史賽克 (SYK) 2011 Q2 法說會逐字稿

Good day, ladies and gentlemen, and welcome to the second-quarter 2011 Stryker earnings conference call. My name is Derek and I'll be your Operator for today. At this time, all participants are in a listen only mode. We will facilitate a question and answer session towards the end of the conference.

(Operator Instructions)

As a reminder this conference is being recorded for replay purposes. I would now like to read the forward-looking statement.

Certain statements made in this presentation may contain information that include, or is based on, forward-looking statements within the meaning of the federal securities laws that are 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. Such factors include but are not limited to -- weakening of economic conditions that could adversely affect the level of demand for the Company's products; pricing pressures generally, including cost containment measures that could adversely affect the price of or demand for the Company's products; changes in foreign exchange markets; legislative and regulatory actions; unanticipated issues arising in connection with clinical studies and otherwise that affect US Food and Drug Administration approval of new products; changes in reimbursement levels from third-party payers; a significant increase in product liability claims; unfavorable resolution of tax audits; changes in financial markets; changes in competitive environment; and the Company's ability to integrate acquisitions.

Additionally, information concerning these and other factors are contained in the Company's filings with the US Securities and Exchange Commission, including the Company's Annual Report on Form 10-K and Quarterly Reports on Form 10-Q.

I would now like to turn the call over to Mr. Stephen MacMillan, Chairman, President and Chief Executive Officer. You may proceed.

Thank you, Derek. Good afternoon, everyone, and welcome to Stryker's second-quarter 2011 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. Consistent with prior calls, I will make some summary comments regarding our quarterly results before passing the call over to Katherine and Curt to provide more specifics.

We'll start with a summary of some of the key accomplishments realized in the second quarter. With sales coming in at over $2 billion, we delivered a 16% increase, with a 6% gain excluding the impact of currency and acquisitions, representing a solid 2 point acceleration in our underlying organic growth from Q1. And with double digit constant currency growth for both our US and international businesses, the top-line performance was geographically balanced.

Two, our reconstructive businesses, including hips, knees, and trauma, achieved stronger top-line growth sequentially.

Three, meanwhile, our MedSurg franchises once again helped drive our double digit top line, with medical the clear standout at 39% growth. And our Neurotechnology business continued to build on the momentum achieved in Q1 due, in large part, to the ongoing rollout of the neurovascular product offering, while our Spine franchise also saw sequential improvement, as well.

Four, our solid sales growth contributed to a 13% increase in adjusted diluted net earnings per share to $0.90. Five, we also continued to strengthen our core product offering, and utilize our cash flow with the announcement of 2 acquisitions during the quarter, Orthovita and Memometal, both of which have since closed. We are excited about the opportunity to leverage each company's unique product offering through our considerable sales force to drive stronger top-line growth.

As always, given the considerable breadth and size of our myriad businesses, each quarter presents us with some challenges. Although we are pleased with the building momentum in our hip business and the expectation for improving knee growth, given the recent FDA clearance of our customized cutting guides, the overall macro environment remains difficult. Nonetheless, we believe we are well positioned to gain market share in both hips and knees on the heels of new product launches.

In summary, our Q2 results underscore a recurring theme that many of you who have followed our Company are familiar with. The benefits provided by the balanced diversity of our businesses and our unique sales footprint that spans medical device implants, as well as key operating room disposables and capital equipment. This model provides tremendous overall consistency of our financial results, and we believe will increasingly differentiate us with our hospital customers.

We started the year with the expectation we would deliver adjusted diluted EPS in the range of $3.65 to $3.73, an increase of 10% to 13%. Given our solid performance through the first 6 months of 2011, we remain confident in our outlook for both sales and earnings. We will continue to focus on leveraging our unique sales footprint, to accelerate growth organically through internal R&D along with supplemental acquisitions, while maximizing shareholder returns through dividends and share buybacks.

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

Thanks, Steve. Similar to prior quarters, my comments today will focus on acquisitions, elected procedure trends and implant pricing.

First, on the acquisition front, we continue to execute on our stated strategy of leveraging our balance sheet and cash flow to pursue M&A. As you are aware, we completed the acquisition of Neurovascular in the first quarter, and continue to be pleased with the market's reception to the new product offering that includes both the next generation coil as well as detachment system.

Turning to Q2, we announced two more acquisitions that are focused on strengthening our core product offering and leveraging our broad distribution channel and selling capabilities, a key aspect of our M&A strategy. Specifically in late June, we closed on the acquisition of Orthovita which competes in the $5 billion orthobiologics market and is a global leader in synthetic bone graft with its Vitoss product offering and also competes in vertebral augmentation with its Cortoss product offering.

In addition, the Company's biosurgery business manufactures hemostasis products such as Vitagel which are designed to control inter-operative and post-operative bleeding. We believe the collective talent of our sizeable sales forces across multiple franchises positions us to build on Orthovita's success and accelerate sales growth.

In early July we closed on the acquisition of privately-held Memometal which manufactures and markets products for extremity indications based on its proprietary methods for preparing and manufacturing a shape memory metal alloy. Memometal is rapidly establishing its differentiated technology in the global extremity device market, with a broad range of products for the foot and ankle, as well as the hand and wrist. With sales in 2010 of roughly $30 million, Memometal's comprehensive and proprietary product portfolio allows us to gain broader access into the fast-growing extremities market. We are excited about the prospects for both of these most recent acquisitions, and similar to prior BD deals, we look for them to help drive our long term organic growth.

Shifting to elective procedures, the macro backdrop and current challenges remain similar to that which we've experienced in recent quarters. As most of you are aware, the ongoing economic softness has been contributing to a slowdown in many elective procedures, including hip and knee replacement. However, despite the current pressures on procedures, we are pleased with the momentum we are seeing from both our new product offering, particularly with hips as a combination of ADM and more recently MDM is helping drive accelerating sales growth. Although our knee performance strengthened sequentially, there's clearly room for improvement. And we expect the Q2 510(k) clearance of our customized cutting guides to help drive share gains in the second half of 2011.

Lastly, on the implant pricing front, the trends are similar to prior quarters with continued but stable pricing pressure, partly offset by mix, particularly as it relates to hips given the new product launches.

And with that, I'll turn the call over to Curt.

Thanks, Katherine. I'll start by saying that at the halfway point our results and the corresponding financial performance are largely on track with the goals we stated at the beginning of the year.

Jumping into the second quarter, Company sales increased 16.3% on a reported basis and 11.9% on a constant currency basis. The underlying core business growth excluding currency and acquisition impact improved 5.7% versus the 4% in the first quarter. On a GAAP basis, diluted net earnings per share were $0.79, a decrease of 1.3% versus Q2 of 2010. Excluding acquisition-related charges, increases are reported US GAAP diluted net earnings per share of $0.79 to $0.90 per share. The US GAAP diluted net earnings per share decline of 1% then becomes growth of 12.5% when excluding the identified non-GAAP items.

Overall, strong results from MedSurg and the Neurotechnology and Spine segments coupled with improving results in Reconstructive supported top-line growth. In general, we're pleased with the momentum we're seeing. Further, our acquisitions continue to perform as expected, and our integration efforts remain large and on track.

With that said, and as we discussed previously, our investments in acquisition integration and the normal cycle of business have resulted in some variation in the presentation of the P&L, which I will discuss in further detail. In reviewing the quarter, I'll start with a discussion of the components of our revenue growth.

In the second quarter, volume and mix contributed 7.2% to the top line, while Company-wide selling prices declined 1.5%, improving from the first quarter's 2% decline but fundamentally in line with recent trends. Acquisitions added 6.2%, and currency contributed to an increase in top-line sales by approximately $78 million and improved the Company's overall reported sales growth by 4.4%.

Looking at our external reporting segments I'll start with Reconstructive products which represented 45% of our sales in the quarter. Reconstructive products include our hip, knee, trauma, and other Reconstructive lines. As noted in the press release, Reconstructive products recorded a 7% increase, as reported, and a 2% increase on a constant currency basis. This was up from the 2% reported in flat constant currency growth in the first quarter.

Knee sales remained challenging, again influenced by a softer market and our lack of a commercial shape-matching offering. Our hip line performed better and strengthened to 11% reported growth and 4% constant currency growth, increasing from the 5% reported and 2% constant currency first-quarter rates. Globally, trauma posted decent results at 11% reported growth, and 4% constant currency growth. Overall, we feel we are starting to see the early signs of the positive impact that our hip lineup is having, and remain encouraged on knees, given the recent OtisMed's shape-matching approval and its potential influence on the second half of 2011.

Next I'll turn to the MedSurg segment which represented 38% of sales in the quarter. For reporting purposes, MedSurg today is comprised of instruments, endoscopy, medical and the Ascent Healthcare business which we have renamed Stryker Sustainability Solutions. MedSurg sales increased a strong 15% as reported, and 12% on a constant currency basis. Acquisition added 1.9% to the reported increase. Overall, the medical segment was the star of the show, delivering 39% reported growth, or 27% excluding acquisition and currency. From a market perspective, sales remain strong in both our bed and stretcher offering, fueled by the replacement and upgrade market.

Our final segment, Neurotechnology and Spine, which represented 17% of Company sales in the quarter, increased 53% as reported and 49% on a constant currency basis. Adjusting for acquisitions and currency, Neurotechnology and Spine sales recorded a 7% increase. Highlights in the quarter include exceptionally strong organic growth from our interventional spine and NSE offerings, as well as the positive influence of the MEDPOR and Neurovascular acquisitions. Spine implant sales remained challenged but did record positive global constant currency growth in the quarter.

Finally, the progress of the Neurovascular business, both from a commercial and integration standpoint, remains on track. Quarterly results included continued strong performance in the US market, as well as positive growth in the international market on the strength of the target coil rollout.

Now I'll turn to the income statement beginning with our gross margin performance. On a reported basis, gross margins declined 410 basis points to 65.2% as a result of the Neurovascular acquisition inventory step-up which totaled approximately $55 million. Excluding this charge, margins were 67.8% in the second quarter which was lower than the prior year by 150 basis points.

I would remind everyone that as we discussed last year, our second and third quarter 2010 gross margins were favorably impacted by currency. This year the impact of the weaker dollar on purchases from our international manufacturing operations is putting pressure on margins. Given first half results and current currency trends, we now forecast margins for the year in the 68% to 68.5% range.

Research and development continued as an area of investment priority, moving to 5.6% of sales, an increase of 21% versus the second quarter of 2010. Absent the influence of the Neurovascular business, total Company R&D spend increased 9%. Selling, general and administrative costs represented 38.4% of sales. Adjusting for acquisition and integration related charges for the Neurovascular and Orthovita acquisitions, SG&A finished at 38% of sales. Of note, we did settle an IP litigation issue in the quarter that drove G&A higher.

Reported operating income decreased 11% over prior year and moved to 20% of sales, reflecting the impact of the Neurovascular inventory step-up and other acquisition and integration related charges. Adjusted operating income increased 4%, while the adjusted operating margin decreased 280 basis points versus prior year to 22.7% of sales.

Other income and expense increased pre-tax income by $10 million in the quarter. Components of this included investment income of $9 million and a $1 million positive impact from interest expense. This was the result of the reversal of tax interest from accruals following the effective closing of tax years 2007 and prior for US federal tax matters, with the exception of the Irish cost-sharing controversy. Overall, the best way to think about this is that our legal settlement in G&A was generally offset by the favorable interest in the interest expense line.

The Company's effective income tax rate was 24.6% for the second quarter of 2011. Excluding the tax benefit associated with the Neurovascular inventory step-up and other acquisition-related charges, our effective income tax rate would have been 25.7% for the second quarter. During the quarter, we settled an open tax controversy with respect to our Puerto Rico subsidiary for years 2006 through 2009. And additionally, as previously mentioned, also effectively closed 2007 and prior years for federal US tax matters with the exception of our Irish cost-sharing matter. Overall, the net impact of these items on our tax expense was insignificant in the quarter.

For the year-to-date, our tax rate, excluding the acquisition-related charges, is 25.9%. And we are comfortable with this for the year, although we note there is downward bias on the rate.

In terms of the balance sheet, we ended the quarter with $2.7 billion of cash and marketable securities, down $1.7 billion from year-end 2010. This balance has been reduced by both the January 3 closing of the NV transaction and the associated $1.45 billion payment, and the June 28 closing of the Orthovita transaction and the $0.33 billion cash payment. As a reminder, we have $1 billion of debt on the balance sheet associated with our January 2010 debt offering.

On the asset management side, accounts receivable days ended the quarter at 59, which represented an increase of 2 days compared to the prior year. Days in inventory finished the quarter at 164, which was up 3 days sequentially versus the first quarter, and 1 day against prior year level. The impact of acquisition-related inventory step-up on the P&L netted a higher dollar amount running through the cost of goods and impacted the DII calculation by reducing days in inventory by 10 days. Keep in mind this includes both step-up for the Neurovascular and Orthovita acquisitions.

Turning to cash, in the second quarter we generated cash flow from operations of $156 million and free cash flow of $106 million. We expect to pick up the pace here in the second half.

Finally, there were no share repurchases in the second quarter. Year-to-date, we have repurchased 4 million shares for a total spend of $250 million. We currently have open authorizations totaling approximately $575 million.

In summary, the second quarter was solid, and through the first 6 months we are on track with our annual goals. Key objectives in the second half include continued acquisition integration, operational focus and a sharpened focus on cash generation.

Turning to our outlook, our guidance, as Steve noted, remains unchanged. Currency remains a positive. And if rates hold near current levels, we would expect third quarter sales to be favorably impacted by approximately 2.5% to 3.5% when compared to 2010. Using current rates the full-year currency impact on top line sales would be an increase in a range of 2% to 3% when compared to 2010, up from the original expectation of 0.5% to 1.5%.

We are maintaining our outlook, calling for a net sales increase of 11% to 13% in constant currency. Excluding the impact of foreign currency as well as acquisitions, sales growth is projected to be 5% to 7% for the full year. Adjusted diluted net earnings per share are anticipated to be in the $3.65 to $3.73 range, representing an increase of 10% to 12% over 2010 adjusted diluted earnings per share.

Finally, we now anticipate acquisition and integration related charges associated with the Neurovascular business and recently completed Orthovita business acquisition to reduce reported diluted net earnings per share by approximately $0.33 to $0.35 versus the previously noted $0.28 to $0.30 given the addition of the Orthovita and Memometal transactions.

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

Thanks, Curt. In closing, we're pleased with our performance through the first 6 months of 2011 which reinforces our conviction and our ability to deliver on both the top- and bottom-line targets we set out at the start of the year. Importantly, our top-line momentum accelerated in Q2 with all Reconstructive businesses achieving stronger sequential sales growth globally. While our MedSurg franchises remain a solid contributor to our top-line growth targets and collectively delivered double digit revenue gains.

Our newest franchise, Neurotechnology, is benefiting from key new product launches. Combined, these performances drove both a year-over-year and sequential uptick in our US, international, and global sales growth. And we are making significant investments in R&D, as evidenced by the 22% increase year-to-date on top of a 17% uptick in 2010, resulting in a steady stream of new product launches across all our franchises, many of which we highlighted at our recent May analyst meeting.

We are leveraging our balance sheet to augment our organic growth through selective acquisitions that strengthen our core and allow us to maximize the strength of our diverse sales footprint with its considerable distribution capabilities. Along with buybacks and dividends we will continue to follow a 3-pronged cash strategy in order to maximize shareholder return.

With that we'll now open it up for Q&A. Back to you, Derek.

(Operator Instructions) Mike Weinstein from JPMorgan.

Thank you. Good evening. Happy birthday.

You remembered again. Very impressive.

Let me ask a couple questions. Maybe Curt can start off. The gross margin line is probably going to get the most attention coming out of the quarter because it was lower than people thought. And you're adjusting your gross margin commentary for the year. I guess the part that we would like to spend more time on is just the FX impact because the dollar, if we look at where the dollar was versus Euro and yen at the time of your first quarter call to where it is now, hasn't moved that much to maybe change how we would be thinking about the impact over the balance of the year. So, I was hoping you could spend a minute on that.

And then, second, maybe you could just talk about the impact of mix, particularly the strength in the beds business this quarter and how that might have impacted your mix. Thanks.

So, two responses there, Mike. First of all, it's really the currency movements from both the fourth quarter and the first quarter relative to the second quarter because it takes time for the inventory to move through our system. Especially when you look at the Reconstructive line which has most of its manufacturing in the European market, Euro-based. And that has slower turns generally in the 7 to 9 month time frame. When you look at mix, given that the medical segment did have strong growth, certainly that will contribute a little bit. But I would tell you, on a relative dollar basis, the medical segment as a percentage of total sales is probably not big enough to meaningfully move the gross margins on a full-year basis.

Let me just follow-up with 1 additional question. And that's on MedSurg because people are going to look at the first-quarter performance and this quarter's performance and see a fair amount of volatility between the different divisions within MedSurg. So, can you just talk about really all 3 the way we've historically looked at instruments, endo and beds? Beds had a phenomenal quarter this quarter, but people always get nervous about that. And then instruments and endo had great first quarters but were slower this quarter. So, what do you think is steady state growth profile of those 3 businesses? Thanks.

I don't think we're going to offer a forward-looking comment on the growth profiles. I think if you think about Stryker Medical, I tried to include in my commentary that the replacement market is where we're seeing the biggest influence from a growth standpoint. And that market feels pretty robust as evident by the trends we saw in the first half of the year. And I don't think we see anything that's going to meaningfully slow that down from a market standpoint.

Certainly, our business has to execute on that front. To your point, the endoscopy and instruments segments did slow down second quarter versus first. But, I think we feel pretty good about both of those as we look to the second half of the year given product line-ups, given the introduction of new products into those businesses across multiple areas. All of that said, they're still capital businesses.

There are purchase cycles that we're working through. And if you look specifically at MedSurg and the instruments segment, the third quarter is their toughest comparable. So, that may slow the year-over-year comparables just a little. But, I think the fundamentals there are still pretty respectable. And we feel good about MedSurg as a category in whole as we look at this year.

Matt Miksic from Piper Jaffrey.

Hi. Thanks for taking our questions. Just following up on the topic you were just talking about, MedSurg, Curt or Steve, if you could expand a little bit on, you talk about replacements being the driver there. How much of this is the ability for you to approach this market differently now that you have Gaymar onboard? Is that having an impact? Or if you can maybe step back and give us a sense of, if you're growing 27% ex-acquisitions and currency, what do you think the market's growing?

The market there is a tough one to predict until our other friends report. But having said that, we thought the Gaymar acquisition was a great acquisition, right in our wheelhouse. It does help us probably more on the margin, Matt. I would say probably the overall market is just a little more robust right now.

And any sense that this Q2 result, are we pulling anything? You mentioned [tempered] comps in Q3 but are we pulling anything out of Q3?

No, absolutely not.

Okay, that's helpful. And then one follow-up on spine. 4% constant currency worldwide isn't historically a phenomenal number, but certainly better than we were expecting. Just, if you could talk about what's been working in Spine. You gave us a sense of what some of the new products are that are coming. Maybe talk about what some of the drivers were in the quarter.

I think you characterized it well, Matt. I think we're seeing stability to gradual improvement. So, some of the trends that had turned negative very quickly 12, 18 months ago have been stable, and we've been retooling and refocusing that organization. Certainly not ready to jump up and say we're back to where we want to be. But, just modest sequential improvement driven by some of the new products and just learning how to better navigate through the current market challenges.

So, not out of the woods yet, but we do feel that we're clearly at a point of stability to a slightly improving backdrop. And certainly, the Orthovita acquisition will be a nice focus for that group given it's also very much in their core.

Derrick Sung from Sanford & Bernstein.

Hi. Thanks for taking the questions. I wanted to go back to guidance here. So, you touched on gross margins. It looks like, though, the tax rate that you put forth is an improvement over your thinking at the beginning of the year. And then also the currency benefit is up. So, is the right way to think of this that the gross margin offsets the benefits that you're getting from both currency and the lower tax rate as we move forward?

I think clearly, if we go back to the beginning of the year and we put out some general guidance on where we thought various elements of the P&L would be, through six months, gross margins a little bit lower, which obviously is a negative impact. But conversely, the tax rate, we believe, has downward bias. And that's probably driven by the mix of where products are manufactured and the geographic tax rates that apply in those markets.

I think what we've tried to imply over time on currency is it's not as easy as looking at top-line currency influence as a straight one-for-one drop through there. Just many elements in the P&L. For the currency on the top line, you also lose it when you convert those currencies into US dollars and look at the cost some of our US divisions take because of that currency conversion. So, I think I would just try to keep gross margin and tax rate as perhaps one offsetting the other, to keep it as simple as possible.

Okay, thanks, Curt. And on pricing, your overall pricing pressure for the Company as a total was down 50 basis points, as you pointed out. You said that the general trends still remain the same. But I was wondering if you could give a little color as to where, at least on a sequential basis, we're seeing that improvement in pricing and if your commentary implies that you think this is a one-time issue. Or just any additional color on that pricing number that you could put out would be helpful.

I think you characterized it correctly. It improved 50 basis points, although it's still down 1.5% in the second quarter, which we would characterize within the normal realm. So, I wouldn't point out and say we've seen some big reversal. Hip and knee pricing remains negative, maybe modestly better sequentially. And offset partly by mix with a little bit better on the mix side, on the hips, given some of the launches.

But overall none of these trends we would call out as outside what we've been seeing. So, certainly better than it getting worse but within the norm that we have been modeling.

David Lewis from Morgan Stanley.

Good afternoon. Curt, not to have a whole run on MedSurg here this afternoon, but going back to this issue of sustainability of that growth. You're talking about the fundamentals. In taking the cap cycle recovery out of the mix for a second, I wonder if you can talk about specific emerging market trends impacting MedSurg. Or is this replacement cycle that you're seeing, is this a frame cycle or is it a surface cycle?

Because, I'm wondering if perhaps actions to reduce hospital-acquired infections are driving an increase in demand for services and perhaps that is the way that we're seeing right now. So, maybe any other granularity you can provide on either services versus frames or on emerging markets would be helpful.

I'm probably not going to get quite to the level of detail you want me to go to, David, but I would certainly hope that any members of our selling organization that are listening would be willing to step up and say we're selling both services and frames given the Gaymar acquisition.

In discussion in review of our business with the folks in our medical entity, the replacement cycle they view is a function of 2 things. Number 1, selling organization focus on both the patient handling and patient transport. But, as well, as on the pure bed side, we've got selling organizations now very focused on those. And I think you couple it with exactly what you said, which is, there are some drivers from a reimbursement standpoint that talk about never events, be it hospital- acquired infection, be it falls, that our technology facilitates very well the elimination of those never events.

So, I think it's part of clinical story but it's also part of focus story. And then certainly the fundamentals of the market are probably better today and have improved every quarter since the bottom in 2009. So, I think it's a combination of right product, right selling organization, and certainly some right market dynamics that are helping out here.

Okay, thank you. And then, Curt, just one quick question on knees. Just in the interest of setting expectations appropriately as it relates to custom knees coming back in the back half of the year -- hips performed as many would have expected this quarter. Knees did not.

How important is getting custom in the back half going to be to performance? What I'm trying to drive at is, which is challenging, trying to separate out the external factors versus the internal factors, and how we should be thinking about sizing the relative improvement with the new products on the market.

David, it's Steve here. I would tell you, I think the shape-fitting is a big deal to us. Having said that, in terms of its ramp, the ramp will be a little slower obviously, but we are rolling out OtisMed right now. Cases are being held. The sales force has been trained on proper labeling and all of that kind of stuff. But I think it was starting to hurt us by not having a custom fit option. And we were probably on the verge of, frankly truthfully, we were starting to lose some surgeons where they loved Triathlon, but frankly, just got finally tired of waiting for us.

And we were probably right at that breaking point here in the first and second quarter after the Academy when we didn't have it. A few docs, I think, had held on long enough and said -- Okay, enough is enough, I'm going to go use somebody else's product. So, now it's a question of getting those back. We feel good that we will. But, as you know in this business, the docs don't come back to you day one. But, I would suspect we're going to be starting to see an uptick here in the third quarter, absolutely. But, it will be, again, probably a little bit more of that freight train getting back in gear.

Joanne Wuensch from BMO Capital Markets.

Thank you very much. Two questions. One, can you talk about the trauma and extremities market? It looks like you had a nice little pick up there in your sales. And then second of all, if my memory serves right, you have a 3-year compliance program that's rolling off at the end of this year. What is your current thinking about that? Thank you.

In trauma we did see a little bit of a pick up. I think it's part organizational focus and probably part organizational enthusiasm around the extremities acquisition.

I don't think any of us are jumping up and down about our second-quarter trauma results. We think there's better days ahead given the acquisition emphasis there on the extremities piece and more work that's being done from an innovation standpoint. So, a decent, respectable quarter but we think there's more to do there.

Relative to the compliance spend, it really relates to the 3-year investment that we've laid out. That starts rolling off in the second half of this year, or the project, the focus, the journey, whatever you want to call it, formally comes to an end. But, the reality is, when you look at the acquisition track we have been on, and the facilities that that brings, there's plenty of acquisition integration from a quality compliance systems standpoint to keep us very busy.

There's the 1-time events in the quality journey that probably have come and gone. But there is a new level of base spend that is in our cost structure. And really what we hope to see in the years ahead is the benefit of that quality infrastructure starting to play out in terms of lower scrap rates, lower labor variance, lower warranty return rates. It's far too soon to see any of that showing up in the P&L right now.

Jason Wittes from Caris & Company.

Hi, thanks a lot. So, just some follow-up questions. First off, in terms of Otis Med, you're implying that it's become a lot more important in the last, say, six months as the market has gotten used to the concept with some of your other competitors out there. I'd love to hear your opinion in terms of what percentage of the market is really going to think to use this right now, and I think what the ultimate potential is. The way you're talking, it sounds like the majority of doctors are thinking about converting over to this type of approach.

Jason, I'll take the first question. Tough to know, obviously, ultimately how much penetration shape-matching will have. Some of the data we've seen, it's maybe around 10% of knees. We think it has the potential to go higher but a lot of that will be longer term, multi-year in nature as there's more clinical data produced that validates many of the benefits that clinicians believe they're seeing -- shorter procedure times, better consistency, improved outcomes but that there is not yet a pool of data to support definitively.

And that's probably what will be needed over the next few years to really drive the broader market acceptance. So, we think the trend is going to continue upward. Over what time frame and to what magnitude is probably too speculative to call out. But, we do think there's a nice opportunity for clinical data to help drive some of that adoption.

Okay. And similarly, if I looked at your hip number, you did provide some color but I'm curious, is most of the growth that we saw mix related or do you think you're winning back competitive accounts this quarter?

A little tough to know until we see everybody's new numbers come in. But, we do feel that having a product, the combined offering ADM and MDM in the large hedge segment of the market, is a nice alternative. And, it obviously gets us into a segment of the market that we weren't in previously. So, obviously the hope would be we gain market share. That's the expectation with the product launches but really couldn't say definitively until we see everybody's numbers coming in.

Bob Hopkins from Bank of America.

Thanks, good afternoon. Thanks for taking the question. Just 2 quick ones. First on the OtisMed side, other companies have suggested that their products have a similar look, are able to gather maybe $1,000 to $1,500 price tag per procedure. And I was just wondering, is there any reason why pricing of your shape-fitting technology would be materially different from what we're seeing in the marketplace from other competitors?

I don't think so.

Okay. And then on the bed side, I'm having a hard time wrapping my head around a 27% growth rate for that business ex FX and MA. And I know you're in the sweet spot of a lot of nice trends here. But, just from a big picture perspective, are you guys confident that this is a cycle with real legs here? Is this something that you think can continue for a while? Just would love some big picture thoughts on that division. I know we've talked about it a lot already, but, just want some big picture thoughts.

Bob, to get your head around the number you just have to meet our sales force. Come to one of our sales meetings. That wouldn't quite work, but that would give you the confidence as to how they're doing it. Having said that, this number, we have to tell you, it shocked us too. Let's be honest. You don't have quarters like this very often.

But we do think a sustainable rate -- right now medical is in a pretty good cycle. Is it going to be another 27%, 37% kind of quarter? We can't possibly forecast anything like that. But, the orders trends have been pretty good right now. And I think we feel over the course of this year, medical is going to be one of those businesses that delivers more revenue in 2011 than we expected at the start of the year to offset some of the others that won't. But, we'll have to continue to see where it goes. But, we still feel good about the long-term fundamentals of that business.

Glenn Novarro from RBC Capital Markets.

Hi, two questions. First on the revenue guidance -- you maintained organic constant currency of 5% to 7%, but you actually had a better-than-expected underlying quarter. And we're now adding Orthovita and Memometal into the numbers. So, I'm curious why you didn't take that number up a little bit. Is it just conservatism or is there something other than the macro that you're concerned about? And that's question one.

And then, Curt, just one question on the gross margin -- we've talked about it on the call but down 100 basis points. Can you quantify or elaborate what part of that down 100 basis points relative to consensus was FX? Thanks.

I'll take the first part of the question. A couple of points -- I think most of you on the call know us well enough. We tend to outline commitments that we're fully committed to hitting on at the start of the year. We are midway through the year. It's still, some markets are challenging. And although those acquisitions obviously are additive, they will have a 6-month contribution.

Also keep in size -- this was a relative size. So, it still is consistent with the addition of those into our total targeted range. To be fair, it does obviously increase our conviction in the higher end to the degree that those are additive. But, overall the range, it doesn't materially impact that range.

Glenn, on the second question, I'm probably not going to get into the minutiae there and break down the decrease relative to people's model. Suffice it to say it's a combination of pricing, currency that all influence the ultimate gross margin. And they all contributed in the quarter. So, hopefully what we've tried to do here is restate our outlook for the second half to give people a sense of where we think things are going to finish as we look at what's in front of us.

Michael Matson from Mizuho Securities USA.

Thanks. I was just wondering with regard to Orthovita where that revenue will be recorded. Is it going to be split between Spine and instruments for the vertebroplasty portion? And are you maintaining their sales force that they had?

So, a couple questions there. The revenue will be split. You'll have the Vitoss product which is carried principally by our Spine selling organization. You have the Vitagel product which will be carried by a combination of selling organizations, both part of our Reconstructive group and part of our MedSurg group.

And then the Cortoss item will be carried by our interventional spine group, which as a reminder is now reported publicly in the Spine and Neurotech segment. So, if you divide all that up, you'll see the biggest segment of it in the Spine and Neurotech public reporting, and then a smaller slice in both MedSurg and Reconstructive. And, obviously, we're just 2 days remaining in the second quarter. We closed the transaction. We're in the process of integrating that organization and that's inclusive of their US selling effort.

Okay. And then I just had a second question. In your hip business, I remember maybe it was a year or two ago you launched a modular stem, I believe it's called Rejuvenate. I haven't heard you talk a lot about that really recently. Is modular neck stem still an opportunity for you guys, and how is that particular product doing?

I would say it's part of that portfolio of hip products. I wouldn't call it out specifically as having a major impact. But then again, as you know, that's generally true for the entirety of our portfolio, more in that singles and doubles. So, it's just a part of the product offering to be able to have a comprehensive portfolio for those doctors that want a modular offering. But, beyond that I wouldn't get into any specifics about how that individual product was faring.

David Roman from Goldman Sachs.

Good afternoon, everybody. Curt, I was hoping you could just clarify, from your prepared remarks, you mentioned that there was some moving parts with respect to where certain items were accounted for in the P&L. Could you just remind us of what those were? And also can you quantify the impact of some of the charges that increased G&A in the quarter?

So, David, the first thing I'd probably do is correct the statement. There is no question in my mind whatsoever we have accounted for everything in our P&L exactly the way it should be accounted for. What my comments were is that in the presentation of the second quarter P&L, I think it's a fair statement to say it probably doesn't line up with any of the models that anybody created. And that starts with the gross margin level and probably goes all the way down to the tax rate, inclusive of G&A being higher than people probably modeled because of the IP legal settlement that we settled in the quarter.

And then you had some tax controversy that settled. And part of the settlement of tax controversy is you unwind accruals, and all the interest that built up on those accruals can come back through the interest expense line. And that's where you saw interest expense actually be a positive this quarter versus the traditional negative that interest expense is. So, I think the way I would summarize is, we had lower gross margin, really attributable to some of the manufacturing and how currency moves through there.

We had higher G&A associated with an IP settlement. We had better than probably modeled interest and other income because of that reversal of tax interest. And then, we had a lower tax rate which is really driven by the mix of products and where they're geographically manufactured. So, that's how I would package all of that.

Okay, that's helpful. And then, Steve, maybe to follow up on your comment regarding the OtisMed rollout -- and obviously, we understand that there's a training element with surgeons in it, and I think other products that your peers have launched have taken anywhere from 6 to 12 months before we started to see a material impact.

Have you seen accounts where custom cutting blocks have been adopted? Have you lost just certain business in those accounts or have you lost full accounts and this is really an effort to regain those lost accounts? Or is this more gaining back parts of accounts that you might have lost certain pieces of business in?

In most cases, it's gaining back parts. So, a doctor might have been using both hips and knees and got tired and wanted to use somebody else's knee. And I would say that was really just starting to happen in the second quarter. So, it will be more, I think, turbo charging a lot of our existing surgeons and then inching away and getting some competitive ones along the way.

Matt Taylor from Barclays Capital.

Good afternoon. Thanks for taking the question. Just wanted to tick-and-tie a couple smaller points here. If you could comment a little bit on the Ascent acquisition, how that's trending. I don't think we've talked about that yet.

Second quarter Stryker Sustainability Solutions business had a better quarter than the first quarter. I think we commented after the first quarter there were some competitive market responses, not surprisingly. But directionally we feel good about the trend that we saw in the second quarter relative to the first quarter.

And I think overall we remain very high in our conviction that this is the right business for Stryker and for the market, and that longer term we see very favorable trends here. Further, you think about these smaller businesses that are acquired. There is a period of integration and every time you go through integration, there are stumbles or challenges that perhaps disrupt the business model. And, we've got to work our way to the other side. And, we feel good about the progress we're making there. So, directionally, better second quarter than we saw in the first quarter. We've got the nose of the plane pointed up and going in the right direction at this point. And it was a positive contributor, so we feel good about it.

Okay. And then looking for a similar update on the Neurovascular acquisition, you had stated previously a goal to get to market growth; you're probably still a little bit below that but new products could help. Can you give us an update there?

We feel very good about where the Neurovascular business is at the halfway mark. I think we commented in the first quarter that we saw positive growth in the US market. That remains true in the second quarter and through the first half of the year. And sequentially, it built on the first quarter.

And then in my prepared comments, noted that in the international markets, based on the strength of the target rollout, that we had recorded a positive quarter. So, all in, the business on a global basis was positive. We like where the new products are taking us. We like the stickiness with customers who have used the products.

All of that said, there are some market challenges in the neurovascular space today, given things like Brazil and reimbursement cut that I mentioned in the first quarter. That's still to be sorted out, hopefully sometime in the second half of this year. So, like any business it has its headwind, but generally on track with the direction and pleased with it through the first six months.

Matthew O'Brien from William Blair.

Good afternoon. Thanks for taking the questions. I was just hoping that you could talk a little bit about the extremities market there with your acquisition of Memometal. What are your plans as far as expanding your sales force there or potentially breaking out and having a focused sales group focus primarily on that segment of the market? And then, are there other products that you're planning to bring through, potentially a new shoulder system, to augment your portfolio at this time?

Yes, a couple of comments. Very excited about this product offering because it really gives us access to a specialty customer with a lot of the podiatric surgeons performing these foot and ankle procedures. You combine that with their proprietary technology and manufacturing know-how, we think it's a very nice fit.

We'll be able to make investments in the sales force to a much greater degree than they were, given just the relative size. And so, it will be an area of investment and we think there are opportunities to pull through other products. Nothing that we would speak to specifically. Part of what we liked here was what they have on the market, and part of what we liked was the pipeline of products. That's generally consistent with what you see in our other businesses -- singles and doubles that in totality really work to move the needle. So, it's an exciting market given the growth potential and we think this acquisition specifically helps us tap into a customer segment that is really not an area we have historically called on.

Okay. And then the second question on the biologics side, with the Orthovita acquisition, can you just talk a little bit about where your utilization was with your biologic portfolio before the Orthovita deal in terms of all the spinal fusion cases you were involved with? And then where you think that may go over the next 6 months or a couple of years, even, with that broad portfolio available to you now?

I would view that the acquisition is very similar in that we're going to leverage the product offering that we got with the Orthovita deal through our much broader distribution channels in both inpatient and outpatient, and across multiple divisions -- instruments, spine as was mentioned earlier. I wouldn't view this as leveraging the revenue that we were generating within our biotech specifically. This is really rounding out our product portfolio where there was a gap and, again, focusing on our core and leveraging that distribution capability that we have.

Kristen Stewart from Deutsche Bank.

Hi, thanks for taking the question. Just a couple actually, probably short ones. Just looking at the organic growth rate this quarter versus last, it picked up. I'm just interested if there's any differences in selling days this quarter relative to what we saw in 1Q on a year-to-year basis. The pricing dynamics overall looked better.

How much of that was just anniversarying of Japan? Was that most of the difference if we look at 1Q versus 2Q? And then any additional color just on the incremental acquisition and integration charges, and should we expect those to continue as we just look ahead or will those just be a 2011 phenomenon? Thank you.

Kristen, on the days, the days were effectively the same as they were in the prior quarter a year ago. On the pricing, do not have anything material coming out of the sunsetting of Japan that influenced the general pricing in the quarter. Certainly the sunsetting helps a little bit in the Japan market but total Company influence was insignificant there.

And your last question, I believe, was on the acquisition charges. We updated, I tried to update at the end of my prepared comments the full-year expectation for acquisition and integration-related charges given the addition of the Orthovita closing here at the last couple days of the second quarter. So, I may not be fully understanding that question.

Just is it all inventory step-up charges? It's a pretty big number and should we continue to expect there will be some residual integration related to all these deals flowing into next year?

Okay. So, the first half of the year, the biggest component of the number was Neurovascular inventory step-up charges. That is far and away the lion's share of the number. Other charges related to acquisition and integration are truly those one-time costs. -- anything from perhaps banker fees to the use of consultants as you're going through the integration from a systems approach, things like that. So, if you take what we said the charge would be for the full year, subtract what we've already recorded, that gives you the idea of what's left. As we head into 2012, I would expect the callouts there would be minimal, at best.

And then everyone's been asking in a different way, but can you specifically break out the litigation that was in the SG&A line, just so we can all understand a little bit better what the ongoing number was, and to what degree there was that impact just related to tax and other?

I'm not going to give you a specific number. I would just refer people to look at the prepared comments. I believe I said that in the other income and expense, that change effectively equalized the IP settlement. And, I think if you look at the charges we usually record in other income, you'll be able to back your way into what that relative number may have been.

Rick Wise from Leerink Swann.

Good afternoon, everybody. Back to hips briefly, Steve, you highlighted seeing the early signs of the positive impact of the new product launches. And, I think you still have another one to launch, maybe the Accolade 2 later this year or early next year. You've talked about this train and the slow moving momentum. Is the momentum here now and we should expect that year-over-year rate of growth to continue to pick up from here based on what we know about the markets? How are you thinking about that?

Yes, I think, Rick, clearly MDM is getting some nice momentum. And, I think it is building. Frankly, we've been almost a little bit of supply constrained on this one because we didn't overbuild inventory on this one. But, it is building nicely. And, I think it is going to be -- it is that train building.

Accolade, probably, by the way, even though we mentioned it at the analyst meeting, we'll probably end up pushing it back into next year, just to temper the expectation. Because, frankly, with OtisMed approval and all of the momentum on MDM, we feel so good about the second half of this year, that that will give us more news for next year. So, I think it's why we feel really good as we look at the hip pipeline over the next 18 to 24 months. I think we feel very good about seeing sequential builds, not just this year but through next year, as well. But, it's not a ramp like our medical business, as you know.

Right, but maybe back to mid to upper single digits in the second half doesn't sound unreasonable?

A lot of it, we're so leery to over communicate numbers given we're not sure exactly where the total volume of the market will be. I think we'll be taking share and feel good about that.

Okay. And maybe just last for me, a couple of bigger picture questions. Just one, any updated thoughts on your European business just given the debt crisis and various concerns there? And last, you've had a very rapid pace of acquisitions over the last 12 months or so. Should we expect that pace to continue? I appreciate that all subjects are in negotiation but are you as intensively at work on the portfolio now as you were a year ago, say? Thanks.

Yes, probably going to refrain from any specifics about whether the acquisition activity is going to be at the same pace, higher, or lower. Just the very nature of BD is such that it's going to ebb and flow, and maybe following a period of a lot of activity it ebbs a little bit more.

But, you never know in terms of there could be a strategic decision to make an acquisition, and wouldn't want to have comments that could prove to be incorrect down the road. So, a long-winded way of saying probably not going to make a comment beyond reiterating we've got a strategy for 3-pronged uses of cash and M&A is part of that. But, it will be more or less active at different periods of time.

And on the Europe piece, Rick, I think we feel really good about our leadership over there right now. We've been reigning in a lot of old product lines and dealing with a lot of things and fighting through a pretty tough market.

I think we look at Europe right now and say it's a very low growth market and we're slugging it out and fighting through it. So, I think we've stopped the bleeding there and on the way back, but we've also still got some stuff we can do better.

Steve Lichtman from Oppenheimer & Company.

Thank you, hi, guys. Just on gross margin, we've gone through the near term movements with currency. I was wondering if you could talk to the progress you're seeing be made by Lonny Carpenter in his efforts to streamline the manufacturing process overall?

Certainly a big area of focus for the Company and a lot of work going on. I think you have to keep in mind that anything revolving around manufacturing, product changes, product consolidations, the first approach is understanding what it does or how it influences the quality system that we've worked so hard as a Company to build and instill. So, almost in a sense, first do no harm as we look at the opportunities. These opportunities are evident. There are project teams lining up and they are sorting through the priorities.

And, keeping in mind that some of these projects, a majority of the projects will take an investment to get them off the ground and get the long term leverage. I would, however, as an early indicator, point to, perhaps, our tax rate as an indicator of some of the changes.

As we've moved some of our manufacturing, it does have influence across the entirety of the P&L including the tax rate. And just as a reminder, we made some changes with one of our Europe plants last year, moved some of that production into a different geography that has a better tax rate.

Thanks, Curt. And then just on Japan, were there any surprises in terms of the impact of the earthquake and tsunami as you went through 2Q? I'm guessing it wasn't material overall but were any segments impacted more than others and are things normalized at this point?

Actually Japan was probably one of our bigger upside surprises in the quarter. Our Japan business did very, very well, and pretty much across-the-board, but especially the reconstructive hips and knees were very healthy there. It was probably 1 of our, believe it or not, best regions of the world.

Bill Plovanic of Canaccord.

Good evening and thanks for taking my question. Just 2 clarification questions. One, I think for gross margin you said there was a 1-time charge of about $55 million pre-tax. What was that number for SG&A?

And then also, as you look at Q3 and Q4 for the one-time charges, I know you gave us an earnings impact but how much of that do you think will fall in Q3, how much in Q4? And then, I think you said that most of it will flow through the G&A and I just want to get clarification there.

In the quarter it was about $9 million, rough numbers. And then we didn't break it out between third and fourth quarter. And honestly, Bill, I don't have that in front of me right now off the top of my head.

Okay, and then lastly, just on Orthovita, I think you said that, when you said Cortoss is in Neurotech and Spine, is that more the Neuro piece or the Spine piece?

No, what I said is Cortoss is distributed by our interventional spine organization, which, from a public reporting standpoint, used to be included in the instruments segment. And beginning this year, when we created the new segments, we moved that over to report it under the Neurotech and Spine segment.

It would be specifically in the spine of the Neurotech and Spine.

Sorry, specifically within spine of the Neurotech and Spine.

Rajeev Jashnani from UBS.

Hi, good afternoon. Just maybe a quick 1 on R&D. The Company has aggressively increased R&D investment in recent quarters including this 1. Just wondering if you could comment on what you might see as a sustainable steady state level of spending given the current mix of businesses, given the regulatory environment.

We haven't called out long-term targets specifically. We have said to assume that R&D is generally in that 5% to 6% range of sales, and you've seen it trend upward this year. So, I think for near term modeling 2011, that remains a safe assumption.

If I could just follow-up. Do you see this as a line that's going to consistently grow faster than revs or is this potentially going to moderate understanding there's an impact of an acquisition in there currently?

Clearly it's a little bit inflated this year by the acquisition. Having said that, as we said we grew R&D 17% last year. I think as long as we continue to feel good about the products in the pipeline, that line might grow faster than sales.

Jeff Johnson from Robert Baird.

Thank you, good evening. Curt, wondering if I could just ask 1 last clarifying question around gross margin. And maybe I missed it last quarter but I remember on the fourth quarter call you talked about gross margins, expecting them to be up a little bit from the 2010 level of 68.8%. Did you formally update that last quarter as the next formal update just coming this quarter?

No, this quarter is the update.

Okay. And so I understand what you're saying, the US dollar, obviously, has been weaker since fourth quarter when you really last addressed that, and that all makes sense. Obviously orthopedic implants probably a little softer here than any of us would have thought. And the second half recovery maybe not going to be as robust. And MedSurg has been stronger.

Is there anything else going on besides those 3 things? Any of the deals you've done now maybe being more margin dilutive, gross margin dilutive, than any of us might realize, or anything else in there? Or is it really just those 3 factors changing from the fourth quarter guidance to tonight?

There are no other factors. I think I understand the confusion. It's just part of the complexity of the manufacturing network. When currency moves, it's not only the cost of the underlying currency. It's the inventory excess and obsolete charges and how those dollars are restated into a US-based P&L.

So, you've got to think about it in broad terms with how these currency movements impact the entirety of the P&L. And, they're not insignificant movements. That said, we do have some things that help edge that a little bit with the way we're set up. But, it's not a perfect model by any stretch and there's going to be movements as currency and as inventory turns change.

No, understood. There's just nothing else hanging out in there, is all I'm trying to confirm here.

No, Jeff. And I want to clarify that, as well, because clearly it's not anything from the acquisitions. What I'd also say is Curt and his team are really doing a much better job, I'd say, than what we had historically in terms of understanding the swings in gross margin because of all the various lag effects in the inventory.

And, when you go back and look historically, I think second and third quarters last year, we probably got even more of a benefit from the FX than we had fully maybe grasped at the time. If you recall we were surprised by the gross margins and I think it probably was more driven FX. And it's a bigger headwind this year than what we had fully grasped.

Thank you, Derek. I think we'll wrap up on that. And so that everybody knows, the conference call for our third quarter results will be held on exactly 3 months from today, October 19 of 2011. Thank you, everyone.

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