史賽克 (SYK) 2011 Q3 法說會逐字稿

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

(Operator Instructions)

As a reminder, this conference is being recorded for replay purposes.

Certain statements made in today's conference call may contain information that includes, or is based on, forward-looking statements within the meaning of the federal securities law 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; resolution of tax audits; changes in financial markets; changes in the competitive environment; and the Company's ability to integrate acquisitions. Additional 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 conference over to your host for today, Mr. Steve MacMillan, Chairman, President and CEO. Please proceed.

Thank you, Keisha.

Good afternoon, everyone, and welcome to Stryker's third 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. Before passing the call over to Katherine and Curt to provide more specifics, we know there have been some investor concerns that we would like to address, including the slowdown in elective procedures, capital budgets, and gross margin.

First, with respect to elective procedures, the recon market continued the softness that began last year in the second quarter. While we look forward to the day the market picks back up, we feel good about our recon portfolio and our ability to deliver, even in a slower environment. Second, turning to capital budgets and the potential impact to Medicare spending, we believe there has been an understandable but misplaced over-reaction. While the current economic environment remains challenged, hospitals do have access to credit, a clear difference versus the 2008-2009 downturn. Our own third quarter MedSurg results, especially our medical business, are evidence that these markets remain solid.

It's also important to note that since late 2008, we have significantly changed the composition of our MedSurg businesses, including expanding our disposables product offering, with the Ascent, Sonopet and Gaymar acquisitions. Our MedSurg businesses are better positioned now than at any point in our history to drive share gains, engage with hospital customers, leverage new product offerings, and expand geographically, a fact that we believe will remain clearly the case in the fourth quarter in 2012 and beyond.

On the gross margin front, we have been negatively impacted in 2011 by a greater than expected degree from swings in foreign exchange rates. Although these same swings inflated our gross margin in Q2 and Q3 of 2010, the reverse has been true this year. Beyond FX, we are making the necessary investments to help unlock decentralized inefficiencies that represent a clear long-term leverage opportunity. With Lonny Carpenter now overseeing global manufacturing since the start of this year, we are investing in various aspects of this multi-year initiative, including our IT infrastructure, procurement, vendor consolidation, and numerous other aspects, while also absorbing the various acquisitions. Ironically, it's the strength of our P&L that's enabling us to make these investments that will yield dividends longer term, while not deviating from the earnings targets we provided at the start of the year. Looked at somewhat more succinctly, our underlying P&L performance is enabling us to manage through some unexpected pressures, as well as M&A costs that often result in companies trimming guidance. We are not one of them.

It's also worth highlighting the fact that over the past 24 months, we have bolstered our core franchises by leveraging the tremendous strength afforded by our solid cash flow and strong balance sheet via acquisitions. We have entered into key adjacent markets that are on track to help accelerate our organic growth in 2012 and beyond. With 10 acquisitions completed in the past 2 years, and 4 in 2011 alone, we are committed to further broadening our sales footprint with M&A targets. And it's important to note that we are not just buying one-off growth. Every one of these acquisitions is a platform that we fully expect to grow above the rate of our core markets for the foreseeable future. Our sales mix has also strengthened considerably within our MedSurg businesses, particularly through Stryker Sustainability Solutions, and more recently, Gaymar. These moves have provided our sales team with a stronger product offering and a greater ability to gain market share, despite some ongoing challenges in underlying elective procedure growth.

We also remain highly focused on ensuring we are investing in internally driven innovation, as evidenced by the 23% increase in R&D in the quarter and year-to-date, on top of a 17% increase in 2010. The investments in R&D are balanced throughout our portfolio of businesses and include the necessary incremental innovation that's driving our ongoing market share gains in many of our businesses, while also making longer term investments in both product, procedural, and service offerings. This level of R&D is a clear reflection of our confidence and the opportunities we still see for innovation in our markets.

Our commitment to a 3-pronged strategy as it relates to cash deployment is reflected in our Q3 results, as we further leveraged our P&L via buybacks that totaled $289 million in the quarter. And our quarterly dividend represented a 20% increase year-over-year. We believe this balanced approach will drive maximum shareholder return for both the short and long term as we look to accelerate organic growth while also driving greater P&L leverage.

Overall, looking back on our Q3 results and our financial performance to date in 2011, we are pleased with the unique strength of our Company, both our products and our people. Although the global economic environment has proven to be more challenging than anticipated at the start of the year, it's clear that our unique business model is enabling us to navigate the challenges while further building on our strengths. The expansion of our sales footprint through our focused M&A activity will be an important driver of our revenue and earnings growth long term. Near term, our strength is allowing us to modestly raise our EPS target for the year, while simultaneously absorbing a series of key strategic acquisitions and making meaningful investments in R&D.

We believe this combination of funding our innovation pipeline, augmenting our business with additional higher-growth franchises, and achieving consistent double-digit earnings growth will ensure we are able to maximize shareholder returns in both the near and long term. Net, although there are always challenges, and there will inevitably be things we don't like in any given quarter, we feel good about our ability to deliver, and see lots of opportunity for growth in all of our businesses.

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

Thanks, Steve.

In light of the relatively high level of M&A activity that's occurred with us in recent quarters, my comments today will focus on some additional granularity around these transactions. As many of you on today's call are aware, our cash deployment strategy has focused on acquisitions, along with buybacks and dividends. With our cash flow capabilities, we believe that the ability to execute on all 3 is an important competitive advantage, and positions us well to deliver on both our short and long-term financial targets. From a scorecard perspective, we are pleased with the performance to date of the various acquisitions. Although retrospectively, the 510(k) clearance of our shape-fitting technology obtained by the OtisMed acquisition took longer than anticipated, the early read on the rollout is positive and we view the product as a key offering in our recon sales force's portfolio.

We're also pleased by the reacceleration in Stryker Sustainability Solutions, which delivered strong double-digit top line growth in the quarter. We completed a number of deals focused on our core markets in 2010, including Sonopet, Gaymar, and Medpor, all of which are tracking at or ahead of our expectations. Although clearly still early, we're excited about the opportunity for us to leverage our considerable sales and distribution capabilities by adding the terrific product portfolios provided by both Orthovita and Memometal. Overall, we look for the totality of our M&A activity to help us to generate solid top line growth despite the softer than expected orthopedic implant markets.

Turning to the most significant acquisition we have completed recently, Neurovascular continues to execute on the launch of its new products, including the next generation coil and attachment system. We view the long-term growth potential in the treatment of stroke to represent one of the most exciting segments within medical technology, reflecting both the tremendous unmet need and opportunities for device-based innovation. This was a key factor behind our move to further expand our market-leading presence in the interventional stroke market with the recent acquisition of Concentric Medical, which allows us access to the ischemic stroke segment.

Although today the vast majority, nearly 90%, of Neurovascular stroke sales are from devices to treat hemorrhagic stroke, this population represents just 13% of stroke patients. Over 85% of stroke incidents are from ischemic. And we're excited about the opportunity to leverage our core platform in Neurovascular via the addition of Concentric, with its long history of device-based innovation and a truly exciting product pipeline. Its latest-generation Trevo stent retriever device, designed specifically for the removal of ischemic stroke, is CE approved, and Concentric is currently 1 of just 2 companies with an FDA approved IDE trial underway in the stent retriever category. We are targeting a late 2012-2013 510(k) clearance, and believe this technology will represent an important long-term growth driver for our Neurotechnology franchise.

In sum, our recent series of M&A transactions reflect our stated strategy of both leveraging our core in order to drive sales and cost synergies, while also entering key adjacent markets that can help improve our long-term organic growth rates.

With that I'll turn the call over to Curt.

Thanks, Katherine.

I'll start by saying we again delivered solid financial results based on the inherent strength of our evolving business mix, financial discipline, and a diverse and expanding base of recurring revenue, all of which positions us well in today's challenging global economy and changing med-tech landscape.

Overall, in the third quarter, Company sales increased 14.9% on a reported basis, and 11.7% in constant currency, in line with the second quarter. Sequentially, core growth, excluding currency and acquisitions, slowed in the quarter, but was consistent with levels achieved in Q1, finishing at 4.1%. Despite the lack of any meaningful recovery in elective procedures, we are encouraged by our ability to sustain mid-single digit organic growth, which we are augmenting through our strategic business development activities. Drivers of growth in the quarter included solid MedSurg results, reflecting both continued strength in our medical and instrument segments, and an acceleration in our sustainability solutions business. Additionally, we saw continued incremental quarter-over-quarter gains in our core reconstructive business. While the majority of our Neurotechnology and Spine franchises achieved solid growth, this was offset by a sequential slowdown in our spinal implants.

Looking at earnings, we delivered encouraging results, with adjusted diluted EPS, before non-recurring charges, of $0.91, representing growth of 13.8% over Q3 of 2010. On a GAAP basis, diluted net earnings per share were $0.84, a decrease of 1.2% versus Q3 of 2010. Overall, our 2011 acquisitions, as well as those completed in recent years, are performing as or better than expected, and our integration efforts remain on track. The P&L continues to reflect our investment in systems to support acquisition integration, R&D expansion, and the tax benefit driven from our focus on optimizing our operational footprint. Other factors in the quarter include the now-typical movements associated with currency, and a per share gain of over $0.01 associated with share repurchases and a favorable tax election. Finally, in the quarter we generated $446 million of cash from operations.

In reviewing the quarter, I'll start with a discussion of the components of our revenue growth. In the third quarter, revenue growth was driven by volume mix, which contributed 6.1% to our top line growth; while Company-wide selling prices declined 2%. Overall, pricing remained consistent and in line with recent quarters. Acquisitions added 7.6%, and currency contributed approximately $57 million, and improved the Company's overall reported sales growth by 3.2%.

Looking at our external reporting segments, Reconstructive products, which represented 44% of our sales in the quarter, and include our hip, knee, trauma and other Reconstructive lines, recorded an 8% increase as reported and a 4% increase on a constant currency basis. Acquisition added 1.7% to the constant currency increase. This represents another sequential improvement in our Reconstructive segment, while acknowledging the gains have been marginal and the market remains challenging. At the segment level, hip sales continued to perform well, recording a 10% reported gain and a 5% increase in constant currency.

International markets accelerated in the quarter, delivering our best hip results since Q1 of 2009. Emerging markets and Japan paced the gains. In the US, market hip sales continue to benefit from our MDM offering, and recorded 5% growth.

Conversely, knee sales remained weak in the quarter with reported growth of 3%, and down 50 basis points on a constant currency basis. International markets recorded 2% constant currency growth, with mid single- to low double-digit gains in other international markets, offset by softness in Europe. The US market remains difficult, as evidenced by the 2% decline in the quarter. However, the commercial launch of our shape-matching offering is going well, and we expect it to contribute to modest sequential improvement in the quarters ahead, noting tougher fourth quarter comparisons.

Globally, Trauma posted 17% reported growth and 12% constant currency growth. Acquisitions added 6% to the top line. Domestic Trauma results recorded a 20% gain, while in international markets, Trauma recorded 5% growth on a constant currency basis. Overall, we feel good about our Reconstructive results in a challenged market, and remain optimistic regarding our hip lineup, the OtisMed shape-matching solution, the MMI acquisition, and its influence on our broader trauma offering.

Next, I'll turn to MedSurg, which represented 38% of sales in the quarter, and is comprised of our instruments, endoscopy, medical and Stryker Sustainability Solutions segments. MedSurg delivered another solid sales quarter, increasing 12% as reported, and 10% on a constant currency basis, with acquisitions adding 2.2%. Once again, the medical segment was the star of the show, delivering 31% reported growth, 20% excluding acquisitions and currency. From a market perspective, the bed-and-stretcher offering continues to perform well in a market fueled by the replacement and upgrade cycle; as well as hospitals' increasing focus on the ability of certain capital purchases to improve efficiencies and facilitate better patient outcomes. Finally, our Sustainability Solutions Business returned to mid to high teens growth, and this remains our expectation given all the opportunity we first identified in this market over 2 years ago.

Our final segment, Neurotechnology and Spine, which represented 18% of the Company's sales in the quarter, increased 46% as reported, and 43% on a constant currency basis. Acquisitions added 42.5% to the constant currency increase. Highlights in the quarter include strong organic growth from our interventional Spine and NSE offerings, as well as the positive influence of the Medpor and Neurovascular acquisitions. Obviously, continued pressure on the spinal implant market in terms of both volumes and price influenced core growth in the quarter. Finally, on a positive note, our Spine business did begin its initial launch of a lateral access fusion system.

I will now turn to the income statement, beginning with gross margin performance. Gross margins finished at 67.1% as a result of acquisition charges totaling approximately $18 million. Excluding these charges, gross margins were 68.0% in the quarter, which was lower than the prior year by 140 basis points, but represented a 20-basis point improvement over Q2. Also recall, 2010 third quarter gross margins were favorably impacted by currency. These comments aside, given our management and operational structure, our efforts remain focused on reducing our material and conversion costs in support of our long-term growth strategy, which we believe will drive operating margin expansion, despite the potential for greater pricing pressure as the healthcare environment continues to evolve.

Research and development continued as an area of investment priority, moving to 6% of sales, an increase of 23% versus the third quarter of 2010. For the first 3 quarters, R&D spend is up 23%, influenced by our commitments to increased innovation and the dollars now in the R&D category associated with acquisitions. Stated more succinctly, we believe innovation still matters as a catalyst for long-term growth, and we're excited about the current and future flow of new products across our various divisions.

Selling, general and administrative costs represented 37.7% of sales. Adjusting for acquisition- and integration-related charges, SG&A finished at 36.6% of sales, a decline of 120 basis points versus prior year. Intangible amortization in the quarter was $31 million, and represented 1.5% of sales versus the $14 million and 80 basis point of sales in the prior year quarter. Year-to-date, intangible amortization is $90 million and 1.5% of sales, versus $42 million and 80 basis point of sales in 2010. Clearly, the acquisition influence on this line is deleveraging our P&L and the EBIT margin this year, but we expect to see benefit here in the years ahead.

Reported operating income decreased 5.7% over prior year, and moved to 21.9% of sales, reflecting the impact of the inventory step up in other acquisition- and integration-related charges. Adjusted operating income increased 8%, while the adjusted operating margin decreased 150 basis points versus prior year, to 23.8% of sales. Other income and expense decreased pre-tax income by $13 million in the quarter. Components of this included investment income of $9 million, offset by $21 million of interest expense.

The Company's effective income tax rate was 24.1% for the third quarter. Excluding the tax benefit associated with acquisition-related charges, our effective income tax rate would have been 25% for the quarter. For the year to date, our tax rate, excluding the acquisition-related charges, is 25.6%, and we are comfortable with this for the year.

In terms of the balance sheet, we ended the quarter with $3.2 billion of cash and marketable securities, up $500 million from the $2.7 billion at the end of the second quarter. We supplemented this balance on September 12 with a $750 million 5-year 2% coupon debt offering, and offset the increase with working capital expansion, acquisitions and share repurchases. As a reminder, we now have $1.75 billion of debt on the balance sheet, associated with our January 2010 $1 billion debt offering and our September 2011 $750 million debt offering.

On the asset management side, accounts receivable days ended the quarter at 58, which represented a decrease of 1 day compared to the prior quarter and prior year. Days in inventory finished the quarter at 176, which was an increase of 12 days sequentially versus the second quarter, and 2 days against the prior year level.

Turning to cash, in the third quarter we generated cash flow from operations of $446 million, and free cash flow of $389 million. Finally, in the quarter, market volatility created a buying opportunity, and we repurchased 5.9 million shares totaling $289 million. Year-to-date, we have repurchased 9.9 million shares for a total spend of $539 million. We currently have open authorizations totaling approximately $286 million.

In summary, we delivered a positive third quarter and in general, are on track with our annual earnings goal. Key objectives remain driving core business growth, continued acquisition integration, operational focus, and a sharpened focus on cash generation.

Turning to our outlook, our guidance, as Steve noted, has been adjusted in a couple areas. Starting with currency -- if rates hold near current levels, we would expect fourth quarter sales to be favorably impacted by approximately zero to 1% 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.

From a revenue standpoint, we are now calling for a net sales increase of 11% to 12% in constant currency. Excluding the impact of foreign currency as well as acquisitions, our sales growth is now projected to be 4% to 5% for the full year. The adjusted diluted net earnings per share range has been raised, and is now anticipated to be in the $3.70 to $3.74 range, representing an increase of 11% to 12% over 2010 adjusted diluted earnings per share; and comparing favorably to our prior $3.65 to $3.73 target. We anticipate acquisition- and integration-related charges to reduce reported diluted net earnings per share by approximately $0.33 to $0.35.

Overall, we think the year is largely in line with our expectations. With our continued actions to both leverage and further diversify our revenue base, coupled with our ongoing investment in quality, the significant uptick in R&D investment, and more recently, our efforts around operational simplification and alignment, we are highly encouraged regarding our near- and long-term top and bottom line growth prospects. Additionally, we've been supporting these efforts with disciplined capital deployment through share buybacks, dividend expansion, and strategic acquisitions. We believe we are well-positioned to maximize shareholder returns through our highly-focused and balanced approach.

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

(Operator Instructions) Mike Weinstein with JPMorgan.

Steve, maybe as a starting point, would like to focus on MedSurg. And given the concerns out there, I would be interested in your comments, some of them which you made earlier about the health of the various end markets. And I'm thinking geographically, I'm thinking Europe and the US, as you look at the fourth quarter.

And then a second part I'd like you to comment on is where you are in the product cycle for your various businesses. I think our understanding is that you have a new product cycle coming on the endoscopy side of the business in cameras in 2012. So any additional insights there would be appreciated, thanks.

Sure, Mike. I think we do continue to feel very good about our MedSurg businesses, both in the US and particularly outside of the US. We'll tell you, Europe was a little rougher in the third quarter. And that was probably our little spot of weakness for our MedSurg businesses in the third quarter. We think that's just a little bit of a market issue. Nothing that's got us too concerned.

And the bigger issue probably is our product cycle, particularly as it does relate to both endo and to some degree our instruments businesses, that we've got some very good things coming. And particularly on the endo side, as you said, things in the pipeline there that we may be a little softer here in the next quarter or so. But feeling very good about what's in the lineup. And I would say probably feeling really good about what we have coming in 2012 across all 3 of the big MedSurg franchises.

And the visibility on that, for the Street, will that have to wait for AAOS?

Yes, in terms of (multiple speakers). Probably in terms of (multiple speakers).

It's probably as we get into -- Mike, as you know, historically we haven't gone into a whole lot of specificity around exact timing of those launches, both for competitive reasons as well as sales force focus. So these are 2012 rollouts. The exact timing, probably not going to be too specific on right now.

Okay. And then Steve, just to think strategically, we've seen medical device end markets become increasingly challenged this year or over the last few years. And so it's hard to find end markets that are at this point at least showing meaningful growth. With that reality, how do we think about your further appetite for M&A, given how aggressive you've been over the last 24, 36 months?

Sure. I think what we've clearly tried to do, Mike, as you know, is find additional growth opportunities. That within any overall market, you've got pockets of strength in things like extremities, things like orthobiologics, things like surfaces in our medical business. Or Sonopet, which was great for our NSE, our neurospine franchise. And I think we've been very active and opportunistic in what's gone on there. So that, really, the way we look at it is those markets should grow faster than the overall markets. And continuing to look for those, dare we call it, niches or smaller pieces. And then looking at big things like the Neurovascular that we feel will have a very good growth profile.

Going forward, would you expect the same pace of acquisition? I'd tell you truthfully, we're probably largely focusing right now on integrating what we've taken. We've taken a lot on over the last 12 to 18 months. And I think you would probably see a slowdown. We're not going to be serial acquirers, but we are going to take advantage when the opportunities pop up. Katherine, I don't know if you want to add to that.

No, I think [it] ebbs and flows. And right now we want to make sure that we leverage the opportunities we have and not muck it up on the integration side. So it's not an on and off switch, but probably one right now a little bit more focused on integration and execution.

Yes, I'd say Mike, to add 1 other comment to that, I think as a CEO, you have to be careful that you're paying attention to truly the organizational abilities to digest so many things. And we're probably, I don't want to say maxed out, but we're stretched. And I think love what we've done, but would want to be careful not to take so much more on at this point.

(Operator Instructions) David Lewis with Morgan Stanley.

Steve or Curt, just thinking about the quarter, margins came in actually better than we thought, and actually so did revenue, in many respects. So just thinking about the fourth quarter change to the top line constant currency number, can you just talk about some of the factors in the fourth quarter that are resulting in incremental pressure? Is it orthopedics, is it the international market?

David, the second part of your question was the fourth quarter change? Our outlook was the full year.

Agreed. So I'm just assuming, given this third quarter performance is actually in line to a little better than we were looking for, I'm just wondering what the specific slowdowns would be in the fourth quarter.

I think our overall full year guidance, I can't overlay my guidance on your model, but I think our overall guidance is a statement of, we've not seen any meaningful recovery in the Reconstructive business, though we are personally incrementally making gains, as you look at our Reconstructive business -- hips, knees, and trauma. That core business has improved each of the past 3 quarters, albeit very incrementally by our historical standards. But certainly that market has not recovered in the way that I think a lot of people would have assumed as we entered this year. And I don't think in the large, broad European market we've seen any meaningful recovery, as well. So those are probably the number 1, number 2 areas that are driving the little bit of core business pullback and overall outlook pullback.

Great. Very helpful. And Steve, you made some comments, and I appreciate Katherine's comments of giving us more detail about many of the acquisitions and the growth platforms going forward. You talked about beginning to see the evidence of acceleration in the core business in the '12 and '13 time frame. As you think about mid single-digit organic constant currency guidance for this year, is it too early to think about acceleration from those levels heading into '12?

Yes, I think, David, we want to stay away from getting too far into guidance for 2012. But I think you should expect that we feel good about the way we've been reshaping the portfolio this year. The big question really is going to be do the markets come back much or not. But I think we're trying to position ourselves to have solid organic growth despite -- even if the markets continue right where they are. And we'll obviously come back with more specific guidance in January.

Great. Very helpful. Thank you.

All right. Sorry I can't give you more at this point.

Bob Hopkins with Bank of America.

So 2 things I wanted to cover. One, I was wondering if you could give a little bit more color on the endo business, because that seems to be the one within MedSurg that declined in terms of its growth rate the most from the trends you've seen over the last few quarters. So if you could talk about that a little bit. And then I wanted to ask a question on operating margins, but I'll save that for the follow-up.

On endo, I think it's really product life cycle related. And I would tell you, Katherine, Curt and I were actually out at that business last week and feel really good about where they will be headed next year.

And Steve, did I hear you correctly when you said you should expect incremental softness in the fourth quarter?

No.

Okay. And then on the operating margin side, either Steve or Curt, this year we've seen declines in operating margin. We obviously all understand the R&D piece. But in terms of gross margin and SG&A, can you just talk from a top-down perspective about the pressures on those line items this year? And as we look forward -- and again, I'm not asking for 2012 guidance -- at what point can those turn and what allows it to turn, the operating margin back up again?

It's obviously a hot topic here the last couple quarters, Bob. Specifically as it relates to gross margins, clearly, currency movement does impact gross margins. But I think in addition to that, when we look at our business, we really we start with what's the revenue outlook and what's the earnings target that we're going for. And all the levers in between those 2 are at our discretion to use to run our business in the way that we think will best help us in the given quarter, the given year. But also as we look to the future on where we think the business needs to be.

So as you look at gross margins specifically, there's clearly been a currency influence there this year. But in addition, and Steve mentioned this in his opening comments, we now have a global executive who is focused on our global operations. Any time you do that, any time you align an operations team, a lot of projects come forward. Those projects all come with a price and you have to make those investments before you see the return. In addition, the M&A that's been discussed also brings costs that hit gross margin. And not all of those costs get called out as acquisition- and integration-related charges because some of those costs are investments that we'll use across the Company for further leverage in the out year.

Specifically as it relates to SG&A, I honestly feel decent about where SG&A is right now. We've had some ups and downs over the last 3 quarters. But in general, I feel pretty good about what we're doing there. I think everybody in the med device space is looking at distribution-related costs and trying to figure out where those are going to move over what period of time. And that includes Stryker. But in general, I think we've got the right approach and the right focus on those right now.

Bob, if I could just add 1 other thing. I think we clarified when we did the Boston Neurovascular acquisition, what we're doing is they're absorbing a division from a company that was structured very differently than ours. And, again, one of the things we've had to do this year is invest in some of the back office support areas, as well, to absorb that acquisition and let them focus on what they do well, which is drive the top line, drive the innovation. So there has been additional cost in the SG&A line supporting that this year that we should start to see leverage in the future, as well.

And just from a metric standpoint, year-to-date, adjusted SG&A is identical to what it was a year ago. So to my comment about I think we're doing okay given everything we've put in through the P&L this year, to be equal to where we were as a ratio, 37.3% of sales, I actually feel okay. And think about that in the future periods how we can leverage that as we expand the sales base.

Kristen Stewart with Deutsche Bank.

Just wanted to go over the reduction in underlying sales growth, Curt. I think you'd said the new guidance assumes 4% to 5%. And I think the old guidance was 5% to 7%. I just want to clarify that.

Yes, we started the year with core business growth of 5% to 7%. We're moving that to 4% to 5%. And I would just tell you it's a reflection of where we are in the year through the first 3 quarters. And the size of core growth we'd have to deliver in the fourth quarter to stay within our 5% to 7% range, number 1, doesn't feel realistic after 3 quarters being under our belt. Number 2, we think the 4% to 5% is a realistic reflection that some of the core markets, i.e., Reconstructive, have not returned to a level that we had originally assumed as we started this year. We're as optimistic as anyone and we want to continue to drive our teams to higher growth levels. But I think the 4% to 5% more accurately reflects our first 3 quarters and where we see the year finishing up.

And then just the changes, mostly you would say is attributable to the slower performance within Recon, mainly hip and knee?

Yes, and Spine. Spine is recorded in our Neurotech and Spine segment. And as I mentioned in my comments, we did not have a good spinal implant quarter. It was, frankly, disappointing. And I think it just reflects the broad pressure in the overall reconstructive market, even though we report those in a different segment than our Reconstructive business.

Rick Wise with Leerink Swann.

You talked about the slightly better performance in hips and it sort of accelerated from the second quarter in the US. Is this the new products you've launched? Is that the primary driver? And should we expect a continued gradual step-up, as you've talked about the freight train image in the past? Should we expect that gradual increase going forward despite the tough market?

Yes, I think the freight train analogy is a very good one, Rick. We're seeing MDM take off. I would just remind you we're going against a tough fourth quarter comp, but overall the trend here is looking up. And I think we're hearing very good stuff out of the field and out of the surgeon community on MDM. I think we're in the right place at the right time with that product.

So it is all about the new products?

Yes.

Okay. Ascent. Katherine, if I heard you correctly, did I hear you say strong double digit growth? I forget your exact language, if I understood you correctly. J&J's now bought SterilMed. Maybe, Steve or Katherine, you could talk about the dynamics of that business and is this going to be a more important growth driver, small still, but going forward as reprocessing gains more traction?

Yes, Rick, to clarify, we did have double-digit growth. And it was a clear step up in the quarter. Business bouncing back very nicely and we feel we've got that back on track. Continue to feel great about the fundamentals. And frankly, we think J&J's entry into it is going to, A, further validate this as a market to an enormous degree. I think it's wonderful when you have Stryker and J&J both as now the number 1 and 2 players in a market. And I think the underlying fundamentals in healthcare costs and everything else, we continue to feel really good about having identified this one a couple years ago and picked up the market leader with great growth potential in a market that's probably going to become more validated now than ever.

Matt Miksic with Piper Jaffray.

I wanted to follow-up on an earlier question on strategic interests. I know you have taken on a lot recently and your organization's integrating those acquisitions. But one of the questions on a call earlier today raised a question in my mind about your business.

You're pretty much fully exposed across your business lines in government and private pay reimbursed products, maybe with the exception of hospital equipment. And I'm wondering if you've contemplated, if you would contemplate, diversifying that, especially given the regulatory and payer environment that we're in, to include something that's a little bit more patient pay, commercial pay, self-pay oriented. And then I have one follow-up.

Matt, I wouldn't say that that's got to be a strategic driver. We do talk about that a lot and I will tell you have looked at some markets that are more exposed to a bigger private pay component. But we feel good still about the markets we're in. And I think over time, ultimately, we would also believe there may become more of a private pay component even to some of the businesses that we're in, and ultimately, where innovation will continue to drive the business. But we think about it, but wouldn't expect a big move. We're pretty good sticking close to our core, as you know.

And then the follow-up was on Recon and some of your launches there. Even though you are not calling here for a recovery in orthopedics or Reconstructive, it does -- halfway through the reporting cycle, it does seem like you're coming up in the top quartiles of performance this quarter. And I'm wondering --.

As we should.

Pardon?

As we should.

As you should. That's what we like to see. But in these new product launches, just to set the right expectation, it used to be that it would take a good solid couple of years to be into the meat of a new rollout. Given the environment, I guess what we're hearing is maybe even those time lines have become a little bit stretched out in the way that you deploy instruments, the way that you train and roll these things out, just maybe because the market's capacity to absorb new products has changed. Any color on that? Is that something -- should we think about these products that way?

Matt, I think it's going to be difficult to make a blanket statement. So if you look traditionally in hips and knees, those are typically longer, a couple year, as you fully roll out. And not just the instruments, but you train the sales force, train the surgeons. But if you take, for instance, right now, MDM, which is our key hip product launch, it really benefited from a lot of the heavy lifting that went on around both the philosophy and the instrumentation, et cetera, from ADM. So that's probably had a little bit better of initial uptake than you'd see with a traditional recon product. And also OtisMed, there was familiarity with that shape-fitting technology as it was on the market a few years ago. And there's general familiarity with it. So I don't think you can make a blanket statement. It's going to depend on the type of product and the type of launch, but I wouldn't say from a macro environment we're seeing stretched out product uptakes.

Tao Levy with Collins Stewart.

I had a question on the 1% to 2% change in the core growth. Is that something that you realized throughout the quarter or as you looked into Q4? Or it's been a little bit light throughout the year and there's been some sort of expectation that things would get better and now you just need to readjust expectations?

I would consider it a borderline adjustment at the end of the day, when you look at it. 4% to 5% versus, we were the low end of 5%. We were seeing how the year's been playing out. Clearly the markets have not materialized. But it's a very modest incremental adjustment.

Because what I'm trying to figure out is, are things appearing worse than they had in the hip and knee market?

No.

Or -- they are just not getting as good?

It's really seeing where things shook out in the third quarter and being this close to the end of the year. We've got obviously more data at this point and just recognizing the comps for the fourth quarter and product life cycles and everything else. So do not read it at all as a signal that we're concerned about where we're headed.

Dave Turkaly with SIG.

I know you mentioned that pricing was down 2% in the quarter. And just curious, as you updated the guidance, how is that relative to your expectations? And is that what we should be expecting as we look forward for the Company ahead?

Pricing this year has been in the 1% to 2% down range, so it somewhat fits right in with where pricing trends have been the last couple quarters. And I think we're comfortable saying that it will remain in that category or that range as we look forward. I think it's the same old, same old.

Okay. And then I know you mentioned OtisMed and having a customized product coming. Can you tell us what you think what the size of that market is, so what the opportunity might be for you? How big that is as a percent of the overall knee market, so what kind of opportunity you have ahead as you launch that?

Yes, it's tough to get really firm data on penetration rates. Some of the numbers hover around 10% of knee procedures using customized shape fitting. We obviously think there's opportunity for further inroads. And longer term, some of that may be required to have clinical data that really demonstrates some of the benefits that we believe exist as it relates to higher throughput, et cetera. So no specific target we would put out there, but clearly we think it's going to be an important part of the sales force's arsenal of offerings in the knee side.

David Roman with Goldman Sachs.

This is actually Topher Orr in for David. Just to follow-up on some earlier questions. I was looking at acquisitions over the past year and I was hoping you could just give us an update on which of those acquisitions have the biggest overhang on gross margins currently and over the next few quarters. How you see further integration of these acquisitions shaking out from a gross margin perspective. Thanks.

I don't know if we're going to go acquisition by acquisition here and evaluate gross margins. But I think the key focus here on all of the acquisitions is executing a well-defined integration plan. And as we said in our commentary, we feel good about our acquisition integration plans as it relates to, most recently, Orthovita, Memometal, Neurovascular business at the beginning of the year, and going back into last year, the acquisitions that we completed then. We feel good about our integration plans, don't want to overburden the organization with additional integration. So that's a key focus, is the focus on the integration so we don't run into problems and then do damage to the revenue outlook, which is really where you bring the P&L pressure. I think keeping focused on integrating and doing it right and doing it in a comprehensive fashion is where our focus is.

Okay. And then for Neurovascular specifically, could you provide an update of where you guys stand now and, maybe not gross margin specifically, but just overall, where you see the time lines for that.

Yes, as Steve said, it's a complicated integration because you're going from a culture that was highly centralized in terms of the back office support to a company in Stryker that's a little more decentralized in some of the back office support. It's got 3 facilities that have to be brought over from Boston Scientific to Stryker. And I think we originally stated this would be a 2 to 2.5 year acquisition integration. And we're pretty much right on track with that. Now, obviously, as we go country by country, there's different regulatory approval pathways. Some of those are online, some of those stretch out. Those don't materially impact the selling revenue. What they do impact is employees who are waking up every day, saying at some point I become a Stryker employee. So we're very sensitive to that.

But the business, we feel very good about the business. The target coil and detachment system rolled out early in the year. We've effectively got a global launch at this point, having recently introduced that to the Japanese market, which was really our final core market there. So I think we feel really good about the team at NV and what they're doing on a global basis, and how they're both going out and winning in the commercial market, while dealing with the challenges that are inherent with every integration.

Michael Matson with Mizuho Securities USA.

Yes, I have a question just regarding the ischemic stroke market and the Concentric Medical acquisition. I understand that they're studying their new Trevo product. But I'm just wondering what's really held that market back, because their sales so far have been somewhat disappointing.

I guess a couple of comments. A big part of the rationale behind that acquisition was our excitement around the ischemic market. The use of device-based innovation for ischemic is in the very, very early stages. So they have launched in some markets outside the US. But candidly, part of the rationale for becoming part of Stryker is to have the considerable benefit we bring from sales and distribution capabilities that they were not able to tap into, just given their size. So we're really excited about the pipeline there and the potential we see and the early adoption, quite frankly.

Okay. And then just 1 question on the share count. Sorry if you've already given this, but given the buyback, what share count should we be modeling for the fourth quarter and the full year?

Let me get back to you on that one. I don't have that right in front of me.

Derrick Sung with Sanford Bernstein.

Starting with a high level strategic question, the markets are clearly slowing, you're facing an environment of increasing cost pressures. Some of it may be cyclical, but I think no one would argue that a good portion of it is secular in nature. Given that context, have you thought about, or what are the opportunities to further reduce your cost structure? And in particular I'm thinking about your selling cost by perhaps altering your selling model here in the US to something more similar to that in what you're doing in Europe. Is that possible at all or is that just out of the realm of possibilities at this point in time?

Derrick, you should assume we are constantly looking at all kinds of options. And we operate with different models within our Company. Our MedSurg businesses are different than the orthopedic implant businesses. And they give us some different avenues to call upon. And I think actually creates some competitive strength for us to think about some different models. We've got some lower gross margin businesses with lower SG&A that still deliver very good operating margins. And we know how to play different ways. And you should be assured we're thinking along those lines as we head forward.

Okay. Thank you. And then turning to your international markets, it sounded like what's keeping some of the growth going right now is your Asian sales and your emerging markets there. And you're seeing the continued weakness in Europe. Could you split each of those 2 apart? How much of the emerging markets benefit that you're seeing, or the Asian markets benefit that you're seeing, how much of that is transient versus sustainable? And then if you can give us maybe a little bit more detail on how bad is Europe really, is it getting worse. And maybe some examples of what you're seeing there.

I'll take it on a big picture basis. We've got a lot of really good things going on in our international markets, beyond emerging markets. Our Japan business, Australia, Canada, a lot of our businesses are really performing very nicely right now. And I'd say as you think about our international business, what you ought to think about is Europe, from both a market standpoint, as well as some of our own issues, we can do a little bit better, and that's a clear focal point. And emerging markets from a growth standpoint. We're focused on sustainable growth as we go into those markets. And we've probably been a little more cautious, but again, trying to build for the long term, not just going in and grabbing tenders or this or that, in certain markets. So we're very much building for the long haul, as we always do within this Company.

Vivian Cervantes with Kaufman Bros.

I wanted to drill down a little bit more on beds and the performance in medical. Understanding the move towards increased efficiencies and hospitals wanting to invest in that, can you drill down a little bit on what the minutiae might be? Is it helping nurses out a little bit? Is it reimbursement related? Is it quality and compliance? Anything that will give us something to bite on to on what increased efficiency means.

It's really combinations of all of them, Vivian. Certainly, some of -- the way we've put some of the software into the beds, there's great opportunities for nurses to operate things more efficiently. But also the never events. We are helping reduce never events, which from a reimbursement standpoint, as you know, under the new healthcare laws and everything else, for hospitals is a big deal. And there's still a lot of hospitals with very outdated beds and stretchers that we are clearly capitalizing on.

Okay, that's helpful. And my last question, heading into North American Spine Society, you do have that new lateral product. Wondering what else we should keep an eye out for, particularly from the Orthovita side with some of the new products I think they may have recently introduced, or even pipeline products that may be coming out.

I think you want to see it there, but in the meantime, obviously, the lateral and Orthovita are a couple of our big things.

Jason Wittes with Caris.

Actually, I wanted to tack on to the medical question about beds. Is that specifically new products that you're offering, or is this the new sales approach, where you're basically going in there and doing an economic calculation to take advantage of new reimbursement rules?

It's primarily product. And I would say the '08, '09 downturn taught us how to probably sell better and sell value. So it's a bit of both, Jason. As well as, frankly, Gaymar, and selling surfaces along with our frames now. We used to sell the frames without really the surface revenue.

Okay. And in terms of Ascent, which is also part of that segment, I believe, are you focused on reprocessing your own products or have you opened it up for pretty much anything that you can handle?

Remember, Jason, at the time of that acquisition, the vast majority, well over 95%, of the revenue that they were achieving, was from products that had nothing to do with Stryker. So there are some Stryker reprocessed products and we do think longer term there's opportunity to leverage our MedSurg offering. But the bulk, the vast majority of what they reprocess is not Stryker.

Charles Chon with Stifel.

First question is just a follow-up on pricing. So I can appreciate that there are some moving parts as the Company plans 2012, and why you wouldn't want to provide a glimpse into next year. But of the things that we do know, can you verify for me whether the biennial reimbursement cuts in Japan are expected to take effect in 2012?

Yes.

Okay. And that would come in the April time frame?

Usually, yes.

Okay. And then the second question is I'd like to dig a little bit more into the performance of Spine. We were expecting a significant contribution from just the Orthovita acquisition. Maybe you could just give us a little bit more color as to what exactly happened during the quarter there.

I think the Orthovita acquisition performed as we expected. My comments were more specific to Spine as it relates to the metal, the implant piece of that business. So I think we feel very good about Orthovita broadly speaking. Because as we said in our acquisition announcement, that product offering will be sold by multiple parts of Stryker's selling organization, be it Cortas, Vitas, Vitagel. And we've in fact done that, and feel very good about our distribution patterns right now across all of those franchises.

I think as it relates specifically to the Spine business and our hardware franchise, it was a little tougher going in the third quarter than what we had anticipated. And it's probably a combination of both some market dynamics and perhaps some self-induced factors. So disappointed with that growth rate overall. Excited about the lateral access fusion product and reenergizing that organization.

Matthew O'Brien with William Blair.

Just curious on the trauma business, it was again pretty strong on an organic basis in the quarter. I know you said last quarter that there was some exuberance around Memometal really driving that performance. Are we seeing a carryover of that effect or are you seeing some benefit from the proposed Synthes J&J deal? Just some more granularity on that performance would be helpful.

Yes, I think it's actually neither. I think it's just the core blocking and tackling still of our trauma franchise. I think that team has been winning really, frankly, for 5 or 6 years now and continuing to have good momentum there. There is some excitement around the Memometal acquisition. And that helped the overall numbers. But the core trauma business still posted some good growth. And I think the Memometal is certainly a nice add-on and we're excited about where that will be going for us. And on the J&J Synthes thing, I think it's still too early to really tell. And we know they are going to be a formidable force.

And the follow-up question I had, Steve, 6, 7 straight quarters now, some pretty accelerated R&D spending. When should we start to see some more of this new product flow? I don't know if you want to call it a bolus of new products coming out, but when should we start?

2012.

How would you characterize them? Would you say they're more product iterations? I know there's some M&A additional spend associated with the deals you've been doing. But would it be more product iterations or additive new products adding to the bag?

It will be a bit of both. And I think, obviously as we come into 2012, you'll see some new things coming. But a lot of that, we talk a lot about hitting a lot of singles and doubles. We're certainly making some other investments but it should be the stuff that we've been really good at.

Rajeev Jashnani with UBS.

Just on gross margin, is 68% about the way we should be thinking about it for the fourth quarter? And then in the past, I think you've talked about gradually increasing gross margins over time. And I was just wondering if that was contingent on, quote/unquote, normalized recon growth. Or is there an opportunity in the near to intermediate term to see gross margin expansion based on mix or perhaps other efficiency initiatives that might be underway?

So the gross margin in the third quarter was 68%, adjusting for all of the acquisition-related costs. And I think going back to the second quarter, at the end of that call, or somewhere during that call, we said that we anticipated gross margins to be in the 68% to 68.5% range as it relates to the full year. And I think we're still comfortable with that guidance.

As it relates to gross margins longer term, my commentary in the gross margin discussion was around our operational focus and looking at everything from procurement cost, material cost, manufacturing cost. Independent of which franchise the product falls into. And really, as a Company, this is our first time taking a hard look, broadly speaking, at our manufacturing operations. So that's what gives us confidence that there's a lot of opportunity in the years ahead.

Again, keeping in mind, as the business expands, be it into emerging markets or there's additional cost pressures which everybody likes to talk about, we may need those gross margin points to offset that. We may want to fuel those gross margin gains into R&D or other areas of investment for the business. So I think our walking-around sense is gross margin expansion remains an opportunity in the quarters and years ahead. Keeping in mind we have areas of investment within manufacturing that do influence gross margin. And so I don't want to lock people into this steady stair step. We're going to manage the business across the entirety of the P&L and strategically make investments where we believe they're most important at a given point in time.

And if I can follow-up on SG&A. It's a similar question. But SG&A margin held flat year-to-date inclusive of a lot of things going on at the Company. Do you expect to see some leverage there going forward, particularly in '12?

I think we're very focused, broadly speaking, on financial discipline across the Company. And whether that's in SG&A or gross margins, we're taking a hard look at every dollar we spend and how we spend it. And whether there's leverage opportunities across multiple parts of the Company or shared services opportunities, things of that nature. So we continue to look and be very diligent, ensuring that we don't disrupt the culture of this Company that's made us so great over time.

Steve Lichtman with Oppenheimer.

Two questions. First, is the Company taking advantage of your diversity versus some of your peers in terms of getting more hospital business? There's certainly more talk about approaching the C suite more broadly. Can you talk about how you guys are getting synergy across your business lines? And I'll have a follow-up.

Steve, I'd say we're still in the very early innings of that. I think we've been building the capabilities to do that. But a lot of our businesses are still hand-to-hand combat down in the operating rooms. So I think what you should think is we're positioning ourselves for when that day really comes, and think we're well poised to capitalize on that. We're having some discussions with certain hospital systems on that, but I would call it very early innings.

And then on MedSurg, the EU market's obviously soft today, and your exposure there in MedSurg is small, which is good today. But when should we think about international expansion for MedSurg being a growth driver for Stryker in the coming years?

I think it has been. Other than this quarter, really for the last couple years, our endo and instruments business has been growing pretty nicely outside the US. And they continue to win a lot of the market. So I think you should expect those to grow pretty nicely here. And probably be growing faster than some of the domestic markets for a good period. There's always going to be some quarterly bounces, as you well know, from knowing our MedSurg businesses well over the years.

Jeff Johnson with Robert W. Baird.

Curt, just wanted to follow-up on maybe Charlie's question on the spinal implant side. You describe that as maybe some self-induced issues as well as market driven. Do you feel like there was a step up at all in payer pushback issues and some of the commercial payer issues and on the self-induced side? Was it product driven? I know you've lost some sales reps there over the last few quarters. Any more color you could provide there?

I don't think we saw meaningful change in payer pushback. I think that's been tough going back to the fourth quarter of 2009. So there's not a new dynamic there. I think, again, the self-induced challenges are more the right products, the organization waiting for products. And, again, encouraged about our lateral access device getting out. But self-induced stuff is probably internal execution.

And before we wrap up, I do want to get back on the share count question. We finished the quarter at 386 million shares. So I think people from a modeling purpose should use that for the fourth quarter and then again heading into 2012.

And then can I ask my follow-up question there? Steve, just for you on organic growth. I know you don't want to get into 2012 guidance. Understandable at this point. But is it fair to think as a target on some of these roll off from being acquisition to then an organic growth number, even if your end markets, especially ortho implants, don't really change at this point, if they stay in that low single-digit growth range, your natural Company-wide organic growth maybe picks up 0.5 to 1 point? Maybe even a little more than that next year just based on some of these higher growth areas now layering into the organic side?

I think we would probably hope that, Jeff. And again, we'll give that guidance in early January.

And to that end, we want to thank everybody for joining us today. And we will report our fourth quarter results and talk about 2012 on January 24. So thank you, everybody, for joining us today.

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