constant currency decline in Q2.

Looking at the franchise segments, sales for instruments which historically generates 40% of sales from capital equipment, grew 2% in the quarter and 3% operationally. In the US franchise, instruments reversed the prior quarter's decline, reporting growth of 3%. While continued general softness in the capital equipment market slowed results, sales of single use consumables, as well as increased sales in the products to serve markets outside of orthopedics, helped to offset this decline. Internationally, instrument sales increased 5% in constant currency with gains in Japan and Latin America, partially offset by small declines in other international markets.

Our endoscopy segment reported third quarter sales that were down 5% and off 4% in constant currency. As a reminder, approximately 60% of sales are from capital equipment in this franchise. US endoscopy sales were down 10%. Encouragingly, the consumable portion of our main line endoscopy business showed solid double-digit growth in the quarter. However, we continued to experience weakness with our larger ticket capital items, such as the operating room integration product, resulting from the slow in hospital construction markets. Given that the backlog for some of these capital purchases is typically several quarters, we would expect the softness in this area to continue for some period going forward. Internationally our endoscopy sales remain positive, recording a strong 16% operational gain. Growth was paced by Pacific, Latin America, and Canada.

Finally, our medical products which generate approximately 90% of sales from capital equipment, saw global sales decline 28% in the quarter as reported and 27% in constant currency. The US medical sales declined 23%, while international market sales were down 43% in constant currency. Keep in mind the international dollar basis is limited, so quarterly variations will show broader swings. As we stated on the Q2 earnings call, medical's third quarter comparable of 31% is the toughest quarter this franchise will face in 2009.

Clearly, this remains the most challenged of our capital equipment business segment and the one we feel has the longest road to a normalized recovery. Having said this, we do believe that our product line up and value proposition continues to resinate with customers given its emphasis on patient and hospital staff satisfaction. In short, we remain bullish on this business for the long term.

That wraps up the franchise segment so I will turn the remainder of the income statement beginning with gross margins. Third quarter gross margins increased 20 basis points compared to 2008. Gross margins for the quarter were impacted by a favorable mix of product sales partially offset by continued investment in our compliance initiatives. Research and Development spending represented 5.1% of sales in the quarter while being down 10% versus prior year. [Through] three quarters, spending on R&D remains within our desired range of 5% to 6% of sales. Selling, general, and administrative costs were flat versus prior year and as a percentage of sales dropped 10 basis points below last year levels, and are 120 basis points below 2008 levels on a year-to-date basis, while SG&A in both dollars and as a percent of sales was at the high end versus the previous three-quarters, we are comfortable that fluctuations in these categories for selective investments are appropriate.

Also, as noted in the quarter, we recorded $67 million of restructuring charges related to decisions to terminate certain third party general agent agreements within our European division to simplify the organization structure in our Biotech, Europe, Japan, and Canadian divisions and to discontinue selling certain products within both the orthopedic implants and MedSurg business segments. These moves represent our ongoing commitment to evaluate our operating model to ensure we continue to drive focus and efficiency. On this note, our third quarter adjusted operating margin increased to 22.9% of sales, leading to a 4% increase in adjusted operating income in the quarter.

Next, I'll provide a breakdown of other income for the quarter. This was made up of $9 million of investment income offset by interest expense of $5 million in foreign currency transaction losses of $400,000. The Company's effective income tax rate was 27.2% for the third quarter of 2009, equal to the third quarter of last year and down 20 basis points from the 2008 full year rate. We continue to expect our full year 2009 effective tax rate to be substantially in line with our reported full year 2008 tax rate. As we look at our balance sheet, we're obviously pleased to report another strong quarter with cash and marketable securities increasing by approximately $500 million. Our goal, as has been noted on several occassions is to find the right ways to deploy this resource to assist in our long-term growth strategies, while ensuring we return maximum value to our shareholders.

Accounts receivable days ended the quarter at 61, which represents an increase of one day compared to the prior year. For the quarter, accounts receivable days averaged 58. We continue to maintain a diligent focus on this important asset. Days in inventory finished the quarter at 164, which was down three days sequentially and flat against the prior year. Although we realized a modest improvement, our inventory levels are still an open area of opportunity.

Finally, I will provide some quick commentary on cash flow. We continue to perform well with year to date cash flow from operations up 22% to $921 million, and free cash flow up 28% from $648 million to $833 million. Turning to our outlook for the remainder of 2009, we are tightening our top-line range with full-year constant currency sales growth, now estimated at 1% to 2% versus the prior range of 1% to 3%. We are also tightening our full-year EPS targeted range to $2.90 to $3.00, up 2% to 6%, which compares to our prior range of $2.90 to $3.10, up 2% to 10%. Our 2009 targets continue to assume that Q4 results benefit from several factors, including the easier year-over-year comparisons and the elimination of the XFS drag based on current exchange rates. As we have stated previously, we do not assume a meaningful recovery on hospital capital spending in 2009, rather we expect the current environment to remain relatively stable with ongoing modest up ticks. As it relates to our expectations for 2010, we'll provide details regarding our outlook and related topics on the January 4th quarter earnings call.

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

Thanks, Curt. Before we open up the call to Q&A, I would like to offer some closing comments.

Looking ahead, there's obviously a lot of uncertainty right now as we attempt to gauge the timing and magnitude of the economic recovery, as well as the ramifications of the healthcare reform. Having said that, we think we've made a lot of progress in three key areas this year which should put us on solid as we exit 2009 and enter 2010. Specifically, we've made progress on our quality and compliance journey with our whole organization having more clearly defined and embraced the actions required and we're on the road to implementing these changes, though again much work still lies ahead. Second, we've taken actions to better control our cost structure, and third, we've stayed very focused on our customers and delivered through the year a testimony to our resilient teams around the world. While the challenges ahead are sure to be significant, we think our team and our Company are emerging stronger and better prepared.

In closing, as we look back on the third quarter, although our financial results are below our historic levels, we believe it's note worthy that despite facing considerable external and internal challenges, we still delivered sales growth, both year-over-year and on a sequential basis. We achieved these results despite the ongoing economic upheaval that placed considerable pressure on our MedSurg businesses and while still making major investments in quality and compliance which speaks to the underlying strength of our organization We are pleased by the ongoing solid results from our orthopedic implants business as well as our ability to generate tremendous cashflow and drive ongoing operating leverage. Combined, these efforts will continue to allow to us meet our near-term commitments, while also ensuring we are able to make the investments necessary to achieve strong results over the long term.

With that, we'll now open it up for Q and A.

Ladies and gentlemen, (Operator Instructions). If your question has been answered or you in the interest of time we request that you limit your questions to one and one follow-up. Questions will be taken as time permits. (Operator Instructions). And your first question comes from the line of David Lewis with Morgan Stanley. Please proceed.

Good morning. Good afternoon. Sorry, long day.

Hey.

Maybe Curt, start with you, quickly on margins, can you give us more specifics around what drove -- you talked about a 50-bip depression, it was a little heavier than that, you mentioned some compliance programs, so maybe some clarity around that, as well as specifically on the SG&A spending and what would you expect for the remainder of the year?

Couple questions there, David. I think the first on gross margins, is we look at the third quarter. We've had a favorable product mix as evidenced by the growth in the broad orthopedic implants to include our spine franchise and certainly those are going to carry a higher gross margin; countering that is obviously our continued commitment to the compliance initiatives and the investment that's going to flow through the P&L at our various manufacturing plants as we continue this three-year initiative.

Relative to SG&A, we had another good quarter as I noted in my comment. It was not our absolute lowest dollar level of the year, nor did we generate quite as much leverage versus prior year as we had in the the previous quarters. However, I think there was some decision making that went on about where we're placing strategic investments, be they in sales force expansion or other categories that we think long term benefit the organization. As we look at the fourth quarter, I think you should expect somewhat of a same offense that we're going keep things pretty tight.

We do believe that as we look at our business, we are not going to limit ourselves, and we are going to make the right strategic investments, so as you think about the fourth quarter and perhaps look at our prior year, you'd notice how those trends flow.

Okay, very helpful. Steve two, quick ones. First of all, on medical, there's been some improvement obviously in broader MedSurg businesses, but specifically in medical, the underperformer. Do have enough visibility now to at least believe that next year that business can be at least flat?

Probably. The truer answer there is, David, no. We have a gut feel that the business could at least be flat? Yes.

Very helpful. Sorry, Stephen, lastly, if you think about the orthopedics obviously an encouraging sequential improvement in that business. Two questions here. One, do we see that as at least a movement that you think is maintainable? You talked about last quarter some OUS restructuring and management changes. It sounds like that was still a drag, so to the extent that we can alleviate some of these international issues, could we expect a further improvement from these third quarter levels?

Yes, but I'd be cautious. I think with all of the orthopedic implants, it's going to be modest, modest changes. Our goal is always to get a little bit better; I think that's the path we're on.

Okay. I'll let someone else jump in.Thanks.

As a reminder, ladies and gentlemen, please limit your questions to one and one follow-up. And your next question comes from the line of Rick Wise with Leerink Swann. Please proceed.

Good afternoon, every body. I'll start with the mixed signals that we're seeing from different med tech companies, so far. the cardiac folks, seems like we're seeing more pricing pressure, some procedures slow down, more pressure on contracts as contracts are renegotiated. It seems like the ortho industry is not seeing that. Is that -- am I understanding that correctly?

I can't really comment on them, Rick, as much as you probably can. But I can sea we feel a lot of pressure but we continue to manage through it. I think the combination of the product we're bringing, the services we're providing, it's not without its pressure, but we continue to feel pretty good about working through them.

So you're not seeing any incremental pressures on price or procedures or volumes versus the first half of the year?

Rick, maybe if I just jump in with a couple of comments, I think on the pricing side dimension have been very stable relative to what we saw throughout '09 and that we are seeing some pressure, but the magnitude of it from a quarter to quarter basis hasn't changed. I think on the volume side we're still seeing some pocket where there's been the economic impact on elective surgery, but that has not changed meaningfully throughout the year, certainly in the third quarter, recognizing we do have the normal seasonal effect that you see in Q3.

I think the other thing to keep in mind is, and I'm not telling you anything you don't already know, but our footprint here. We are very diverse in terms of the range of med tech products that we offer. So there's going to be different parts of our business with different challenges, and also the geographic footprint.

In some ways, that probably differentiates a little bit from some of our peers. It doesn't mean that we don't have challenges. It just means that when you add up at the end of the quarter I think what you're seeing is our ability to offset some of the weaknesses in some businesses with greater underlying strength in other businesses. That will change in another quarter.

Just a follow up. Congrats on the warning letter resolution. That's excellent. Can you help us understand what's next for biotech and for the other warning letters? Any incremental color there? Is there any cost savings -- costs go away by resolving the biotech portion that we can feel a little bit more positive about on cogs or SG&A? Thank you.

Sure, Rick. Don't assume any cost savings going away. As we reiterated, we're on a three-year, probably $200 million journey. We're continuing to make those investments in our facilities around the world. Can't predict what's next, but I think after the direction we've been going over the last couple of years, which is publicly certainly been incrementally worse; we're encouraged.

We're very pleased that certainly the journey we're on, the investments we've been making, we think this should be a validation that the work we're doing is going in the right direction.

Thank you.

Next question comes from the line of Bob Hopkins with Bank of America. Please proceed.

Hi, thanks, can you hear me okay?

Yes, Bob.

Great. So I just wanted to follow up the on Rick's question about the warning letter, and I don't think the biotech warning letter was the first one you received, and yet it's the first one you're getting resolution on. Is there any sort of structural reason why that was the case? Anything to be read into the other processes that are going on?

Nothing to be read into that, Bob. Just the way thinks work, I think.

okay. And then could you just remained me of how the process works? Did you formally get a letter that sort of said you're free and clear, or did you just get an incremental approval or something, or was there a formal notification? Is that how this works?

We in this particular case did receive a formal notification. We're obviously very careful to say anything like that without a very clear understanding, given the journey we've been on.

Yes. Just trying to understand the process, and that did involve a plant inspection as well, or a reinspection?

Absolutely. Very detailed.

and still no --

Bob?

Yes.

There's just one detail, at that time biotech warning letter, it was last one of that group of that first three received. If you go back to the timing of the actual inspection, it was actually fairly close to when the MAWA inspection occurred.

That's helpful. Thank you. Just trying to see what we can read into that.

Let me try to -- Bob, let me try to help you here a little bit, because I've gotten many questions from you and most of you on the call here over the last couple years. Where are we, how do you know your program and your spending are working.

Right.

As we said, we've been very engaged with the FDA on this journey and close communications and working very closely. But I know for the last few years all the external signals you've been seeing have largely been going in one direction and that's not been a direction that we've considered particularly favorable, nor have you.

I think the way you should think about this is, they've embarked on a program, this is a step in showing that that program is probably working. We still have more steps, and we really look forward, we still got three outstanding warning letters as we remind you. We've got work to be done. We certainly look forward to hoping to say the same thing for the other sites down the road here.

Just one more on the subject, Steve. In your opinion, should we be looking at these as really four completely separate issues, or can we look at approval here as something that is certainly an incremental positive it is a relates to the other three situations? I have to imagine that to some degree you wouldn't have progress in one, if the other three weren't at least headed in the right direction.

I just want to be really careful from over-commenting. They are four separate individual things. Having said that, what's very clear is the FDA had a lot of issues that transcended sites. So a huge part of our program here has been not just responding to the issues in one warning letter at that site.

We've been taking actions for every observation at all the sites, and then addressing that across all 21 sites, not just the four that were expected. So that's the magnitude of the effort, and I think hopefully should be able to see a little bit of progress from this.

Okay, thanks. I appreciate it. I'll get back in line.

Thanks, Bob.

As a reminder, please limit your questions to one and one follow-up. And your next question comes from the line of Mike Weinstein with JP Morgan. Please proceed.

Thank you. Evening, everybody. Let me ask you this as we think about the fourth quarter. Steve, have any thoughts on specific countries in Europe and how their budgets are looking going into the end of the year? What I'm specifically asking is how do you feel the various countries are going to look? Are we going to have a weak December because they can no longer fund hip and knee replacements?

Yes, I think it really varies country to country, just on when their own fiscal years are. You look at the UK. It's really an April 1st to March 31st fiscal, and then even at different provinces, within different countries. I don't, think we see a -- we're not modeling a dramatic change within Europe in terms of much in the fourth quarter. A modest -- modestly down, but nothing significant.

Okay. Everybody focuses on pricing and mix and recon. Can you talk for a minute about pricing and mix in trauma and spine?

Sure. Curt, do you want to take that?

Sure. Pricing and mix in trauma and spine is a little bit analogous to our prior comments where we lump in the entire orthopedic reconstructive segment. I think we still feel very good about the pricing trend we see in our trauma franchises, that is not to say or imply that there isn't pressure there, but I think overall we feel very good. I think we have a bit of the safe thing going on in our spine franchise.

At the end of the day, where innovation is apparent, customers are adopting that innovation and willing to pay that price. Where the product is a little bit long in the tooth, there's far more price pressure, and when there's competitive pressures around those items because people have similar offering you are going to see that. That that's kind of the here and now.

Certainly over the long term, there's a great potential for pricing trends to be down, depending on where everything shakes out, but that's a touch speculative for me to get into. So as we stand here today we feel pretty good overall with where our reconstructive pricing falls.

Non recon?

Say that again?

You meant trauma and spine pricing?

Trauma and spine. I tend to lump it all together.

If we think about how businesses have held up through course of the recession, it looks like trauma and spine, you might come out of the recession with the ability to still capture positive mix and price in aggregate, which would definitely differentiate it from recon at this point.

In aggregate, yes. I think we still hope in even the recon market with the right innovations we can collectively mix on pricing and still be a little bit positive.

Okay. Let me switch back, if I can, to the warning letter from the FDA picture. Since we haven't heard anything on the 483s from the demand section, should we assume anything at this point relative to the Company getting warning letters or not getting warning letters in those 483s?

Probably the best I can tell that you, Mike, is we're clearly working very hard at those sites as we have on all of our other sites and communicating that program very closely to FDA on a fairly regular basis in terms of our updates, and it's part of the comprehensive program that we're on.

Okay. Can I read into that at this point you think you're not going to get warning letters or you don't know?

I think, Mike, the more time that goes by without receiving additional warning letters is obviously good news. There's always a lag period when you are interacting with FDA, following inspection. We're going to continue to give you updates as we get news that's definitive, like the receipt of the lifting of the biotech warning letter. Obviously given an organization as large as ours, we're going to continually have inspections going on.

Right now we're focused on the fact that the investments we're making seem to be paying dividends in terms of making progress, but we still have work to do. It doesn't make sense to say whether one could or could not lead to a warning letter.

I understand. Last question. Steve, you value the number $7 a share in cash. Can you envision a transaction where you would spend more than $7 a share in cash and would actually put you in a net debt position?

Not in the short term, or medium term, probably, no. We're not going to do anything stupid with our cash.

All right, great; thank you, guys.

Great, thanks, Mike.

As a reminder, please limit your questions to one and one follow-up. Your next question comes from the line of Matt Miksic with Piper Jaffray.

Good evening. Thanks for taking our questions.

Sure, Matt.

So one follow-up on that use of cash question there. Not expecting to you do anything stupid with your cash, but I'd love to know where you're leaning, how you're looking at potential strategic opportunities or are we getting to the point where you've got enough cash here to just have to say it's time to return to the share holders?

We're looking at all three. We're looking -- as Curt mentioned, both acquisitions, buybacks, and dividends. We're just not going to get much more detailed than that at this point.

And I think, Matt, that's consistent with what we've tried to say all year with M&A as our preferred use, but we retain the right to pursue those other options.

Just to push you a little bit on that, you have been saying it all year, given the process you're going through with the FDA, given healthcare reform and the uncertainty in some of these markets heading into 2010, do you -- is it -- I don't know how to put this question, so that you can answer it. It seems like you've had a hard time getting to the right opportunity or getting to the right opportunity with the right visibility. When do you think we'll have a decision which way you're going to break on that.

Give you a couple of things here, Matt. First off, overall, we think the market -- there's going to continue to be good buying opportunities. I would say, and you touched on something there, the FDA. We clearly have been very focused internally this year and have add lot of work to do internally before we can automatically just take on something big and complex, or even something of big scale. And candidly I think that has held us a little bit more on the sidelines during this year while we've frankly been watching the global economic meltdown.

It's clearly had an impact on our MedSurg businesses, while we've been making tremendous investments and getting a lot healthier. It will put us in a better position going forward than -- and I'd say six or nine months ago, candidly we had the cash, but it would have been a much bigger distraction. It would still would have been a bit of a distraction, but we're further down the road.

Okay. That is helpful. So maybe 2010 you'll feel a little more free to focus externally?

Yes, the other reminder -- the big reminder is we don't feel -- there is no timetable in our plans to use our cash. If there's a great opportunity, we can move, and we love having the strong cash position, but we don't feel an urgency to do anything other than good opportunities. So we're not going to be pinned down to any specific timing.

fair enough.

I guess I would just offer the one comment, and not to assume that the lack of an announcement of us doing a major acquisition or a deal is somehow indicative of lack of activity on the BD side. We've tried to impress upon everybody that we're sticking to a very strict discipline it is a relates to due diligence.

A lot of that has gotten even stricter as we've learned more about FDA compliance related type of issues, given what we've gone through as an organization. We're sticking to our discipline on value and not going to overpay, and as a result, we pass on a lot.

So there's a great deal of activity going on here, a lot of is it not obviously evident you guys externally, but I would just impress upon you that we will continue to view dividends, stock repurchases and M&A as a use of cash but our level of intensity or activity on the M&A side hasn't changed.

Thanks. I wouldn't assume that. But that's helpful. One follow-up, and I hate to do this. Seems like nobody can get off this call without asking a question about these warning letters. But I did want to understand, I think you touched on it, Curt, that there's a number of -- that there's sort of a broad process going on across all your facilities having to do with kappa and standardization of your procedures there. What's different about the biotech business?

Just to help us look at it as either an indicator of progress, but, I don't want to run with it as sort of a strong indicator that these letters are going to start to go sort of one after another. Was there something different about biotech that enabled you to sort of put that one to bed? Is it less device oriented? Anything you can tell us that might give us some color as to how it relace to the rest of the process as you're going through?

Matt, I would just, if I can just jump in, the warning letters are all publicly available. You can see the issues that have been outlined. There are some very consistent issues raised across the warning letters. Also some ones very specific to biotech, and as a result, it does impact the timing and the amount of resources required to resolve the warning letters. I think overall biotech is evidence of the commitment we've made and the investments we're making in a total program. It's an important milestone, and I think it says we're on the right path, but we're not done.

Matt, just to try to be a real simple comment here, I would encourage the group to not overthink this. This is Stryker in a very broad approach to its network of 21 plants in a quality system, but we are working hand in hand with the FDA on these, and it's a combination of those two things coming together, and as Katherine said, there some consistent themes across our plants that the FDA took exception to. There are some themes that are very unique to the plants, and it will go at the pace that both Stryker and the FDA allow it to move forward at.

Your next question comes from the line of Matthew Dodd with Citigroup. Please proceed.

Thank you. Couple questions. Steve, for you first. Of all the implant markets, it seems the spine market has held up pretty well on volume this year versus last year. I assume some of that would be elective. Just wanted your comments on why you think the spine market is holding up so well on a volume basis.

Kathryn, for you, on the OP-1 review, you mentioned the manufacturing plant. Should I broadly take that to assume, just looking at the value of that as a sale or as an asset?

On the spine market, I think we just continue to see a lot of people in a lot of pain. And there's still a fairly young population of people that want to get back in the game, either, frankly, back to work everything else, and from everything we can tell around the world, the spine market is probably going to hold up pretty well.

Matt this is Curt. On the question relative to OP-1, and the intent here in our comments, the intent is to convey to the audience this is a very complicated series of decisions that the organization is going through. We've been on a very long journey related to a product for spine applications. We believe the product has some very broad applications that we've not historically discussed. We also have a very large investment in manufacturing site that Katherine referenced.

So when you put all that on the table, there's a lot of things for this organization to consider, and a lot of parties that need to be part of those discussions. And again, we're not going to jump to a quick decision here, and it's just a matter of sorting through all of that with all relevant parties around the table.

Thanks, Steve. Thanks, Curt.

Thanks.

Next question comes from the line of Tao Levy of Deutsche Bank.

This is Seth for Tao. Just had a question, just to stick with pricing. Wanted to see if you could give us the specific price impact on the US on the hip and knee businesses. And also, you also mentioned that you discontinued some products in continue restructuring. Wanted to see if they were material just in orthopedic growth.

I'll start with the second question first. The discontinuation of products. I think you should assume we are not material for the long term or the short term, and I think you should probably perhaps consider realigning that to our quality initiatives where we simply felt it was better for us to exit that market versus continued remediation efforts that may not really bear much future fruit.

On pricing, we historically have not gotten down to segment detail on pricing. I think what Katherine was trying to convey was what we earlier talked about in our first quarter call where we did get into some specificity on the hip and knee lines. If those trends are fairly consistent quarter-over-quarter as we've gone through 2009.

Fair enough. And just one follow-up. I'm assuming hospitals, calendar year hospitals, they're within the budgeting process, so your reps are probably at least getting a first glimpse at what next year has to offer. Can you just speak broadly on any -- just any color for the calendar year hospitals, their capital budgets and what you're seeing?

You know, it's an interesting question. And I would probably frame it this way. Certainly hospitals are looking at their needs. Certainly hospitals are probably lining up their priorities, and in some cases, they are probably talking to the folks at Stryker about their capital equipment requirements. Talking about and submitting proposals for budgetary requirements is very different than the hospital CFO, the hospital CEO actually agreeing to spend the money.

And I don't think the hospital environment is any different than any other company environment today. We have the same discussions within Stryker that they're probably having within hospitals. We think we need to do these projects, but where do we really want to spend our money given the economic situation?

So is the normal dialogue going on around budgetary planning? Yes, we've had pockets of that reported. Is it meaningfully different than year-over-year? I don't think I would go there.

But I also think you have to understand the fundamental environment has changed, and having a budgetary discussion is very different than predicting the future spend.

As a reminder, please limit your questions to one and one follow-up. And your next question comes from the line of Bruce Nadel with UBS. Please proceed.

Thanks for taking the call. Totaling up the results posted by the three companies and major joints that are reported so far, looking across the first two quarters and contrasting what we've seen so far, it looks like the US market for hips and knees is in the 4% to 5% range and the ex-US market on constant currency basis is in the low single digits. Is that fitting with your view of things and is it safe to assume that most of that, or if not all of that, is basically volume?

Those are pretty good assumptions, Bruce.

And then just thinking about major joints going forward, in the developed markets, what sort of unit growth assumptions, assuming conservatively that price is offset by mix and basically flat in the environment. I know you're hoping to do a little better, but -- what sort of unit growth is plausible, sustainable in the developed market for major joints?

Call it low to mid-single digits. Certainly don't want to get too far ahead of ourselves on that.

Steve, is it fair to assume that even if MedSurg isn't what it used to be, it can still be a pretty darn good business in the high single digits, once we get past this economic turmoil? The fundamentals of the MedSurg business will continue to be very good. There's a lot of great stuff and great opportunity ahead of us.

I think just the crawl back is going to be a little slower there, but we continue to feel great about all of the business these we're in. There's not one business we're in today that we'd look at and say let's get out of it because we don't think it's got a good future.

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

Thanks for taking my question. Just wondering if you can provide a little bit more specifics on the restructuring charge. Just seems to be a significant number. I'm just wondering to what degree we're likely to see an earnings benefit either this year or next year, with the return you're assuming and how much is cash.

the charge in the quarter was $67 million, and it was broken into a couple buckets. The first one I would think about would be some sales distribution changes in our European business, and if you're familiar with the way those countries operate, there's typically a couple levels within that process between the companies such as Stryker and the end customer. And a big part of our change here that runs through restructuring was the elimination of a couple of those layers in some of the markets. That's a part of it.

Another segment was what we referred to as simplification within a couple of our businesses. Biotech, Canada, Japan, and what we're really talking about is looking at the processes and the people around those. In some cases making some changes of operating structure, and then the final component is this product line obsolescence and taking charges related to that. The goal here is to really simplify and provide focus.

I think your final question on that was which component was cash. I think it was -- about $9 million in total. We don't break it out separately, but minimal charge, and I think $4 million is in the quarter -- $9 million in Q3, I'm sorry.

okay, and what sort of run rate, I guess, in terms of savings would you anticipate by these actions on a go forward basis?

Certainly we would hope that there's some benefit to the P&L. I think you should probably expect minimal this year as we continue to sort through and get the new footing underneath us. I think we probably hold off on quantifying that as we head into 2010 at this point in time.

A lot of it was quality and compliance focused, if you really think about it. Eliminating some of the middle people in the European distribution chain, close to our customers and more clearly in control of things like that, and then getting rid of some of the product lines so there won't be much of a pickup there.

Your next question comes from the line of Adam Feinstein with Barclays Capital.

Thank you, everyone. Quick question here. If could you just talk and even just, if you can't give us any specific numbers, just in terms of trends, implied within the revenue numbers for Q4, maybe just talk about what you're anticipating relative to the third quarter for both MedSurg and ortho. So do you think the year-over-year growth rates should be similar, better? Just want to get a sense in terms of how we should think about the different segments for Q4.

We don't really give guidance by segment, Adam.

Okay. Understood. Just figured I would try to get that in. So let me ask another one then. I guess just how are you thinking about -- obviously within ortho you guys had some good growth there. So how are you thinking about the overall market growth, and do you believe you're taking market share within hips and knees in both the US and outside the US?

I think we probably to have wait for the reporting period to finish because we've got a couple of fairly significant players still out there to report numbers. I think, as you know, this is a market where market share shifts tend to be fairly glacial. You don't see demonstrative switches in any given quarter.

Overall we feel pretty good about where we've been at with knees and the think the momentum there continues. Hips, it's been slowly improving, not where we want it to be, certainly moving in the right direction. But I'd be surprised if Q3 is very different from other quarters where you don't see major market share shifts in any given quarter.

Your next question comes from the line of Derek Sun with Sanford Bernstein.

there's been some talk about COBRA coverage running out amongst the ranks of the unemployed near the end of this year. I was just wondering if you had a sense for how that -- or were concerned about how that might impact orthopedic recon procedures if either you're seeing procedures being pulled up forward so that patients can get them while they're under COBRA coverage or you're concerned that this might lead to a step-down in the US market.

I think it's just another one of those vary variables we've seen, whether it's people hurrying up to get procedures done while they still have coverage in place, or while they've got a COBRA place. We don't expect it to have a demonstrable impact one way or the other. It's probably what's going to continue to put some pressure on elective procedures overall.

Okay. And just going back to what you're seeing in Europe, and I think you mentioned that you were still seeing a small decline in knees, at least, in Europe, how much of that is procedure volume versus pricing pressure? It sounds like both are generated from the national health budgets. Are you seeing procedures being pulled back on, or is it more hospitals and government focused on pricing and mix?

Derek, I think at this time, we still see is it as mostly a procedure volume slowdown on the knee side.

okay. And on the hip side, would it be the same as well?

Yes, I think both trends are slower. I think knees certainly are going to feel it more similar to what they done the US, where those procedures tend to be -- if you can say it, a little more elective in nature.

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

Your US hip and knee growth was a bit better than what I think the street had been modeling. I think, as Bruce mentioned a couple questioning a, it seems like volumes are continuing to improve a bit along the lines of what we saw last quarter. Is there any sense you have as to whether or not this year may even be more back loaded than what we've seen the last couple years when it comes to hip and knee volumes, and do you have any sense as to whether or not there's been any notable differences in how outpatient versus inpatient volume in some of the other areas are trending?

I don't think at this point we expect to see any significant change in fourth quarter volumes, recognizing Q3 as you know traditionally the seasonally weak quarter, so you'd have the normal benefit, but no sense that there's a backlog waiting there. The vast majority of these procedures are still done on an inpatient basis.

I don't think we've got any real noteworthy comments in terms of differences between the two groups, if any exists.

Okay, and then clearly you guys have faced a lot of challenges over the last several quarters, and you've talked about this a little bit, but seemingly you've had to be a bit more on the defensive than usual, and I'd say that's to some extent, true both maybe operationally as well as what you mentioned earlier in the context of discussion M&A. Are you at the point where you now feel like you can be a little less defensive and if not, how far away from you getting to the point where you want to be in terms of being aggressive, both operationally and on the M&A front?

Yes, we're -- I think we're moving well along the road. It varies in overall, but we love playing offense. The economy and our own compliance journey clearly did push us into defensive.

I'd say from an economic -- from the economy standpoint we're probably a little bit closer to being able to play offense, and I think we've made a lot of progress but we still have work to do on the other frame, but I don't think there's anything now holding us back from playing offense.

Your next question comes from the line of Michael matson with Wells Fargo. Please proceed.

Quick question. Not to keep harping on all the quality issues, but just wanted to hear a little bit more about the appointment of Lonny Carpenter to the group, President of Quality and Operations. That move came just 10 months after he was made President of Instruments and Medical. Just wondering why that wasn't done earlier in this process and if we could read anything into that move.

Yes, I would say with the global economic meltdown the way it was and combined with wanting to continue on the journey towards our quality issues, I probably just moved a little quicker on this move. And frankly if I were to turn the clock back, might have done things a little bit differently.

When we appointed that thing, we certainly didn't anticipate the way that MedSurg businesses were going to meltdown and everything else. And frankly, as we look at our overall approach to quality compliance operations, there are so many efficiencies that we can wring out of this organization for many years ahead, and Lonny is uniquely capable, frankly, to have a bigger impact on the corporation in that role than he was running a couple of divisions.

Okay. And then just looking at the medical business, it looks like, by our math, that Stryker probably has lost a little bit of share there, and I understand that compared to some of your competitors you're a little more capital oriented and not really rental oriented. But even accounting for that it does look like you've begun to lose some share there. Just wondering if you expect that to continue and if you can -- if there's anything you can point to there, is Hillrahm more on the offensive now that they've spun out of Hillenbrand or something like that?

We always think of them as a good competitor. Here's a simple way to think about that. Probably we were winning a lot of big deals and a lot of the hospital expansions that were going on, we were winning a disproportionate amount of the big deals. We think that continues to bode well.

As a lot of hospitals with heavily installed base may want to supplement their fleet with five or 10, 15 beds, they may not be as willing to change vendors in that situation. I would encourage to you just keep watching over time.

Your next question comes from the line of David Roman with Goldman Sachs. Please proceed.

Thank you, good afternoon, and thank you for taking the questions. Two quick questions. First on the gross margin side this is the first quarter in some time that you've shown some positive gross margin leverage albeit somewhat what modest. Cost of goods grew about 60 bips slower than sales. Could you give us some sense on a go forward basis how we should think about that both in terms of the -- whether it's increased spending, quality control spending or currency for 2009, then 2010, then just a quick follow-up on ortho. Steve, at the beginning of your comments you mentioned the stability in the end users markets and the attractiveness of the key areas where you compete. Is there something you're seeing specifically related to long-term growth, or is that more a short-term comment?

David, I'll take the first part here. You are correct on the gross margins year-over-year. We feel a little better about where things shook out. I think we still have a very high commitment to our -- relative to FDA remediation and we will not waver from that focus, and we'll spend where we need to spend as we need to spend. Part of Lonny's charter is to drive that program in its entirety through every one of our operating facilities.

I think, the as I tried to say at the onset, our third quarter benefited a little from the product mix that did run through the P&L. I think as we look forward, we're not going to get into comments relative to 2010. I think it's too early to declare victory, that we're going to see this quarterly sequential up tick quarter over quarter. We're not ready to do that. We're still very early in this long-term process, and we're as good as we've said before, as our last inspection.

So I think it's a little too early to make proclamations on gross margin. I think what you should see is we're very focused and we're going to do our darndest to keep them in a range that allows us to continue to grow our EPS and help out as we go through the P&L.

and then could you quickly remind us how currency works through the P&L?

The preference there, quickly remind us, is probably not appropriate because it's not a quick discussion. It's a long conversation.

I think what we've always historically said is that we have some natural hedges in place given our diverse manufacturing footprint, geography. I think what has transpired this year is obviously the rate of change within currency has been dramatically different than anything we've ever experienced, which has led us into a deeper dive of how these parse are flowing through P&L. It gets into things such as product made in one currency, sitting in another market in another currency and what are those inventory turns.

Clearly as various categories of SG&A spending is happening, those are going to have an adverse or positive impact on the P&L. We've never really tried to break that out, specifically, one quarter over the next. I think what we've always tried to do is register it on the on the top line and leave it at that because of the complexity here.

And at this time restrictions, we have time for a couple more questions. Your next question comes from the line of Jeff Johnson with Robert W. Baird. Please proceed.

Thank you. Good afternoon. Deep into the call here so let me get a couple clarifying questions, housekeeping questions in. One, from a secular standpoint, Steve, I think a previous caller was trying to get at this, but do you see MedSurg as being two, three, four hundred basis points higher growth rate potential over the next three to five years versus core recon or how are you thinking of those businesses from a long-term standpoint?

Jim, I'd probably give you a different way to think about med summer. I'd think about the Nike swoosh. Everybody is talking about the W, V, L recoveries.

I think what we see, a sharp downturn, and the way that swoosh starts to come back, that it's going come back and come back over the long run, but it may take us a little bit of time before we're completely back at that level, and the growth rate is probably going to be slower than what it was, but still be a healthy business for us.

Fair enough. Curt, maybe a couple things. Maybe my math is off but it looks like interest income was down something like 40% sequentially.

I understand the year-over-year change in returns and what have you on cash that's basically sitting there earning nothing, but am I right on that sequential and what drove that? And last quarter you quantified the expected '09 impact from foreign currency to be about a, $0.11 to $0.16 cent drag. Can you update that number on what you think that full-year drag might be?

I don't have some of those details in front of me but I think what you should think about in terms of interest income, the yields have continued to be depressed, even from what we saw in the first quarter. And part of this gets into the amount of cash we have sitting on the balance sheet, where those yields are versus what they were a year ago.

Just for reference, they're well under half of what they were a year ago. And as some of those investments come to maturities and they're renewed at much lower interest rates, that's certainly going to have an impact on our interest income.

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

Thank you very much for taking my question. Apologize if you've answered this. Could you just give your nickel or dime, if you want, on healthcare reform and what you think it may mean for Stryker?

Sure. We obviously have some concerns. I am encouraged in some sense that I do think some of the key members of the Senate finance committee, they have acknowledged that the device tax needs to be revisited. Do I think it goes away completely? Probably not. But I'm hopeful that we'll goat a much more sensible number, and I think what we've got do is hopefully get that awareness that obviously medical devices are a lot smaller.

We're probably less likely to benefit from the expansion of lives into coverage, and we're probably not going to get a windfall, and therefore the tax that's been proposed probably needs some work to be narrowed down. So we're continuing to work with our friends in Washington to get that message through and in the meantime, planning internally for how we approach these things.

Can you share with us what types of things you can do to plan for that internally?

Well, you know, obviously ultimately what it would mean is, you know, higher, quote unquote, tax, so we're looking at our cost structures and other things to be able to figure out ways to offset some of that. But I think overall there could be certainly some downward pressure.

Your last question comes from the line of William Plovanic with Canaccord Adams.

Thank you, but you've answered all our questions.

Great. With that we want to thank everybody for hanging in there. We want a little longer than probably planned, but I think we do feel good about where we're headed.

We'll be reporting fourth quarter on January 26th of 2010. So thank you, everybody.

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