史賽克 (SYK) 2010 Q3 法說會逐字稿

Good day, ladies and gentlemen, and welcome to the Q3 2010 Stryker earnings conference call. My name is Jeremy, and I will be your operator for today. At this time, all participants are in a listen-only mode. Later, we will conduct a question-and-answer session. (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. For information concerning these risks and uncertainties, please see the Company's filings 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. The Company does not undertake any obligation to update or revise any of its forward-looking statements.

Today's conference call will also include a discussion of constant currency sales, performance, and adjusted diluted net earnings per share. Further information regarding these non-Generally Accepted Accounting Principles financial measures, including General Accepted Accounting Principles reconciliations appears in the Company's Form 8-K filed today with the SEC. The Company's SEC filings may be accessed from the For Investors page on the Company's website at www.stryker.com. I would now like to turn the conference over to your host for today, Mr. Stephen MacMillan, Chairman, President, and CEO. Please proceed, sir.

Thank you, Jeremy. Good afternoon, everyone, and welcome to Stryker's third quarter 2010 earnings report. With me today are Curt Hartman, our Vice President and Chief Financial Officer, and Katherine Owen, Vice President of Strategy and Investor Relations. With three quarters of the year now complete, we once again recognize the benefits and strengths of our diversified revenue model.

Following the late 2009 acquisition of Ascent, we now have nine key franchises that span a broad spectrum of the medical technology market. And although at any given point, these businesses are facing different challenges and opportunities, in totality our unique footprint has a strong history of affording us with tremendous consistency in our financial results.

And with the recent acquisition of Gaymar Industries, our medical division has further expanded its product offering and has strengthened its relevance to customers in the patient handling market.

When we look back to the start of the year, we presented investors with our sales and earnings targets recognizing that some markets would likely outperform our expectations while others would, inevitably, fall short.

Sitting here today, our MedSurg franchises continue to post results that are better than we anticipated while recon market growth in the low single-digits is at the lower end of anticipated ranges. It is no secret that the reconstructive implant market is seeing softer procedure growth and continued pricing pressure. Trends that were evident in Q2's results for the industry and were expected to continue into the third quarter.

Although we are pleased the recon unit and price trends did not materially worsen in Q3, we hope and expect that the combination of our new hip products and a gradual recovery in volumes will contribute to an improving market backdrop in the coming quarters.

We're also encouraged that certain regions and divisions that have been underperforming, including Europe and spine, reversed course in Q3 and posted a sequential, albeit modest, acceleration in sales growth. All told, even in a period of challenged reconstructive growth, we are still delivering on our financial targets.

In totality, our Q3 sales have modestly outperformed our forecasts and combined with continued margin improvement throughout our income statement, have generated accelerated earnings growth.

Importantly, as we remain committed to delivering top tier sales growth through innovation, it's paramount that we make the necessary investments in R&D, which increased 18% year-over-year in the quarter on top of a 14% increase in the prior quarter. Year-to-date, R&D spending is up a very strong 15%. This pace of reinvestment is a strong indication of our belief that many opportunities exist across our diverse set of businesses.

We also remain steadfast in our focus on enhancing our quality and compliance systems as we embark on year three of the initial three-year $200 million investment. The benefits of these investments are increasingly evident, both internally and externally, but much work remains to be done.

The cultural change that has taken place in our Company around quality and compliance cannot be measured by the resolution of warning letters or the magnitude of dollars invested. Rather, those are data points that validate our efforts and reinforce to all our 19,000 employees around the world that we are and will remain a fundamentally different Company in how we think about quality and compliance, and what it means to all of our customers.

Against this backdrop, we are enormously proud of the fact that we haven't wavered from the targets we offered in January. Despite continued economic uncertainty, it has contributed to pockets of market weakness.

We now look for full-year sales and earnings to be toward the high end of our targeted range, reinforcing the collective strength of our diverse franchises and underscoring the benefits of being a broad-based player in the medical technology market. With that, I'll turn the call directly over to Curt.

Thanks, Steve. Jumping into the third quarter results, we are pleased to report another solid overall Company performance. Sales increased 6.9% on a reported basis and 7% excluding currency. The Ascent acquisition contributed 2.3% to our reported growth rate, and for the first nine months has contributed 2.3% to our 9% reported growth.

On the earnings side, another strong gross margin result and disciplined SG&A expense management allowed us to deliver a very respectable performance. We generated adjusted diluted net earnings per share of $0.80, an increase of 15.9% over Q3 2009 results. On a GAAP basis, diluted net earnings per share were $0.85, an increase of 49% over Q3 2009.

Our reported GAAP earnings include $24.3 million gain, $13.4 million net of tax recorded in SG&A from the sale of our Caen, France facility, and a $7.4 million favorable income tax expense adjustment associated with our December, 2009 repatriation of foreign earnings.

Additionally, GAAP earnings in the third quarter of 2009 included restructuring charges of $67 million, $48.4 million net of tax. Finally, the balance sheet remains healthy, and we again demonstrated solid cash flow generation in the quarter.

Turning to some specifics in the quarter. Currency was effectively immaterial to top line sales in the third quarter. Through the first nine months, currency has increased reported sales by approximately $67 million, or 1.4%. Looking to the fourth quarter, currency moves to a modest headwind, and if rates hold near quarter-end levels, we would expect the fourth quarter sales impact to be approximately flat to down 1% when compared to 2009. Using quarter-end rates, the full-year currency impact on top line sales would be an increase in the range of 0.5% to 1% when compared to 2009.

Next, I'll discuss the impact of price and volume mix on the top line. In the quarter, Company-wide selling prices declined 1.8% on a worldwide basis, down 30 basis points from Q2. As we stated previously, we are focused on the total Company pricing trends, which provide a better overall snapshot of how market dynamics are impacting the Company.

However, at the detail level on the hip and knee front, we continue to see relatively modest pricing pressure that was not materially different in Q3 from what we saw in either Q2 or Q1. That same comment also applies to our spine segment, recognizing the pricing pressure here is a bit greater than in our recon segment which has been the case for a number of quarters now.

The number of selling days was effectively equal with 2009 in most markets.

Looking at the business segments, I'll start with orthopedic implants which represented 58% of our sales in the quarter. Orthopedic implants today is comprised of our hips, knees, trauma, spine, CMF, and other implant segments. In the quarter, total orthopedic implants recorded a 1% increase in both the reported basis and in constant currency.

At the segment level on a worldwide basis, hips reported growth of 2% in dollars and 1% in constant currency. In the US market, hip sales were up 3% while in international markets hip sales decreased 1% on a constant currency basis. Finally, while hip sales in Europe were negative, they did improve marginally over Q2.

Our global knee segment sales were flat on both a reported and constant currency basis. US knees reported a 2% growth where OUS knees were down 5% on a constant currency basis. Amidst continued soft results, European knee sales recorded their smallest declines of the year.

Finally, as you recall, we filed the 510-K for OtisMed. And while we have been targeting a 2010 approval, at this point in the year, a clearance appears more likely to occur in 2011.

The global trauma segment was a bit softer in the quarter, recording a 2% increase in dollars and a 4% increase in constant currency. Our US trauma segment posted a 7% increase while our international trauma sales were up 1% on a constant currency basis.

Our global spine segment continued to face challenges in the quarter but edged out a positive gain with a 1% increase on both a reported and constant currency basis. Our US spine sales were flat versus the prior year while our international spine markets delivered constant currency growth of 4% in the quarter.

Next, I'll turn to the MedSurg Group which represented 42% of our sales in the quarter. MedSurg today is comprised of our instruments, endoscopy, medical, and Ascent Healthcare businesses. MedSurg reported another solid growth quarter with sales increasing 16% both as reported and on a constant currency basis. The Ascent acquisition added 6% to the reported increase while the core MedSurg business segments delivered 10% reported growth in the quarter. We think that's an encouraging result given this is our third consecutive quarter of approximately 10% for MedSurg growth.

Sales for the global instruments segment again posted strong results growing 13% in the third quarter on both a reported and constant currency basis. In the US market, the instrument segment reported a healthy 14% gain while internationally instrument sales also increased nicely, recording an 11% gain in constant currency.

Our endoscopy segment reported a sales increase of 7% and advanced 8% on a constant currency basis. In the US market, endoscopy sales were steady, reporting 8% growth. Internationally, endoscopy sales strengthened sequentially delivering a 6% constant currency gain.

Finally, our medical segment saw global sales improve 8% in the quarter on both a reported and constant currency basis. US medical sales increased 8% while our international medical sales increased 6% in constant currency. While the reported sales growth here is below recent quarter results, overall, we feel good about the momentum in this business based on order trends and the benefit from the recently completed Gaymar Industries acquisition.

Overall, we are pleased with the results and trends from our medsurg business segments in the quarter.

I'll now turn to the remainder of the income statement starting with our gross margin performance. Gross margins were again strong in the quarter at 69.4% which represented a 200 basis point increase over third quarter 2009 levels. Frankly, the results exceeded our expectations with the improvement being paced by lower costs associated with inventory charges, solid production absorption, and the favorable currency impact on costs from our euro-based manufacturing network.

Additionally, we again benefited from the multi-currency mix of our manufacturing and distribution activities. As a reminder, timing differences across our natural hedges and multi-currency mix prevent correlating currency movement on the top line for that of gross margin and profitability across quarters.

For the year, gross margins of 68.8% are slightly above our expectations, and we expect the full year to remain in the 68.5% range given all of the variables mentioned above.

Research and development investments represented 5.6% of sales in the quarter while increasing 18% over 2009 levels. For the year, R&D is now at 5.3% of sales and up 15% over prior year. Our commitment to increased R&D spending will continue, and we anticipate fourth quarter investments to increase at rates well above our sales growth.

Selling, general, and administrative costs were flat compared with 2009 levels while decreasing 250 basis points to 36.4% of sales versus 2009. During the quarter, we recorded a gain of $24 million associated with the sale of our Orthopedic Implant manufacturing facility in Caen, France. The gain on the sale of assets is included within SG&A. Net of this gain, SG&A finished at 37.8% of sales, decreasing 110 basis points versus prior year.

As a reminder, in the third quarter of last year, we reported $67 million of restructuring charges and operating expenses. These moves represent our ongoing commitment to evaluate our operating model to continue to drive focus and efficiency in our business.

On a 7% constant currency sales growth, operating income increased 18% on an adjusted basis and 51% as reported. The adjusted operating margin increased a robust 240 basis points versus prior year to 25.3% of sales.

Other income and expense reduced pretax income by $9 million in the quarter. Components of this included investment income of $12 million, offset by interest expense of $20 million, and FX transactional losses of $1 million. Lower investment yields continue to limit earnings on our invested cash even with the higher cash balances.

The Company's effective income tax rate was 26.9% for the third quarter of 2010. In the third quarter, we reported a favorable income expense adjustment of $7 million associated with the repatriation of foreign earnings undertaken in the fourth quarter of 2009. Additionally, the tax rate also reflects the tax charge associated with the Caen facility sale. Absent those two items, the Company's effective income tax rate was 27.6%, in line with the historical trends.

In terms of the balance sheet, we ended the third quarter with $4.51 billion of cash and marketable securities, up $1.56 billion from year-end of 2009. As a reminder, we have $1 billion of debt on the balance sheet associated with our January, 2010 inaugural debt offering.

Asset management remains under solid control as AR days ended the quarter at 59. This represents a decrease of two days compared to the prior year. Days in inventory finished the quarter at a disappointing 174 which was up 11 days sequentially versus the second quarter and 10 days against the prior year level. Excluding 2009, the third quarter has always been our historical high water mark for inventory. This year is a touch outside of that range, and we are clearly expecting a stronger finish before the year is out.

On cash flow, we continue to perform well with cash flow from operations of $428 million and free cash flow of $424 million. On the share repurchase program, we did not execute any additional repurchases in the quarter.

In closing, we feel good about our results and the financial stability that our diverse base of businesses create for our Company. Against these results and as provided in our press release, we have increased our full-year performance expectations to the upper end of the targeted ranges to include a net sales increase of 7% to 8% in constant currency versus the previous 5% to 8% range. This will result in adjusted diluted net earnings per share now anticipated to be in the $3.27 to $3.30 range, representing an increase of 11% to 12% over 2009 adjusted diluted earnings per share. This is versus the prior guidance of $3.20 to $3.30.

In summary, our Q3 results have us firmly on track to deliver the high end of the range we established back in January. I'll turn it now over to Steve.

Thanks, Curt. In summary, we feel really good that despite less favorable market dynamics in some of our markets, we are again delivering at or near the top end of our commitments. The last few quarters underscored the strength provided by the breadth of our unique sales footprint.

Additionally, we will continue to look for opportunities to leverage our balance sheet in order to strengthen our core as well as broaden our presence in adjacent markets. And our accelerated pace of investment in R&D will also drive internal innovation and help further broaden our portfolio of value-added products and services.

In short, we like where we're headed. With that, we will now open it up for Q&A. Jeremy, back to you.

(Operator Instructions) Our first question comes from Rick Wise of Leerink Swann. Please proceed.

Hello, everyone. This is Rich in for Rick. Thanks for taking the question. Great quarter. I just had a couple of questions. Just to maybe start off, when you talked about your overall pricing, you said it was down 1.8%. Is that just pure ASPs, or is that your total pricing with mix or without mix?

Your assessment was correct. We said it was down 1.8%, 30 basis points down from what we reported in the second quarter. And, that's total Company pricing independent of any specific segment call out. And, it's without mix, to your question.

And, you still feel that, that mix is broadly offsetting that or capable of offsetting that for the foreseeable future?

We certainly believe that mix is still a positive component here.

Our next question comes from Bob Hopkins of Bank of America. Please proceed.

Thanks. Can you guys can hear me okay?

Yes, Bob. Thanks.

Great. So just two questions. One, Steve, for you on pricing. And, then one follow-up as far as a broader question goes. First on pricing, we've now seen results from you guys in BioMed and J&J. And, J&J talked about no real changing in pricing for hips and knees. BioMed said it got a little worse in OUS but the same in the US. And, now, you guys are saying for hips and knees, it's pretty much the same as it has been the last couple of quarters.

With that in mind and given what's going on around us in terms of the -- all of the anecdotal evidence out there about the pressures on hospitals and the like, I was wondering, Steve, if you could comment on your outlook for pricing for hips and knees for the market as we look forward into 2011. How confident are you that you think things can kind of stay in the same range versus perhaps get worse? Just would love your thoughts on the hip-knee pricing outlook for the market.

Bob, I think we've had three quarters that are actually pretty consistent now. That probably bodes somewhat well. I also think that at some point here in time, as we have new products that launch and get more premiums and, as people come back into the markets -- I think we're still more bullish on the markets longer term -- but, recognizing we're in a choppy period right now and hard to exactly call the end.

I think to me, the big message is regardless of what keeps happening in this environment, we keep delivering. And, I think there's been, as we've said all year, there's been so much focus. And, it's back to like 2005, people looking at extreme -- expecting extreme movements that frankly are not really occurring. And, that are again -- we can power through some of these changes.

Okay. So, basically, not to put words in your mouth but, as you look forward from what you see right now, you don't see a dramatic change in the outlook for pricing as it relates to hips and knees?

Fair comment.

Okay. And, then the second question I wanted to ask, there was some speculation inter-quarter about certain assets that you guys might be considering buying. And, I don't expect you to comment on that. But, I was wondering if you would just take this opportunity to kind of refresh us on, in a little bit more detail around your philosophy around the kinds of things that you may be interested, your philosophy around M&A and dilution. And, just kind of an update on that front, if you would, especially in light of the cash that continues to build. Thank you.

Bob, it's Katherine. I'll jump in here and really kind of reiterate what we've articulated on prior calls and at meetings, which really speaks to a three-pronged cash strategy. We continue to believe that M&A makes the most sense in terms of being our preferred use of cash. But, it's part of that three-prong M&A, dividend, share buybacks with any mix of those taking place.

We haven't called out, and we won't be, any particular areas at our focus. Other than to say that we continue to focus on our core as Steve mentioned on the call, we have a very unique broad set of businesses that allow a lot of opportunities to leverage our core. I think Gaymar Industries is a terrific example of that.

And, we'll also continue to look at opportunities that are adjacent to our core markets. And, we would view the Ascent acquisition last year, as an example of that. That has been the strategy we've been executing on. And, we don't have any plans to change that going forward.

Our next question comes from David Lewis from Morgan Stanley. Please proceed.

Well, good afternoon.

David.

Steve, your comments on the call are pretty clear that you saw some stabilization certainly in isolated pockets of the Orthopedic market, your specific orthopedic segments in the US and OUS. Can you can comment on that stabilization -- some very modest improvement. How those trends have sort of -- how they trend sort of inter-quarter through August to September and perhaps into October. Are we still in this stabilization mode to slight improvement or have you seen a more sharp improvement.

Yes, I'll probably just jump in here. We have not -- probably not going to go down -- actually, we're not go down the path of inter-quarter updates on trends. We are really just focused on the quarterly trends. And, going back to the comments, we haven't seen anything materially change from Q1 to Q2. And, that's probably the amount of granularity we want to get into.

I'm sorry, Katherine, but Q1 to Q2, but Q2 to Q3 --

Yes, sorry, the comments were in Q3, we haven't seen anything materially different going back to the prepared comments from what we saw in either Q1 or Q2.

Okay, fair enough. And then Curt, just thinking about gross margins. Obviously, there was some inter-geographical FX things driving GM improvements. But, if we look at a go-forward basis, assuming your higher margin products are underperforming right now. Is it safe to assume to the extent that you can see stabilization and growth in those products going forward, we should start seeing more significant mix impact on the P&L, which would be positive for GMs heading into 2011?

Well, David, it's a great question. And, I think it gets into where the gross margins are, for those products that you're referencing. And, the stability -- stability is different than growth. And, obviously, the more volume we put through on those, the better the gross margins are going to be. So, I think it's a little bit early to call those returning and being contributing factors at this point in time. Because we would like to see more growth out of them before we would comment on additional influence to gross margin.

Our next question comes from Matt Miksic from Piper Jaffray. Please proceed.

Hi, thanks for taking our questions. I just, -- if I could just clarify a couple of things that you said here. Bob's question and David's question on volume and pricing, either Katherine or Steve, just it sounds like you've seen pricing that has kind of -- it's not much different in Q3 than it was in Q1 or Q2. Clearly volumes, right, took a step down in Q2 from Q1. And, then so, I guess then on the volume side, are you saying that from Q2 to Q3 things didn't get materially worse? Is that what I heard you say, Steve?

Yes, I think that's -- I'll just jump in. I think that's a correct statement. Clearly, volumes are seeing the impact from the economic environment; people deferring surgeries. Recognizing, all our checks indicate, this isn't something you can permanently defer. Although, clearly calling the quarter, when those volumes start to improve, is a bit tough. It's just something that we would anticipate happening as we go forward. But, no material change on that front either from -- versus what we saw in Q2 as it relates to volumes.

Great. Then I had one on the P&L, and one just -- maybe some color on OUS trauma. So, in terms of what opportunities you have, either that you are executing on in kind of this modest growth, top line environment, certainly in devices.

You could talk about what kind of restructuring efforts you have underway? Anything you could do to sort of quantify what they could mean for the P&L over the next quarter or next -- going forward? And, then just as a follow-up, OUS trauma a little on the weak side. Love to know how much of that was volume, was it comps, was it Japan pricing? That would be helpful, thanks.

Matt, this is Curt on the -- I think to use your words you said the projects. We're probably not going to get into any specifics. I think the message we want out is that as demonstrated over the past year, as a normal part of our business routine, we're constantly evaluating our operating models and making adjustments where appropriate. And, we're not going to pin a number out there and drive our business to that number. Rather, we're going to continue to evaluate the operating model and make the adjustments as necessary.

On the trauma and the OUS component or the slower growth OUS. I don't think there is one thing we would point to here. It's certainly not -- I wouldn't be pointing to Japan price cuts. Those had far less impact on trauma this year, than they did in the other segments of the business. So, I do not think we would point to Japan as a key driver there. It was a little bit all over the board. I think, generally what we would say is third quarter was a little bit slower trauma season, if you will.

Matt -- Jeremy, I'll just jump in with an additional point here, Matt. Back on the projects, I would give an example of just the constant evolutionary changes we make. If you recall, last year we discontinued a series of products in our knee franchise for Europe. We've been paying the price on the top line growth rate for this year. But from a bottom line profitability, we had always decided that was going to make us stronger for the Company.

We're constantly doing a lot of things like that that aren't as obvious. But, that we do sometimes pay a price for in terms of reported sales growth. And, not just going for sales growth at all costs, as we get smarter.

And frankly, the whole quality initiative that we've been through has helped shine a much brighter light for us on some of those opportunities and, has resulted in some of those actions that frankly were depressing pieces of our growth rates for periods of time while we go through this. But, we really do think are making us a fundamentally stronger company.

So hopefully, Matt, that gives a little more context to you. All right, go ahead, Jeremy, next question.

Our next question comes from Adam Feinstein from Barclays Capital. Please proceed.

Yes. Thank you. Good afternoon, everyone. I guess, just to follow-up with some of the other questions here. Clearly, the growth outlook within the core ortho-recon business is lower for everyone. And, certainly you guys have done a good job of managing through it. But, clearly, this seems like a lower than normalized growth rate.

So, with that backdrop, what do you guys think the implications are in terms of strategy, competitive backlash. And, certainly, your comments earlier about acquisitions being the first choice in terms of your use of cash. Would it be safe to assume that acquisitions would be outside of any ortho business. Similar to what you guys have been doing. But, is that point, I guess going to be a bigger area of focus just due to the lower growth rate here. So, kind of a bigger picture question there. But, just curious as you guys think about that, what do you think the implications are?

Okay, I'm going to take part six of the question.

Okay.

And, just in terms of the M&A. And, really just go back to what we articulated in the beginning. We're really not going to focus on specific areas other than reiterating what we've tried to express throughout the year and at various meetings. We are focused on our core, Gaymar, and we are focused on adjacent Ascent, being an example of that.

But, as you get down really granular, looking at the different divisions and the like, it just doesn't make sense for a lot of reasons for us to comment on particular areas or segments or strategic responses to market dynamics that we may address with M&A.

Adam, I'll take the rest of those -- the question. I think we look at it on a couple of different fronts.

If this is a cyclical downturn in the orthopedic implant marketplace, I think you ought to feel really good about our position as a Company that we can deliver these kind of results with two straight quarters of 1% Orthopedic implant growth. And, as those markets come back, you ought to feel really good about what we can do.

And, if it's a more secular downturn, I can also tell you we have got plans in place for that that we think will benefit the larger players and frankly, some of the players who transcend a number of segments in orthopedics. And we have different plans and different approaches for that way. So, I think we actually don't -- I mean none of us love a market downturn. But, to some degree it may allow us to differentiate. We think we may differentiate ourselves more through this period than just a rising tide on everything.

And, our next question comes from Stephen Lichtman from Oppenheimer. Please proceed.

Thank you. Hello guys. Just the first question, I was wondering if you could give us any more details on the increased R&D investment we're seeing here. Any particular segments where that's focused? Are these longer term bets or more of a refresher product line that we could see the benefits of in 2011?

Steve, this is Curt. I'll take a quick stab at this, and Steve or Katherine may also contribute here. But, I think fundamentally, every one of our operating businesses is looking at both incremental innovation because the market still drives, or incremental innovation; product enhancements, additional features, and benefits. But, I also think that there's probably game-changing innovation that is going on as well.

So, I wouldn't slice our R&D investment into one specific aspect of innovation. I would say rather each of our operating businesses have unique features and benefits that are driving in a given product line. But, I think they are also looking for more, what we would call true innovation.

Some of the stuff that may be qualified as, perhaps, a little bit further out than what the normal business is operated on. But, still things that we feel add value over the long-term.

Okay. Great. And, then just secondly, the OtisMed slight pushout there. Any sense of whether this is related to the warning letter trend we saw with other manufacturers and patient-specific instruments or just a little more time needed specifically with the OtisMed 510(k)?

Yes. It wouldn't be appropriate to comment on what the FDA's process is or how they are viewing some of the competitive products. It has clearly, as everybody knows, become a more challenging market to get 510(k) clearance as PMA approvals. Nobody in med tech is immune to that.

We feel very good about the submission and our ability to respond to questions. But, trying to forecast an exact time is clearly challenging. And, we just figure at this point in the year, it made more sense to start thinking about a clearance coming in 2011.

Our next question comes from Derek Sung of Sanford Bernstein. Please proceed.

Hi, thanks for taking the question. One of the concerns around pricing from kind of a secular perspective has been that a lot of hospitals are moving towards kind of a capitated pricing structure where they're setting one set cost for a certain class of hips. And, saying if a vendor wants to participate at the hospital they must meet that level.

But, I haven't seen though any real statistics on how prevalent that is? And, I was wondering if you could speak as to how much in your customer base -- how much of -- what percent of hospitals you are seeing that might have this kind of structure in place. And, is this a concern that investors should be focused on? Or is this such a small percentage that it's not that big of a deal yet?

I think, it's like a lot of industries in med tech and certainly in our hip and knee business. You're always going to have certain hospital accounts that try and drive very strict pricing or try and limit the number of vendors. And, on the other hand, you have other hospitals that are really looking to ensure they have access to the latest innovation, have carve-outs in contracts. So, it's very difficult to make a blanket statement that X percent of accounts are approaching pricing from a capitated way or otherwise.

What we do see is manageable pricing pressure that hasn't materially changed in our hip and knee market, which should give you some sense of what's happening in the larger hospital market. And, seeing a portion of that offset by mix, which also indicates these same hospital customers are willing to pay for innovation.

Okay. Thanks. And, then on MedSurg, so on the equipment, you saw nice sort of acceleration in sequential growth rates. On the bed side, you saw a step down from kind of the blip that we saw over the last two quarters. Maybe, if you could give us a little color as to what you see driving those and how you think about those moving out over the next few quarters?

Derek, I think our comments on MedSurg, we overall feel good about the core MedSurg franchises; endoscopy, instruments, and medical. And, I think, if you think about endo and instruments, it's those capital sales that had evaporated in 2009 that have started to return. And, I reference back to a comment that Steve has made about the shape of that curve and what it's looking like. And, I think we're seeing those businesses move exactly on that curve.

And, on the medical side, it is a little bit more difficult to predict. And, I think our comments on medical were that while the shipment growth rate was a little bit lower, we feel pretty good about the incoming orders volume as well as the added impact that the Gaymar Industry acquisition will have on that business.

So, I think the overall high level tone on MedSurg is we feel good about the trends, feel good about the outlook here and really like these businesses when they are operating at that 10% growth level. And, don't see anything right now that's going to change that.

And, Derek, just to reinforce that point, I know after the second quarter there were a lot of people wondering is it kind of okay, great, you got one quarter pop or two quarter pop in MedSurg. But, remind you that we have years and years of strong performance in MedSurg and 2009 happened to be the outlier to reiterate Curt's point. I think (technical difficulty).

Our next question comes from Raj Denhoy from Jefferies. Please proceed.

Hi, good afternoon, I wonder if I could ask about Europe. It has been a couple of quarters now you've been feeling the impact of the distributor changeout. And, some of the product discontinuations you mentioned. I'm curious, if you could provide us an update of where we are in that cycle? I mean, should we be anniversarying those trends fairly soon or is this going to continue for a couple more quarters here?

Raj, we really took the charge at the end of the third quarter last year, and since started the downturn in the fourth. And, we are close to the end of that full anniversary period. Some of that will trickle into the fourth quarter. So, I think by the end of this year certainly those distributor changes in product pieces should be behind us.

I think what we're pleased with is there was a clear, albeit modest, improvement in our European business. That went from negative in the second quarter, we think we bottomed out in the second quarter. And, we had modest growth in the third quarter here in Europe. So, we're not declaring victory by any stretch but we think we have bottomed out here.

Okay and just one last one. You know the margin improvements continue to be quite impressive. I'm curious, are we seeing any benefit from the warning letters being lifted here? Are any of those expenses coming off?

I would not view it as the expenses coming off. I would say we have learned a lot, frankly around things like product design that have led to more efficient product designs and other things. But the gross margin, I'll let Curt build on this -- gross margin, be careful not to get too far ahead of yourselves on that one.

We had some currency issues; favorable currency as the dollar has now crept back up. There were -- the last couple of quarters were probably unusually high. We're not quite ready to declare that that's our new ongoing level. But, we do think we'll be continuing to move it forward.

Curt, do you want to build on that?

Steve, I think you hit the nail right on the head. I would not read into any gross margin improvements, a dialback on the quality investment. I think Steve tried to make that really clear in his opening comments that we remain very committed here. We're just entering year three of the program we laid out, and we're very committed to that.

And, the gains that we may by seeing as they relate to quality, are probably some of the efficiencies that enhance quality processes are enabling our manufacturing plants to be more efficient, to have reductions in scrap, and things of that nature that come through the broad implementation of those programs.

As painful as it was to get four warning letters and go through what we went through over the last few years, we really do believe it's making us a better Company. We still have a lot of investment to make. But, I think we see those opportunities paying off down the road.

Our next question comes from Vivian Cervantes from Maxim Group. Please proceed.

Hi, thank you for taking my question. Wanted to follow-up on the comment you had made on secular changes to the recon market and, that having some plans on how to deal with that. Can you sort of balance that out vis-a-vis expectations of volume trends? And, I know you said it has been relatively flat, but volume trends that will continue to be pressured in the near to mid-term. How do you sort of pull on what levers to sort of figure out secular versus prolonged cyclical pressure?

I think, from a planning standpoint, we're going to assume pricing pressure is a more secular event and that we can manage through that. And, volumes, I think we think are probably a little more cyclical. Things like the unemployment rates being high, COBRA benefits going away -- all of that.

At the end of the day, joint replacement surgery is deferrable to a point. But, I don't think we see it just completely going down and, people starting to live life on non-steroidals and hyaluronic acid. There is only so long you can defer it. So, I believe, that is probably a little more cyclical.

And, as a follow-up, when you mention deferrable up to a point, are you noticing that maybe this point of deferrals has been extended? Are we talking maybe six months deferral to maybe a year? Or has there really been no change in your thinking about how long you can defer these types of surgeries?

Vivian, it's just hard to quantify at this point. I think, we would be kidding ourselves, if we said we anticipated the complete slowdown that we've experienced in the last two quarters. And so, whether it continues for another couple of quarters or another year, who knows what in terms of how long people can put it off. I mean ultimately we'd probably think it's quarters -- year, year-ish. But, if people are unemployed for a while or are concerned about going in or do not have the benefits that we really have to see.

I think I would just come back to the fact that we are more than a hip and a knee Company. We love those businesses. But, this quarter again, as last quarter and as years of performance should show. We are not beholden to the growth rates for the performance (technical difficulty).

Our next question comes from Joanne Wuensch from BMO Capital Markets. Please proceed.

Thank you very much for taking my question. Actually, there's two. One, you've talked about the hospital purchasing recovery being sort of a Nike swoosh. Are you still seeing that sort of pattern and where are we on that design? And the second one is, in the spring you launched several new products at AAO; The ADM hip, new cervical plates, kyphoplasty products. Could you give us a little bit of qualitative information on how those may be doing? Thanks.

I'll take the latter part of the question first. And, I think I'll put it against the context, if you look at the total Company and what we've articulated at prior meetings; the Academy, our Analyst meeting, it's a series of singles and doubles. It's very rarely the home run type of product but, it's the collective total of all those products that really allows for the top line growth. And, we would view all of those products as in line with that.

On the hip side, as many of you know and we've talked about it, it's the roll out of a new hip system, particularly something like ADM that is a new design. Concept does take several quarters, typically at least four quarters. Certainly, what we've seen historically and with the launch of Triathlon that's been tremendously successful. It takes four plus quarters to really get the message out there; surgeons trained, starting to use the product, et cetera. And that's the path that ADM and the other products that we've launched are on.

So, overall, we feel very good that they are delivering what we would anticipate. But, recognizing none of these in isolation is going to dictate the performance in a given quarter.

And, I think, Joanne, to your first question relative to MedSurg and where we are in that swoosh, if you will. I think we continue to trend.

I think there are still segments -- I'll use our endoscopy business as a great example. We feel very good about the capital sales results that are starting to materialize there. With that said, we've also said in prior quarters that the communications business, which is an element of the Endoscopy business, still has a little bit more pressure on it because the capital ticket item there is much larger.

So, there are still elements of our capital franchises that are a little slower. But, over time, we think they'll recover as well.

Our next question comes from Bruce Nudell with UBS. Please proceed.

Thanks for taking my question. Just, Steve, qualitatively, it's our impression the hospitals when faced with pressure, basically try to control implant costs because it is a lever they could easily pull. But, on the other hand, they love surgery because that's where they make their money.

Where are they in their thinking? Have profits internally at the hospitals started to improve enough; non-operating revenue, et cetera, so they feel they are planning ahead now? Or, are they just refurbishing stuff they have deferred or a little of both?

And, then, I guess, on the second question is just structurally, when you sit down and do your strat planning given the realignments that are going on, do you think about the major joint market across price and mix as a 0% ASP inflation thing or do you think it's going to be slightly positive or slightly negative? Thanks a lot.

On the first one, Bruce, I think we -- it really varies a lot by hospital. So, it's hard to give a blanket answer. I think, there are a number of larger institutions that really do grasp that the total joint replacement surgery is actually a very good profit center for them.

And, I think that what you had certainly in the advent of the passage of the healthcare bill this year -- I think you had everybody kind of running for the corners trying to get every cost that they could. And, then you have people starting to wake up and say, wait a minute, there are pieces of the business that we make a lot of money in.

And, I just -- I always joke you can't drive across the state of Michigan without seeing at least ten billboards for hospitals advertising. Some had total joints done at their centers. Last I checked, I don't think they are advertising those if they're losing money too much on those.

So, I think there is still a little bit more profitability that will shake out, particularly among the larger institutions. Some of the smaller community hospitals are still certainly pressured to that end.

To your second point, I think we still ultimately believe that mix, will be able to more than offset pricing degradation and we'll see certainly some volume growth in the sector.

Our next question comes from Doug Schenkel from Cowen and Company. Please proceed.

Hello. Good afternoon, and thanks for taking my questions. My first question is another I guess longer term question. Turning over to the MedSurg side of the business, while many are concerned that reform efforts in the US could actually lead to direct or indirect pricing pressure, as many have alluded to, I think there is the belief that volumes could pick up and you actually could see some expansion in certain areas in terms of hospital building and build-outs. Have you thought about the potential for Obama-care actually benefiting your MedSurg business and maybe offsetting some of the areas of potential concern on the recon side?

Doug, I think it's certainly a potential. And have we thought of it? Yes, we've have had a lot of discussions about the Healthcare Reform Act and how it will either positively or negatively impact our business.

Again, I think in one sense that -- and you can put whatever number you want to at the 30 million additionally insured lives -- I think our opinion would be a lot of those are already getting healthcare. They're just getting it under a different forum than the insurance proposal that is out there.

And, on the other hand, if there is a better way that requires additional equipment, we're certainly there and ready to support that expansion of the market. I don't think at this point in time, we're banking on anything one way or the other perhaps except the excise tax that we know very clearly is going to be an adverse event for companies in the med tech space.

Doug, to build on that, for all of the pricing pressure we may feel here and now, I think the one thing we would absolutely bet on is, there is going to be more money spent on healthcare going forward both in the United States and around the world.

Our next question comes from Mike Weinstein from JPMorgan. Please proceed.

Thank you for taking my questions. I wanted to focus on MedSurg, and I guess two questions. MedSurg has been so volatile the last two years. It was, obviously, in a much stronger downturn in the first -- call it, three quarters of 2009. And, we were all expecting -- and here's it's had this much a stronger upturn than we were expecting, the company was expecting.

Do you have visibility on the whole question of inventories? It would seem that there could have been some inventory drawdown, and not necessarily in terms of not talking about your inventory but, talking about the hospitals inventories and how they are managing them, and how they are thinking about, particularly, on the instrument side, on the endoscope side? And, do you think there was drawdown in 2009 and that maybe you're getting some bounce back in 2010?

And then from there, the second piece is how do we think about your contribution within MedSurg from volume mix and price? And, if you can give us any sense of what that 16% constant currency growth -- how that breaks down? That would be great. Thanks.

Well, Mike, on the first question, I'm not sure if I would say that 2009 was an inventory drawdown. And, I'll kind of start my questions -- or my answer with on medical, it was a flat out, we're not buying right now. And, that's a capital equipment purchase.

On endoscopy and instruments, as you're aware they both have disposable components of the business. That component of the business is what I would call very realtime. They either order direct from Stryker or they go through various distribution partners that have very realtime inventory levels that are maintained through par level management.

It was the capital equipment in 2009 in those businesses that slowed down. And, that was either their capital equipment replacement or expansion cycle that slowed down. And, now what we're starting to see is a return of those investments.

It's a deferral that can only be deferred for so long because you're fundamentally rechanneling new dollars into repair dollars. And, and you can only do that for so long. So, I think we're just seeing those healthy institutions needing equipment replacement cycles to occur. And, that's what's really driving those businesses right now, along with our normal stream of new product introductions that go on in those businesses.

As far as the 16%, I think, we called out that 6% of that came from Ascent. So my first slice would be 6% is acquisition. The remaining 10%, I would say that we're not going to get into price-specific commentary relative to those three segments, and, it's all wrapped into that 1.8% decline that the total company felt. So, probably gives you an indication that pricing pressure in MedSurg is no worse or no better than what it has been on a historical basis.

Again, the cycles for new product innovation in MedSurg are a little bit shorter because a majority of items are 510(k). So, you're getting a little better mix outcome in those businesses as the new product pipeline coming out of the quality remediation efforts continues to ramp up and new items hit the market.

Our next question comes from Glenn Novarro from RBC Capital Markets. Please proceed.

Hello. Two quick questions, one on the surgical equipment side. Those sales came in well above our forecast. And, I was just wondering, were there any one-timers or big purchases on the quarter, is question one.

No.

Okay. And, then on the M&A side, maybe to ask the question a little bit differently. The fact that you're not buying back stock? Does that mean like the queue of M&A is pretty full at the moment? Thanks.

Glenn, we're probably not going to get into many specifics here other than to go back to what I think Katherine tried to lay out pretty clearly at the beginning, which was we prefer to use our cash for M&A. But, we do have a three-pronged approach which includes dividends and repurchase and M&A. And, that those are in addition to the normal working capital requirements of our business.

So, really what we hope is that over time when you look at all three of those elements, you see the best possible investment, leading to the best possible returns for shareholders. By being very judicious on how we assign dollars in each of those categories versus one specific bucket in any given quarter.

Our next question comes from Kristen Stewart from Deutsche Bank. Please proceed.

Hello. Thanks for taking my question. I was just wondering in light of the med [tech] panel that was just a couple of months ago, if you guys have updated your thinking on OP1?

We have said we'll give you an update by the end of the year, and we're on track to do that.

Okay. And, then obviously with MedSurg, the comparisons year-over-year are a little bit easier. Just trying to get a sense, as you look at the business, where do you think a more normalized run rate is at? Do you feel confident that it can be mid single-digits? As we look ahead, obviously, we're going to be anniversarying some tough trends. But, where do you think MedSurg overall can grow out?

We absolutely think it can be in mid single-digits. No problem.

Our next question comes from Jeff Johnson from Robert Baird. Please proceed.

Thank you. Good afternoon. Steve, let me just follow-up I guess on your last answer there. No problem on the mid single-digits MedSurg, meaning, you could foresee it being higher than that as well fairly easily?

I would go back to we gave the revised guidance for the full year up to the upper end of the range. I don't think anybody is assuming some dramatic reacceleration in the recon market. Our comments spoke to the fact -- expect it to improve over time, and we have one quarter left. So, that gives you a sense of what is driving the components to get to that revised guidance.

Understood, Katherine on that. I guess Steve sounded pretty confident there. Just wondering qualitatively longer term is mid single-digits the base of what your expectations would be, Steve?

We're not getting into longer term guidance at this point, Jeff. We'll give the 2011 guidance in January. But, I'll just point out we've had a long, long history of building very good MedSurg businesses. And, we continue to believe in those businesses.

Our next question comes from Bill Plovanic from Canaccord. Please proceed.

Great, thanks. Just a couple of questions here. One, you talked about the discontinuance of some products in Europe. And, I know you addressed the distribution changes. Is it fair to say as we go through 2011, we'll be clean on all of the comps and see more normalized growth rates?

And then two, just kind of on the hospitals, you did talk a little about pricing, the way they are thinking. Has there been any change in the way they look at carve-outs and think about that and maybe include or exclude that as you go to negotiations with them in the future? Thanks.

I'll take the second question first. No, there has been no real change in terms of how hospitals think about carve-outs and wanting to be able to have access to innovation. And, a lot of this is still a Physician's preference item, as you look at the hip and knee market. And, in terms of the first part of your question --

Bill, the first part of the question really distributor and product obsolescence that does specifically relate to Europe. And, we are sunsetting those events and really would not expect to see any of that on an adverse side as we head into 2011. That said, as I mentioned earlier, we continue to evaluate our business and we'll take opportunities to make adjustments where appropriate. But, we have with this quarter now sunsetted the changes in Europe.

Our next question comes from Charles Chon from Stifel Nicolas. Please proceed.

Great. Thanks for taking the question. Hips in the US saw some nice sequential acceleration, which is a different sequential trajectory from what we've been seeing from other companies. Can you can speak a little bit more about what drove that sequential improvement? Was it volumes or maybe you guys launched some products earlier this year, could it be mix?

It's beginning to get some traction with our new products.

Okay. And, the follow-up question is actually a similar one for US spine, again, trends firming up there. Is that also volume driven or is that new product mix driven?

I would just caution the sequential improvement in spine, although it's better than a sequential decline, it's still very modest. That business was flat domestically. So, we'll look for that to gradually get better. But, I think it's way too early to ring any bells that new products are having a meaningful impact.

And, even hips was a little bit better. We're not declaring victory on that one.

Our next question comes from Matthew O'Brien from William Blair. Please proceed.

Good afternoon. Thanks for taking the question. Just a follow-up on that last question a little bit. When do you think we'll start to really see the firm traction from those new hip products? Is it kind of a Q1, Q2 event 2011, or a bit farther out?

As we talked about earlier in the call, as you think about reconstructive markets and a long history of having product rollouts here. It typically takes four plus quarters before new products start to get meaningful traction. And, we rolled these products out during the first quarter. So, we would really look to start to see more of an impact in 2011.

And, just one more -- just one last one. Everybody is focused on the pricing dynamic right now, and then the offset on mix. But, what levers do you have to offset further pricing declines, be it service or elsewhere, from these levels. Say, if it was to go from the kind of the negative 2% where it's been in this quarter to negative 4% or something along those lines going forward?

I would look at it this way, we went from a positive several percent a couple of years ago, down to zero to minus two. And, we've continued to grow pretty healthily through that. We continue to look both at the gross margin line, in terms of the cost of goods side, as well as, frankly the middle of the P&L. And, I think we continue to feel that we can deliver in whatever environment is coming at us.

And, our next question is from David Roman from Goldman Sachs. Please proceed.

This is actually, Topher Orr in for David Roman. I have a quick question about CapEx spending in Europe. Kind of where you saw it over the past quarter, where you guys see that going for the next six months and, kind of how it relates to domestic spending. Thanks.

Our Instruments business had a pretty good quarter in Europe; a little bit of capital, a little bit of disposables. I think, frankly, we're still not that exposed to the capital market in Europe. We do not really have much of a medical business there. Our endo and instruments businesses are heavily disposal and some capital.

So, even if it comes down a little bit, I think, again -- I think, what I would remind everybody of is with our diverse footprint, no one of these things knocks us out one way or the other. And, people freak out whether it's hip pricing or knee pricing in the United States or Japan, or capital spending in Europe and all of these things. And, I think again, we just somehow quarter after quarter feel pretty good about our ability to muddle through these.

I think with that, Jeremy, that was the final question as well, I believe right?

That's correct, Sir, there are no more questions.

Great. I think that probably wrapped it up reasonably well. And, again, I think we continue to deliver. And, we'll be back with you to report our fourth quarter, which will also be our full-year operating results on January 25 of 2011. Thank you everyone.

Ladies and gentlemen, that concludes today's conference. Thank you for your participation. You may now disconnect. Have a great day.