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Executives

Stephen MacMillan - President and Chief Executive Officer

Katherine Owen – Vice President, Strategy and Investor Relations

Curt Hartman – Chief Financial Officer

Analysts

Bob Hopkins - Banc of America Securities

Rick Wise - Leerink Swann

Mike Weinstein – J.P. Morgan

Joanne Wuensch - BMO Capital

Matt Miksic - Piper Jaffray

Tao Levy - Deutsche Bank

Raj Denhoy - Thomas Weisel Partners

Bruce Nudell - UBS Securities

Ben Andrew – William Blair

Matthew Dodds - Citigroup

Ed Shenkan - Needham & Company

Michael Matson - Wachovia Capital Markets

Doug Schenkel - Cowen and Company

Kristen Stewart - Credit Suisse

Glenn Navarro - RBC Capital Markets

Jeff Johnson - Robert Baird

Bill Plovanic – Canaccord Adams

Greg Halter - Great Lakes Review

Stryker Corp. (SYK) Q4 2008 Earnings Call April 20, 2009 4:30 PM ET

Operator

Good day, ladies and gentlemen, and welcome to the first quarter 2009 Stryker earnings conference call. (Operator instructions)

Certain statements made in today's conference call may constitute forward-looking statements. They will be based upon management's current expectations and will be subject to various risks and uncertainties that could cause the company's actual results to differ materially from those expressed or implied in such statements. In addition to factors that may be discussed in this call, such factors include, but are not limited to: further weakening of economic conditions that could adversely affect the level of demand for the company's products, pricing pressures generally including cost containment measures that could adversely affect the price of or demand for the company's products, changes in foreign exchange market, regulatory actions, unanticipated issues arising in connection with clinical studies and otherwise that affect United States Food and Drug Administration approval of new products, changes in reimbursement levels from third-party payors, a significant increase in product liability claims, unfavorable resolution of income tax audits, changes in financial markets, and changes in the competitive environment. Additional information concerning these and other factors are contained in the company's filing with the United States Securities and Exchange Commission, including the company's Annual Report on Form-10-K and Quarterly Reports on Form 10-Q.

Today's conference call will also include a discussion of constant currency sales performance and adjusted diluted net earnings per share for the year ended December 31, 2008. Further, discussion of these non-GAAP financial measures including GAAP reconciliations that appears in the company's Form 8-K filed today with the United States Securities and Exchange Commission, which may be accessed from the For Investors page on the company's website at www.stryker.com.

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

Stephen MacMillan

Good afternoon everyone and welcome to Stryker's first quarter 2009 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.

As many of you are aware, Curt assumed the role of CFO effective April 1, 2009, although he has been working closely with both Dean Bergy and our finance team since the latter part of 2008. Certainly some fun times for Curt to join in that role.

Turning to the review of our quarterly results, 2009 has thus far presented us with some challenges but we’ve also achieved a few noteworthy successes. We believe these achievements are particularly impressive in light of the current economic environment.

Looking at the quarter we note the following highlights:

Despite the unprecedented global economic slowdown six of our eight key product franchises delivered mid-single to low-double-digit constant currency revenue growth, demonstrating the strength of our diversified business model;

Strong cost controls throughout the organization, as evidenced by the 1.5% reduction in SG&A as a percent of sales, despite ongoing selective investments in our sales forces;

Ongoing benefit from our geographic footprint as evidenced by the fact that although in the U.S. our endoscopy and medical franchises were under pressure in the quarter, both posted solid mid-teens growth internationally;

Continued strength of our balance sheet with our total cash and marketable securities balance totaling $2.2 billion;

The successful launch of a number of important new products, including the Q1 roll out of our endoscopy 1288 camera, wireless monitor, and light source;

Expansion of our medical division’s footprint with our latest entry into the U.S. surfaces market via the launch of our Impression offering; and

The successful completion of the Department of Justice’s 18-month monitoring period, which was completed on March 27.

To be fair, Q1 also presented us with some disappointments, most notably our decision to revise downward our full-year sales and earnings guidance as the capital environment has proven more challenging than we expected at the start of the year.

However, it’s worth noting that although hospital capital budgets remain under pressure, we have started to see some encouraging signs of customers looking to resume capital purchases. Much of this is still anecdotal and we would remain appropriately cautious regarding the near-term outlook for the roughly 25% of our revenue base that’s tied to capital purchases. But it does suggest the cycle may be bottoming.

Overall, we are encouraged by our Q1 results and our ability to sustain top line growth despite the economic conditions, while also continuing to invest heavily in our compliance initiative and new product launches.

And the actions we undertook in Q4, when the first signs of the market slowdown appeared, to aggressively implement meaningful cost controls have had considerable impact and should allow us to deliver solid earnings growth for 2009.

Meanwhile, our growing cash balances and the overall strength of our balance sheet uniquely position us to capitalize on potential opportunities. With Q1 now under our belts, which we suspect will be the most challenging quarter of 2009, we feel well poised to deliver on our commitments for the year.

With that, I will turn the call over to Katherine.

Katherine Owen

I would like to provide an update and some perspective on three topics that have been the focus of a number of questions from the investor community, specifically: one, reconstructive implant pricing and elective procedure trend; two, hospital capital budgets; and thirdly, the outlook for OP-1.

First, with respect to recon implant practice, there has been some speculation that the current economic environment will drive greater downward pressure on implant prices. We have actually seen similar concerns in the past with various factors serving as the catalyst for the core “imminent” collapse implant pricing, including gain sharing, national account contracting, the DOJ investigation, the DOJ settlement, and more recently, the economic environment.

However, despite these events, reconstructive ASPs have been relatively stable since 2004, decreasing at roughly 1% to 2% annually, although this has been largely offset by more favorable pricing for spine and trauma. Part of the lack of meaningful downward pressure on recon implants is tied to the favorable reimbursement trends in recent years, including the severity of adjusted index that allows for higher reimbursement for more challenging patients such as those often seen at teaching hospitals.

Admittedly there are pockets where we have seen greater pressure of late and we expect that trend will continue. However, we continue to see solid up ticks for premium-priced products such as our X3 poly and the recently launch titanium hip cuff, indicating physician preference for products that provide a value-add to patients.

As we have discussed throughout the quarter we have seen some pockets in the U.S. where there has been a delay in elective procedures, primarily with non-Medicare patients owing to the economic environment. Given that it’s typically the debilitating pain that drives a patient to undergo reconstructive surgery, we suspect a deferral of surgery will last months and not years, moreover towards emphasizing that the overall impact in these isolated delays on our recon business have been relatively modest, as that business was still up 6% operationally in Q1, which is not meaningfully off from the 7% to 9% secular growth rate for the industry.

Put another way, despite the unprecedented economic environment the compelling clinical results from joint replacement for patients, coupled with the importance of this procedure for hospitals, is evident in the ability of this market to continue to sustain solid revenue growth.

Turning to hospital capital budgets, although the backdrop remains tough, we are seeing some early signs that have heretofore not existed, suggesting some hospitals are looking to resume purchases of critical products. We would emphasize the importance of not overestimating either the speed of the recovery or how quickly these early signs will translate into a meaningful rebound in revenue as we expect this to translate into first, stabilization in the year-over-year declines in our capital businesses, followed by a gradual acceleration.

But beyond the timing of a recovery in the hospital capital markets, we remain committed to our ongoing strategy of expanding our footprint and entering adjacent markets. For example, our medical franchise has broadened its offering in the U.S. purchases market with the recent launch of Impression, our first meaningful product introduction in the roughly 400.0 million replacement services segment, a category that is growing in the high single digits, a process that will increasingly migrate in this for-purchase product.

This strategy is incrementally expanding our patient handling franchise, allows us to capture market share, and helps blunt the impact of the overall slowdown in the capital purchases market. Put more simply, although there is pressure on the market, our share of the market continues to expand.

With respect to Point 3 and the outlet for OP-1 we are clearly disappointed by the non-favorable FDA panel recommendation that we received late last month. Given the long-term history of this product’s use and patients under our various existing indications, we [inaudible] its safety and efficacy.

We are reviewing a variety of options available to us, recognizing we do have a base of customers, including patients and physicians, that rely on this product and that’s an important consideration.

And we are encouraged by our early clinical results evaluation OP-1’s efficacy in soft tissue. We expect to report back to you in relatively short order with more specifics regarding our strategic plan for OP-1 but in the interim while this process remains underway we will defer any additional comments.

With that I will now turn it over to Curt to provide a more detailed financial update.

Curt Hartman

I will start this afternoon with the discussion of the considerable impact that foreign currency had on our first quarter sales. The strengthening of the U.S. dollar in the majority of our overseas markets reduced international sales by $87.0 million in the quarter and reduced the company’s overall sales growth by 5.3%.

Trying to the score the magnitude of the note that this dollar amount is approximately equivalent to the entire gain recognized in 2008 from currency and is approximately $20.0 million greater than the adverse impact noted in the fourth quarter.

Unfavorable currency movements in the quarter versus last year included the dollar strengthening approximately 15% against the Euro, 38% against the British pound, and 36% against the Australian dollar. The dollar did weaken approximately 11% against the yen when compared to prior-year rates.

If currency rates hold near current levels we expect foreign currency will decrease second quarter sales by approximately 5.5% to 6% when compared to 2008. At these rates the full-year impact will be in a range of 3.5% to 4.5% when compared to 2008.

Next I will spend a moment on the impact of price and volume on the top line. In the quarter, selling prices across the company were essentially flat on a worldwide basis despite a 7% pricing decline in Japan. As a reminder, the Japan pricing decline is tied primarily to the reimbursement cuts introduce in April of 2008.

On the volume mix side, growth was 4% in first quarter, which had one less selling day compared to the prior year. Volume mix was generally as expected for our orthopaedic implant products but volumes were off considerably for endoscopy and medical businesses, particularly in the U.S. market. Overall, our domestic volume mix growth was 1% in the quarter and international volume mix growth came in at 8%.

Now I will turn to the product categories. Product growth detail has been provided in our press release and I will reference those rates as I provide more detail on our key segment performance metrics.

For this discussion I will start with our orthopaedic implants, which represented 61% of our sales in the quarter. Sales of orthopaedic implants were flat in the quarter on a reported basis and grew by 6% in constant currency.

Our hip business was down 2% as reported in dollars but up 6% operationally in the first quarter on a global basis. The modest acceleration in growth from both prior-year and Q4-levels was expected given the comparables. The Trident and X3 lines paced our growth on a global basis. As a reminder, the Trident’s [prior] issue of 2008 began late in the first quarter with the largest sales impact being felt in March through June timeframe.

In the U.S. hip sales were up 3% in the quarter. X3 poly delivered the largest gain and was drawing by our Trident and restoration modular hip system. Our sequential growth rate increase 3% over the fourth quarter.

International hip sales delivered a nice quarter, increasing 9% operationally. Our European hip sales, the largest of our international markets, increased at a high single-digit rate. Nice gains from X3, Trident, Accolade, and the restoration modular hip revision products were offset by declines in other hip products.

In Japan hip sales declined at low-single-digit levels on an operational basis due to the government price cuts.

Moving to our new franchise, the company recorded sales growth of 1% in dollars and 6% in constant currency in the quarter. The U.S. knee business had a solid quarter in a somewhat slowing market, reporting growth of 8%. This growth, again, came on the strength of our Triathlon line, which as you recall, has been expanded with additional line extensions.

Internationally, knees were up 4% on an operational basis. Europe and Pacific knee sales increased while Japan knee sales were impacted by the previously mentioned government price cuts. However, we are encouraged by the outlook, given the recent launch of the Triathlon system in Japan.

Moving to trauma, the trauma business slowed somewhat over fourth quarter growth rates, recording a 2% gain in dollars and an 8% increase in local currency this quarter.

U.S. trauma maintained double-digit growth at 10% and would have been 13% is military sales were excluded. This was a strong performance when considered against last year’s 23% sales growth. Sales of the Gamma 3 hip fracture, foot and ankle, and upper extremity products led our U.S. trauma growth.

International trauma sales were up 6% operationally in the quarter with Europe posting mid-single-digit constant currency growth. In Japan local currency trauma sales declined in the mid-single-digit range. On a product line basis, international trauma sales were paced by growth and hip fracture, upper extremity, and foot and ankle products.

Our spine business recorded another solid quarter, growing 8% in dollars and 11% on an operational basis. U.S. spine sales recorded 13% growth against an exceedingly difficult prior year comparable of 25% growth. Domestic spine growth was led by inner-body and thoracal lumbar products.

International spine sales posted operational growth of 9%, led by thoracal lumbar products, also. Japan recorded operational growth at low-double-digit levels and Europe grew at mid-single-digit levels operationally.

Now I will turn to the MedSurg group, which represented 39% of our sales in the quarter. As you are aware, MedSurg is comprised of three kit product categories: instruments, which accounts for 18% of company sales; endoscopy, which accounts for 14% of company sales; and medical, which accounts for 7% of company sales in the quarter.

Within MedSurg approximately 60% of sales come from capital equipment and as you are all aware, given the external environment, this made for an exciting quarter. Against this, MedSurg sales growth was down 5% as reported and off 1% on a constant currency basis. This is down from a 6% gain reported in the fourth quarter of 2008.

Touching on the product categories, sales for the instruments line, which, as a reminder, generates approximately 40% of sales from capital equipment, reported an increase of 4% in the quarter and 8% operational growth.

Instruments U.S. had another solid quarter with sales up 11%. The focus on products to serve markets outside of orthopaedics delivered strong results while the traditional power tool franchise did slow somewhat, owing to capital constraints. Other key disposables and service revenue also posted strong gains.

International sales growth was softer at 3%, with Japan posting double-digit results. These gains were somewhat offset by our European results, which were essentially flat on tough year-over-year comparables and timing of some shipments into the market.

Next is the endoscopy segment, which reported first quarter sales that were down 5% and off 1% in constant currency, despite the fact that approximately 60% of sales are up from capital equipment.

Endoscopy U.S. sales as reported were down 7%. Strong shipments of communication suites and growth in our disposable-based business were essentially offset by the drop in video cameras and accessories. I will note that U.S. sampling of the new 1288 camera system is complete and first quarter try-outs have been well received.

International sales remain strong and reported 16% operational growth continuing the favorable results posted in the fourth quarter. Every international market reported positive local currency growth and we continue to be encouraged by our expansion in these markets.

Finally, I will talk about our medical products, which generate approximately 90% of sales from capital equipment.

Globally, medical sales declined 22% in the quarter, as reported, and 18% in constant currency.

Medical U.S. sales declined 27%, which was a bit outside of our anticipated range. Favorable news was found from increased growth in our rentals and service business but the obvious impact of declining bed and structure sales more than offset this gain.

International sales results again delivered favorable news, posting 18% constant currency growth with positive results in both bed and structures after the big year-end finish.

Now I will turn to the remainder of the income statement, beginning with gross margins. First quarter gross margins declined 160 basis points compared to 2008. As we have previously noted, gross margins in Q1 were impacted by significant investments in our compliance initiatives, recalling that there was very little of this spending in the year-ago quarter.

Margins were also negatively impacted by a slowdown in some of our manufacturing plants in a response to a softer top line. Sequentially the 67.8% is a slight improvement over the second half of 2008.

Research and development spending was down 6% in the quarter to 5% of sales. This was at the lower end of our historical range, owing to the timing of expenditures associated with typical new product development cycles. I would note, we would expect R&D as a percent of sales to move forward from these levels over the course of the year.

Selling, general, and administrative costs decreased 6% versus prior year and as a percentage of sales dropped a further 60 basis points over 2008 four-year results. This is primarily a result of our divisional focus on spending controls initiated fully in the fourth quarter in response to the slowing global economy.

Despite significant progress as it relates to our cost-control efforts, given the top line pressure, operating income overall decreased 1% in the first quarter while operating margins increased to 23.7% of sales.

Next I will provide a breakdown of the other income for the quarter. This was made up of $15.6 million of investment income offset by interest expense of $8.0 million and foreign currency transaction loss of $400,000. Clearly lower investment income in the quarter resulted from the drop in yields, which are approximately 200 basis points lower than year-ago levels.

The company’s effective income tax rate was 27.3% for the first quarter of 2009, down 80 basis points from the first quarter of last year and down 10 basis points from the 2008 full-year rate. We expect our full-year 2009 ETR to be substantially in line with our reported full-year 2008 tax rate.

Additionally, as noted in our press release, we are in receipt of a proposed tax adjustment from the IRS related to our cost-sharing arrangements. As indicated in our release, we intend to defend our positions vigorously and will be deferring any additional comments on this topic.

Turning to the balance sheet, the obvious comment is that it continues to be very strong and overall there was very little change in the balance sheet from year end. Cash and marketable securities increased by approximately $50.0 million during the quarter.

Accounts receivable days ended the quarter at 59, which represents a decrease of 1 day compared to the prior year. For the quarter, accounts receivable days averaged 58 which was similar to the fourth quarter of 2008 and 2 days below the average for the first quarter of 2008. These are in line with historical and we feel represent excellence performance given our geographic footprint.

We have not felt any significant change in payor behavior, however in light of the current global environment we are maintaining diligent focus on this important asset.

Days in inventory finished the quarter at 174, which was up 19 days sequentially and 12 days versus the prior year. The average days in inventory for the quarter was 165 versus the 155 average for the fourth quarter of last year and the 153 days for the same period last year.

As a former operating executive with a manufacturing background, our inventory days are a subject of much focus. The two biggest factors impacting this number are compliance initiatives and the sales slowdown. Neither of these events are a surprise so it is fair to assume that we will get better in this category with the progress evident as 2009 unfolds.

Next I will provide commentary on cash flow. We had another very strong quarter. Cash flow from operations grew 43% to $472.0 million and free cash flow was up 51% from $160.0 million to $242.0 million. This increase was predominantly driven by lower working capital requirements. Conversely, the first quarter tends to be a seasonal low for us in terms of net cash flow given the payment of the dividend in January and other cash uses that occur only in the first quarter.

Finally, in closing, I would like to offer some comments regarding our underlying assumptions and 2009 sales outlook for certain key markets.

With respect to reconstructive joint replacement, we assume that we will continue to see some level of elective procedure deferral that will modestly impact the overall industry growth rate by an estimated 1% to 2% points, suggesting market growth in the mid-single-digit range on a worldwide constant-currency-dollar basis in 2009.

Our trauma and CMF franchises are largely immune to any economic slowdown given the predominantly non-elective nature of these businesses so we continue to assume market growth in the high-single-digit range.

Given spines exposure to elective procedure slowdown we assume the market slows to the high-single digits, versus the low-double-digit rates it has been sustaining.

Turning to our MedSurg franchises, these markets are more challenging and given that approximately 60% of total MedSurg sales are classified as capital purchases. We expect to see low- to mid-single-digit year-over-year declines in this business on a quarterly basis for the remainder of 2009 owing primarily to continued weakness in medical.

To further help you with your modeling, we believe our medical business is stabilizing from a dollar perspective but would remind you that growth rates will remain under pressure and we would emphasize the exceedingly challenging year-over-year comparisons for this franchise in Q3.

Also by way of reminder, our instruments business is facing a very challenging comparison in the second quarter given the 22% constant currency growth recorded in the previous year and as such we would expect the year-over-year growth rates to slow from Q1 levels.

For 2009 outlook we are making revisions based on the above assumptions. As most of you are aware, we tend to challenge our organizations in our top and bottom line growth targets aggressively, which has historically served both the company and our shareholders well.

However, the significant economic slowdown, particularly its impact on our MedSurg franchise, was greater than expected in Q1 and prompted us to take a more conservative stance as it relates to the remainder of 2009. As we finalized our budgets in late Q4 the markets were in considerably greater flux and our insights into our hospital customers’ spending plans were more limited.

Four months later there are still uncertainties, particularly as it relates to both elective procedures and the markets outside the U.S. with the latter having remained fairly insulated from the economic slowdown.

But despite these uncertainties, based on trends in recent weeks, and incoming order patterns, we feel comfortable with our ability to achieve our revised sales target of 2% to 5% operational growth for 2009, which assumes low-single-digit constant-currency growth in the first half of the year with a modest acceleration to mid-single-digit range in the second half.

With respect to earnings, although recent trends indicate that our capital-based businesses are bottoming, we are taking a more cautious stance with respect to our guidance with our full year EPS target at the midpoint of a $2.90 to $3.10 range, up 2% to 10%.

We reiterate that given year-over-year comparison, compliance spending, FX, and our assumptions regarding our top line, we continue to expect earnings to be stronger in the second half of the year, which currently does not appear to be fully reflected in the first call estimates.

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

Stephen MacMillan

Before we open up the call to Q&A I would like to make just a few brief closing comments.

As our revised guidance reflects, we are considerably more cautious regarding the outlook for the remainder of 2009 versus our expectation at the start of the year, given lingering uncertainties relating to elective procedures and hospital capital budgets that at this point have been well vetted.

Although we have seen evidence that the downturn in hospital capital purchases is bottoming and we have adjusted for the impact on elective procedures, we are opting to set the low end of our sales and earnings range at a level that we believe reflects any reasonable downside risk to the assumptions in our outlook that Curt discussed in detail.

And quite frankly, given our own disappointment that we failed to accurately forecast our sales and earnings outlook to investors at the start of the year, we believe it is critical that we set expectations at a level that removes as much doubt as possible regarding our ability to deliver.

It’s worth underscoring that our conviction and our ability to deliver low-single to low-double-digit earnings growth, even in the fact of a difficult economic backdrop, in large part reflects the impact from the myriad actions we proactively initiated in the fourth quarter to leverage our cost structure. The moves were company-wide and have unlocked meaningful earnings power despite a challenging to line and underscore the importance of these actions.

Beyond allowing for solid earnings growth in 2009, our efforts on the cost front should position us well to drive greater P&L leverage as we exit the current recession.

Finally, our results once again speak to the unique competitive advantage of our diversified revenue base and underscore the significant opportunities we have to drive continued growth across numerous geographies.

There is another point I would like to make here. It is clear we are facing some short-term challenges but we would be remiss is we did not remind you that we remain very excited about our longer-term growth prospects. With the investments we’ve made in previous years to build a more diverse orthopaedic implant franchise, as well as our initial expansion of our MedSurg businesses outside the U.S., we continue to see great growth opportunities for all of our franchises in the years ahead and our balance sheet remains a source of strength, which should also serve us well going forward.

We look forward to providing you all with a more detailed update regarding our key franchises and new product launches at our upcoming analysts meeting which will be held May 20 in New York City.

Lastly, the conference call for our second quarter 2009 operating results will be held on July 21, 2009. And with that, we will now open it up for Q&A.

Question-and-Answer Session

Operator

(Operator Instructions) Your first question comes from Bob Hopkins - Banc of America Securities.

Bob Hopkins - Banc of America Securities

The first question I have has to do with the guidance, on the top line. Because if you look at the midpoint of your guidance, would suggest that basically for the rest of this year you expect your results to be somewhat in line with the growth that you put up in the first quarter. In other words, you expect things will basically stay the same for the rest of the year relative to that 3.3% growth that you had in the first quarter. But then you also went on to say that you think hips and knees and may decelerate a little bit and spine may be a little bit tougher and you hope that the MedSurg stuff holds in.

So I’m just wondering if you can kind of reconcile those two things and talk a little bit more specifically about the encouraging signs that you mentioned within the MedSurg business.

Katherine Owen

I just want to jump in with one point of clarification. In our comments regarding elective procedures and our assumptions regarding spine and trauma were really intended to give a little bit more color to what was baked into our assumptions than we have historically done and really aimed at helping people understand how the year is going to progress.

We have seen a lot of that in the first quarter. We’ve talked throughout the first quarter about some of the impact on elective procedures, both for hips and knees, as well as on our spine business. But I would not view that as something that is changing meaningfully, from the first quarter into the rest of the year, that’s somehow going to result in a meaningful deterioration in those businesses as the rest of the year unfolds.

Bob Hopkins - Banc of America Securities

But still the basic premise here is that things are going to stay the same with what you saw in the first quarter and I’m just wondering if we can put a little more color around that, especially as it relates to specifically what you’re seeing with MedSurg.

Stephen MacMillan

I think from an overall implant standpoint, I think we feel pretty good about being able to deliver consistent results with what we had in the first quarter. As you look to the balance of the year on the MedSurg side, instruments will probably slow a bit, I think particularly as Curt referenced, the second quarter is a really funny comparable, but hopefully endo and medical, over the course of the year, should certainly not slow any worse. And if anything, by the time we start coming to the fourth quarter those comparables get better.

Bob Hopkins - Banc of America Securities

As a follow-up then, just to clarify, could you talk—you mentioned some encouraging signs within MedSurg. Could you just talk a bit more specifically about what you’re seeing. Is this anecdotal evidence of people saying they’re going to place orders or are these actual orders happening? Just a little more color around that would be really helpful.

Stephen MacMillan

It’s anecdotal in both fronts. I would say it’s certainly some of it feeling, some of our team feeling that they’re a little closer to getting some orders. I would also tell you that I think our sales force is learning that they’ve got to go deeper in figuring out to penetrate the accounts to shake some of the capital free.

But I think we also again, we’re trying to be cautious here and while we’re saying we’re some pockets, we are not declaring the bottom. And I think that’s why we want to still be cautious there.

Curt Hartman

I think one additional comment there is, as we have indicated over the first quarter, we do have a pretty high degree of contact with the large, integrated delivery networks across the U.S. market and we’ve tried to put labels on their spending patterns, be they frozen, be they, on the other extreme, very fluid.

And I would tell you over the last six to seven weeks we’ve not seen a meaningful in those rates, and by that I mean they have not continued to be a higher number of accounts freezing capital spending. We have actually seen them moderate and stay stable, which we think indicates, bodes well, versus the dramatic swings we saw in the first six weeks of the quarter.

Stephen MacMillan

Yes, it’s stopped getting worse. It hasn’t yet turned up but we’re viewing that as hopefully some pockets of hitting bottom. But again, I think we all, in this environment, and particularly given our over-aggressive approach coming into the year, we certainly don’t want to declare we’re at the bottom yet.

Katherine Owen

Just one additional follow-up because it’s probably a point that’s worth covering in some detail, and you probably are well aware of this fact, but it is important to recognize when we talk about capital purchases, hospitals do not view all capital equally.

There is a very big difference between capital purchases they need to facilitate procedures, which is a lot of what we offer, versus some of the really big-ticket items. So some of the trends that we are seeing right now are prospective incoming order patterns and some of the feedback we’re getting from our sales force, may be different for different companies that offer higher-ticket items.

Operator

Your next question comes from Rick Wise - Leerink Swann.

Rick Wise - Leerink Swann

You talked about the one adjacent market for the bed business, track of opportunity, and I’m sure you’re looking around for others. Are there some significant other opportunities you might want to highlight, that you are thinking about, that we could hear more about as the year unfolds?

Katherine Owen

I think we are probably going to defer that a little bit until we go to May. We thought at the May 20 analyst meeting we are going to dive into a lot of that across our franchises. We thought it was worth mentioning the medical one for two reasons: one they did just launch the Impression offering and it’s a fairly meaningful market that we’re not really in right now so we thought it was worth highlighting. And as you know, we tend to talk about products after they’re launched.

And secondly, it’s one of our businesses that has been under the most pressure. It is the most exposed to capital so it’s a way to explain where some of our conviction comes from that they business is stabilizing. We thought it was worth pointing out that there are folks expanding into new markets.

But we will address you area of question more fully at the analyst meeting.

Rick Wise - Leerink Swann

The spine market, you highlighted as going high-single digits instead of low-double digits. Could you give us a little more color on your perspective? Is this people deferring procedures in your view, just what’s going on?

And last, maybe you could give us an update on the FDA inspection issues. You had said in the fourth quarter we have two times as many FDA inspections going on as compared to the prior year, i.e. suggesting progress. Again, any comments there would be helpful.

Katherine Owen

Let me tackle the second part of your question first as it relates to the FDA inspection. At this point not a whole lot of color to add. We have obviously remained extremely focused on addressing the issues raised in the warning letters to lead to a successful re-inspection while also continuing to make the investment in our compliance initiative across the company because we are going to continue to have FDA inspections.

Beyond that there is not a whole lot of new updates from our last call. But as those updates become more meaningful we will certainly circle back in with everybody.

As it relates to spine, I think it is exactly what you said, it is similar to hips and knees in that we are seeing deferrals. A little tough to know how long they will be and it’s certainly not something we’re seeing across the board, but rather pockets where some physicians are seeing some slowdown.

Operator

Your next question comes from Mike Weinstein – J.P. Morgan.

Mike Weinstein – J.P. Morgan

Let me start with a couple of areas that were obviously notable in the quarter. You talked about the medical business, and that business certainly, within the company, is feeling the biggest impact from what’s happening at the hospital level.

You said you thought the sales levels had stabilized, which is maybe good and bad, because the first quarter is usually your lightest quarter of the year. How do you get visibility around that? How do you get visibility around the idea that sales maybe stabilizing at their current level and how far out can you see?

Curt Hartman

I think what we would look at in our medical business at the dollar reported level in the U.S. market, our comment there is we believe it’s stabilized or effectively we don’t expect it to go any lower.

Our visibility is that typically in the medical franchise, those orders are well in advance and they are scheduled shipments because if you think of the size of the bed frames that are coming in, these come in in large trucks. It’s a very much scheduled-in-advance event. You may have patients on beds that have to be moved onto new frames, so these things are pretty far out into the future and as we look at our incoming, or expected, order flow, we still see news of favorable outcomes in the future.

We don’t—I refer back to the summary of customer calls that we make—we don’t see things continuing to degrade out into the future.

Mike Weinstein – J.P. Morgan

Let me touch on another item. You had a real slowdown in the fourth quarter and first quarter, and that was your knee business, where you’ve had sustained double-digit growth in your core knee franchise for several years now but it seems the economy is starting to have an impact on the knee market, and that’s what the other players have reported thus far.

Can you talk a little about knee volumes and the backlog at your customer base, what you’re hearing from the neurosurgeon, maybe just compare it to what we’ve heard about backlogs coming in and what visibility you might have on that portion of the market which seems most successful to the economy, that portion bottoming over some point in the balance of the year.

Stephen MacMillan

The knee market right now, it was a little surprise to us. It did feel like the market itself was certainly a little bit slower here in the first quarter, and particularly in the United States but a little bit outside.

We are hearing just a range of stories right now. From some of the docs at some of the leading big institutions, not affected at all, and then other both geographic or institutional folks who have gone from six-to-eight-week waiting lists down to very little waiting lists. And it just really seems very pocketed and no clear trend other than there are certainly some people pulling back.

And I think, again, that’s part of the reason for our conservatism here as we go. The simple thing would be to say, hey, we’re going to bounce back into the double-digit knee growth range that we’ve had certainly over a number of years, but I think, again, we’re just a little more cautious and you know, hearing some of those pockets, it looks like you’re probably picking up as well.

Mike Weinstein – J.P. Morgan

Steve, with what’s happened to your markets over the course of the last six months and the changes in your business plan for 2009, are you doing anything with your compensation structure for sales reps to help people through this tough period and improve retention, not that retention has ever been an issue for Stryker. But are you doing anything with your comp structure that we should we be aware of?

And on the tax issue that you raised today, the press release, can you give us any sense of range of potential impact there?

Stephen MacMillan

On the comp structure piece we are paying very close attention to it. We have not modified or making significant modifications at this point in time, partially because we want to see how things continue to play out. But obviously our sales people are very important to us and we do pay close attention to that.

Curt Hartman

On the tax issue that was raised in the press release, as we indicated, we are not going to go into great detail there. What I will tell you is that this a multi-year process. The company is constantly being evaluated for its tax positions. That’s just part of the normal process. We are in receipt of a letter that is very specific in nature of what they’re looking at in terms of cost-sharing arrangements with various of our foreign manufacturing entities and we feel these positions are very well justified and we will defend them vigorously and as such we expect this process to play out over many years. We’re not going to get into any amounts here. Suffice it to say we feel good in the position we established long ago on these cost-sharing arrangements.

Mike Weinstein – J.P. Morgan

Do you know of any other companies that received a similar letter and will you be releasing a copy of the letter in the 8-K.

Curt Hartman

We are aware of other companies that have received this letter, some in med tech, some outside of med tech.

Operator

Your next question comes from Joanne Wuensch - BMO Capital.

Joanne Wuensch - BMO Capital

Looking a little bit longer term here, you have hospitals that are delaying purchases. Do you have a feel for how long they can delay these products? Is this more when the money is available they will purchase it? How do we think about return to growth?

Katherine Owen

It’s really a very big range, not only for our businesses but for all companies offering hospital capital purchases. If you look at certain products like power tools for example, those are key in facilitating surgeries that are necessary for hospitals to make money. They do have a very specific life cycle and they do need to be upgraded. Other products like beds and structures where you have seen greater impact, those can be delayed for a longer period of time.

So it really is all over the map. What we have tried to do, accept the expectations based on what we have been able to glean from recent weeks on order trends across all of these businesses, appropriately risk assess it, which is really what’s at the bottom end of the range as opposed to what we’re expecting to put out this year, and recognizing there is going to be variability between endo, medical, and instruments given that they vary with respective to capital exposure.

Joanne Wuensch - BMO Capital

In your guidance, what are you assuming for a share count?

Katherine Owen

For the full year 2009?

Joanne Wuensch - BMO Capital

That would be helpful, yes.

Katherine Owen

Give us one sec.

Joanne Wuensch - BMO Capital

And while you’re looking for that, you spoke about cost controls. Could you give us an idea, or flush out, what kind of cost controls you’ve been able to put in place?

Stephen MacMillan

It started with headcount control. We typically dramatically expand our sales forces at the start of every year and do a lot of hiring very early in the year. One of the things of certainly sensed was it might be a little more difficult so it started with headcount control.

And we’re doing all the usual, you know, certainly at this point looking at our travel budgets and a lot of the standard stuff. Longer term there are also a lot of opportunities, frankly, on the supply side, the manufacturing side, the sourcing side, that we are also getting into, that frankly we think we think will yield more benefits probably in 2010 and beyond.

So we’ve got short-term stuff but also we’re using this as an opportunity to look deeper at our cost structure to wrestle out more costs in the 2010 and beyond period as well.

Curt Hartman

On the share count assumption you should use approximately 399.0 million shares.

Operator

Your next question comes from Matt Miksic - Piper Jaffray.

Matt Miksic - Piper Jaffray

First question, on beds. Business came off here in the U.S. more than we were expecting and it sounds like more than you were expecting. OUS was kind in line but just looking at the second quarter comps it looks like you’re heading into some tougher comps beginning in the second quarter.

And then also I was wondering how confident you are that you won’t see the same kind of freeze-up on the international markets, say, later in the year that you have seen here in the first quarter.

Stephen MacMillan

The second and third quarter, we are clearly going into two additional tough comp quarters on the medical business, in the U.S. and even a little bit internationally. And that’s going to make it a challenge.

Having said that, again, I think we feel that we’re probably at an absolute level, an absolute run rate that we probably won’t go much below based on what the order trends have been for say four months or so running.

As we think about the international piece, the growth rate looked pretty nice in the quarter but we remind you, our international business is tiny and so we think even is the capital starts to freeze up a little bit more internationally we still have so much opportunity and runway because we’re just getting started there.

Katherine Owen

Just one quick follow-up. I would also just call you back to the comments we made in the beginning about some of our new product launches, like Impression that’s going into a $400.0 million market that we’re not really in. So our ability to expand that footprint is part of what also helps going forward.

Matt Miksic - Piper Jaffray

Yes, I got that. What sort of share do you think you could conceivable get in that market over time?

Katherine Owen

Well, we’re starting close to zero, so higher than that. I don’t want to throw out share numbers, it’s really just intended to help you guys understand that strategy of continuing to expand medical’s footprint.

Matt Miksic - Piper Jaffray

In beds, I’m just trying to understand is that a market that is sort of split like two or two-and-a-half ways like some of the other bed markets you’re in or is there a different dynamic there?

Katherine Owen

Are you talking about the number of competitors?

Matt Miksic - Piper Jaffray

Yes, or in other words, like if we think about that $400.0 million add, is that something that you have one large competitor, two larges competitors that are in it and then now is your chance to play, or is it a more complicated adjacent market?

Katherine Owen

It’s fairly concentrated with just two, three key players and then there’s some much smaller players on the periphery. And again, we’ll go through a lot of this in a lot more detail at the analyst meeting next month.

Matt Miksic - Piper Jaffray

And one follow-up here on spine. I think you mentioned that the comps were getting a little tougher, maybe some increase in deferrals there. But I know there were tough comps last year, too, and it just seemed like the drop was pretty significant and primarily in the U.S. Like 6 points or 7 points constant currency, sort of sequential drop, is more significant than we’ve seen in that business probably for the last two years or so.

Is there anything else going on there competitively? Is there anything else going on in terms of your distribution or geographically that has impacted that business.

Stephen MacMillan

First off, the base obviously is getting harder and harder as we go into—I think we’ve had 8 straight years right now of 20% growth so we probably are starting to bump against that. I would also tell you, there’s a couple of little self-inflicted things. We made a couple of changes in sales force stuff and a couple of key geographies that we think will strengthen us for the future that probably set us back a touch in the quarter. And that business is still of a size one or two of those can actually affect a couple of points of growth.

So I think over time that team has shown us they know what they’re doing and they’ll be back.

Operator

Your next question comes from Tao Levy - Deutsche Bank.

Tao Levy - Deutsche Bank

I have a quick question on the clarification. When you talked about the hips and knee markets earlier on, how has that changed from what you were saying at the beginning of the year? Has it gotten a lot worse or has that been about the same. I feel like some of your commentary throughout the prepared remarks was a little bit all over the place.

Katherine Owen

I would say the 6% operational growth on hips and knees in the quarter, I would just back to our comments that it’s been a relatively modest impact and we still expect the market to grow 1 to 2 points shy of that 7% to 9% secular growth rate. So I wouldn’t say it’s a dramatic impact.

Probably the biggest change is when we were entering into the year we were talking about the potential for this to happen and what we’re seeing now and what we’ve alluded to throughout the quarter actually, is that we are seeing it, in reality, in certain pockets.

But clearly, with us looking for the market to grow mid-single digits and with similar growth rate that we put up in the quarter I wouldn’t say it’s a major impact.

Tao Levy - Deutsche Bank

And the price cuts in Japan, so what happens as we move into April. Are there new price cuts or we’ve fully anniversaried them so we should see pricing and rationaling improve a little bit.

Curt Hartman

I think the price cuts in Japan as it relates to hip and knees are two year movements, so these cuts were put in place of April 2008, we would not expect anything additional on the hip and knee side until sometime in 2010.

However, in the calendar year 2009 there are other categories that have been looked at and price cuts proposed. They are on smaller franchises like CMF and in our trauma business and we’re not ready to talk about what those numbers may be at this point in time but we are expecting some price cuts in 2009.

It is possible then again in 2010 that they could revisit the hip and knee market and look at additional price cuts there but again, it would be very early for us to speculate on that.

Operator

Your next question comes from Raj Denhoy - Thomas Weisel Partners.

Raj Denhoy - Thomas Weisel Partners

I wonder if I could ask a little bit on some of the expense lines, particularly gross margin and then some of the other operating expenses. You mentioned that on the gross margin line you are seeing some compliance costs run through there as well as some just slowing in the manufacturing volumes. Now are these trends I imagine we should see continue for the rest of the year so we really shouldn’t expect much expansion in that margin?

Curt Hartman

I think those are fair comments and I just point to the first quarter of 2008, there really was not a sizeable number from a compliance standpoint running through there. That’s fully anniversaried and we are running at a full pace across our manufacturing with the compliance spend.

In addition, as you look at the external market and the revenue growth for guiding, you should expect that we will continue to slow some of the manufacturing sites most impacted by the economy and I think what we would guide you to is a gross margin in line somewhere between we recorded in the first quarter and perhaps 20 basis point or 30 basis point lower over the course of the year.

Raj Denhoy - Thomas Weisel Partners

So actually ticking down over the course of the year.

Curt Hartman

Potentially, and again, guessing a little bit here on what happens with procedure volumes, as we don’t 100% have clarity, as well as guessing a little bit on what goes on with the capital outlook through the second half of the year. While we feel optimistic giving some anecdotal information we just frankly won’t know until we get there. And as I stated in my inventory comments, we are very focused on driving and managing inventory levels so there is a second impact on gross margins from that.

Raj Denhoy - Thomas Weisel Partners

And on the other expenses, SG&A and R&D, obviously R&D was quite low this quarter and you mentioned the timing of some expenses. I mean, on a dollar basis should we look for that to start ramping again as you move through the year or is your sort of cost containment mind set going to kick in here and kind of keep the number relatively low?

Curt Hartman

I think our comments on R&D—and I need to give you a little bit of perhaps a longer-term perspective. As you recall, back in the mid-2000s we ramped R&D up substantially and some of this downward trend in R&D as a percentage of sales is a reflection of some of that spending migrating over the generally 2- to 4-year life cycles of product development within our company.

As we look at the remainder of 2009 we do expect R&D as a percentage of sales to move forward, on an absolute dollar basis. It will be within the range of what you saw in the first quarter, perhaps a little bit higher.

Raj Denhoy - Thomas Weisel Partners

And on the last line on SG&A, is that the line we should really expect to see the cost containment kind of play through and expect that number to maintain relatively where it is or should we see it expand as we typically do over the course of the year?

Curt Hartman

We’re very focused on SG&A right now and have been, really going back to the early part of the fourth quarter and the organization is rallying this as an area of savings to leverage our future earnings. So I think the number that we’re showing for the first quarter is a relatively safe assumption that we’re going to try to maintain that or lower levels.

Raj Denhoy - Thomas Weisel Partners

On an absolute dollar basis?

Curt Hartman

On an absolute dollar basis I think you should see it perhaps moving lower.

Raj Denhoy - Thomas Weisel Partners

I think you said we should expect the tax rate to be the same as it was in 2008, was that correct for the full year?

Curt Hartman

Substantially in line with the reported full-year 2008 tax rate, yes.

Raj Denhoy - Thomas Weisel Partners

So slightly higher than we saw here in the first quarter?

Curt Hartman

Yes, it may move back and forth a little bit. It’s a little bit hard to predict, especially as business volumes have changed, the manufacturing source of those items is going to move our tax rate around a little bit up or down. So right now our best estimate is that it will be in line with the 2008 rate.

Operator

Your next question comes from Bruce Nudell - UBS Securities.

Bruce Nudell - UBS Securities

Steve, I have a question for you. You know, most of the things we’re talking about today are transitory in nature. Capex should come back. Surgical volume should come back, certainly. The question I have, and this is something that longer-term investors are fearful of, is that there has been a period in the past—‘92 to ‘99—when commercial insurance payments to cost ratios depressed and that had an adverse impact on the price environment, a significant adverse effect on the industry.

Is there anything that you see, either in the healthcare reform packages that are circulating through Congress, or just the economic pressures on employers that could result in that payment to cost ratio going from around 1.3 back down to the historical nadir of 1.15 or so?

Stephen MacMillan

You know, there’s nothing specifically that we’ve seen to that effect. Having said that, I think we’re continuing to assume that certainly the days of the early 2000s of very positive pricing are long gone and we’ve got to figure out to make money in a basically a flat pricing environment to even, you know, as it’s been the last few year, trickling recon modestly down.

Having said that, we also continue to look at every market we’re in and from a patient standpoint knowing there are opportunities for more and more surgeries. You know, if you still look at it there are a lot of people that still are great candidates for joint replacement that don’t have them. The younger population is going to continue to demand and want products. And ultimately I think will be willing to pay up if there’s more co-pays and things like that.

So I think we certainly see some payor pressure but we also continue to feel that one of the pieces that I think is getting missed in all the current pressures are, you know, people are going to need their joints replaced and need spine surgery and everything else is still going to be there for us. And we think the companies that are there are still going to do very well.

Bruce Nudell - UBS Securities

So to put a finer point on that, that period—‘92 to ‘99—looked like it was ASPs net of price and mix were minus 5% per year. Do you see that as likely?

And my second question is really pertaining to—I noticed in I think it was a Wall Street Journal report, they said that the FDA has been encourage to revisit class III devices that have been 510-k’d and that there will be a grace period in which perhaps PMA-like data sets will be submitted to retain the label on those devices. Is that likely and would that complicate your life immensely if in fact a corporate warning letter issues?

Stephen MacMillan

First, I’ll answer three questions even though you should have only asked two.

We don’t see it going that negative, back to your comment about the 5% of the ‘92 to ‘99 period.

The specific class II piece, obviously—as it turns out, our particular businesses are relatively unaffected by that label [inaudible] FDA will overall be working on and looking at probably more data rather than less data over time.

On the third part, just as it relates to a corporate warning letter, we remind you, we continue to invest a lot in—you know, we have a lot work to do. I think that’s become more painfully clear to everybody. I’m very proud of a lot of the work we’ve done, we’ve still got work to do. We’ve been investing very heavily, as you see in the margin side, but each month that goes by, it’s a month we’re closer to the other end, and yet again there’s probably still many, many months before we’re completely where we want to be, but each month goes by feeling better.

Curt Hartman

I have one additional comment here in terms of long-term EPS guidance, both for pharmaceutical and med tech companies, and that’s the debate that’s going on right now relative to corporate tax rate on foreign earnings and depending on where that shakes out and what potential number shakes out, you could see the industry, med tech and pharmaceuticals, with much different earnings outlook.

Bruce Nudell - UBS Securities

And how vulnerable is Stryker on the [inaudible] of companies?

Curt Hartman

It all comes down to what that rate, if that law advance and what that rate winds up being. So it would be premature to speculate because it all based on how that law, if there is a law, is set up, what rate it is, and what kind of reciprocal tax rate alignments are with the international markets that companies like Stryker have foreign operations in.

Operator

Your next question comes from Ben Andrew – William Blair.

Ben Andrew – William Blair

Looking at the mix dynamic, given the relative lack of kind of cost benefit analysis and higher mix products, at least from randomized trials, is there more exposure there longer term as we see pressure on reimbursement structurally?

Katherine Owen

I think that one is a little bit tough to answer. I think we are clearly seeing an FDA that is looking for more data and some the commentary that’s come out of some of the proposals from the administration about wanting to see more clinical data. How it plays out with different price products, we’re really in a period of absence of any real details to put some parameters around that.

Ben Andrew – William Blair

As you think about the MedSurg or the capital equipment portion of that, has the softness you’ve seen, can you characterize as a mix of either orders not coming in our actual deferrals of existing orders or outright cancellations? And what sort of policies do you have on that sort of behavior pattern because that seems to me—I guess the main question is, is it a mix of those things?

Curt Hartman

I think the principal outcome right now in slower or lower MedSurg revenue is the deferral of orders. We’re not seeing big trends in cancellation of existing orders or complete elimination of orders and I do think deferrals are the biggest majority.

And on that, as we look across the segment, we don’t see any share losses, either. So it’s just an overall deferral or delay in the order trends, which I would assign to the majority of the revenue decrease.

Katherine Owen

The only additional comment I would add on to that, if you think about the products that we have within MedSurg, whether they be power tools or the endoscopy products like the video cameras, those are all necessary to performing surgery so in essence they have to be deferrals, you cannot just stop making those purchases. It’s not like there’s an option to you if you don’t have a power tool to develop on doing a hip or a knee replacement, or at least not an option you would really want to consider.

And on the bed side, even though there is probably a greater ability to defer some of the medical products, as capital budgets start to come back and hospitals resume building, those purchases will have to be made just simply to meet the volume demand.

Operator

Your next question comes from Matthew Dodds - Citigroup

Matthew Dodds - Citigroup

When you look at your sort of general recon forecast for Stryker what are assuming in shares? Should we assume it’s flat or up for 2009?

Katherine Owen

I think you could probably assume the share trends are relatively consistent with what you’ve seen. If ever there was a period where we’ve gone through potential upheaval, it’s over the last 18 months with the monitors even then, you saw shares relatively stable. We have tended to do better on knees and not as well on hips. Probably more of a migration to the mean between the two of them. But in general you really have never seen a dynamic play out in the recon market where you’ve seen dramatic change in the share shift and we would expect that trend to continue.

Matthew Dodds - Citigroup

One follow-up on the recon market, internationally, other than Japan where you’re seeing the impact of price, are there any other decent-sized markets that are seeing an economic impact or is it pretty consistently stable across the board?

Katherine Owen

It’s relatively stable outside the U.S. Remember, as it relates to the orthopaedic business a lot more of that comes under nationalized health care so you don’t see the same out-of-pocket pressure that some of the individuals in the U.S. have seen. When we talk about elective procedure deferrals that’s much more of a U.S.-based comment. And again, on a selective basis because it’s not a wide-spread trend we’re seeing uniformly across all of our accounts.

On the MedSurg business probably partly because our shares are so low and we are in the very early stages of that expansion, we haven’t seen the same impact. Certainly can’t rule that out. Quite frankly, it’s part of what’s dialed in to the low end of our forecast as we talked about trying to address any reasonable downside risks, one of those would be much greater pressure on the OUS businesses.

Matthew Dodds - Citigroup

So when you give the 1% to 2% decline in volumes, you’re really only seeing that in the U.S. at this point.

Katherine Owen

On the reconstructive?

Matthew Dodds - Citigroup

Recon only, right.

Katherine Owen

Yes, that was much more of a U.S.-based comment.

Operator

Your next question comes from Ed Shenkan - Needham & Company.

Ed Shenkan - Needham & Company

I just wanted to follow-up on the pockets of weakness in the U.S. We heard about that, at the orthopaedic surgeons meeting in February. Are there more pockets now and have the pockets of weakness, have they gotten weaker since then?

Katherine Owen

I wouldn’t say there’s any real change from the comments that we made back at the academy where we talked about seeing some pockets of elective procedure. It’s very much the same trend that we were noticing back earlier in the quarter. It hasn’t worsened, it hasn’t gotten better.

Ed Shenkan - Needham & Company

And on the international side for capital equipment, I just wanted to follow up on the earlier questions that people had. Has that slowed off as much as the U.S. already? Have you seen the impact as profoundly already on the international side?

Katherine Owen

I think what we were pointing to is certainly you see it in the number given medical and end over growing in the mid-teens outside the U.S. but we’re down domestically. Our international MedSurg businesses have fared much better and as we commented early, part of that is the nature of that market. It isn’t seeing the same capital pressure, but part of it’s also we have much smaller bases in those markets so we are in much more of a growth mode.

And again, the low end of our range is designed to reflect some of the worst-case scenarios that could play out, such as greater downward pressure on the international businesses going forward.

Operator

Your next question comes from Michael Matson - Wachovia Capital Markets.

Michael Matson - Wachovia Capital Markets

I guess I will ask the obligatory use of cash question. By my math a share repurchase would be pretty accretive. Just wondering what your plans are there and then I guess the second part of that question would be how much of your cash is overseas and would there be tax issues with repatriating some of this and is that why you’re not going to necessarily use that cash for buy backs?

Katherine Owen

There really hasn’t been any change for our overall strategy as it relates to cash. We view it as multi-pronged meaning that whether that is looking at M&A opportunities, potential for share buy-backs, which we did last year, as well as the dividend which we have continued to increase in recent years.

M&A remains our preferred use of cash. Clearly in this environment we’ve had an opportunity to revisit certain areas, given where evaluations are. But I would also remind you I wouldn’t interpret the lack of seeing deals close as a lack of activity. We have very high hurdle bars that relates to due diligence and also where we think about valuation, we think that has served us well in the past as we look at different opportunities and we will continue to do.

Share buy-backs remain a potential use of cash. We do not currently have one in place. That could change going forward but nothing to announce at this time.

Curt Hartman

And I would reinforce Katherine’s earlier comment that acquisitions are definitely the preferred use of our cash at this point in time.

And your second question relative to our cash position, U.S. versus OUS, we historically have not broken that out but it’s safe to assume that over time we’ve built a large cash position outside the U.S. and certainly any time you repatriate those funds you are going to pay a tax penalty over the rates that are applied in those respective international markets.

Michael Matson - Wachovia Capital Markets

I know that you don’t want to say a lot about the tax issues and the letter that you received from the IRS but you did note it in the press release and I guess if you have gotten these in the past you haven’t, as far as I’m aware, notified us about them. So you say that’s it’s material; what is your threshold for what you would consider to be material.

Curt Hartman

I would answer that question two ways. It’s noted in the press release because it’s a very specific letter related to a very specific issue called cost-sharing arrangements. And cost-sharing arrangements, if you were to dive inside the IRS, they note it as a tier-1 agency issue and by that the IRS defines a tier-1 agency issue as an issue that they intend to investigate across various industry segments, if not the industry in its entirety. And as such they have taken a very aggressive position and from an internal standpoint we felt it was best to disclose it.

I’m not going to get into the level that we define as material relative to Stryker overall.

Operator

Your next question comes from Doug Schenkel - Cowen and Company.

Doug Schenkel - Cowen and Company

OUS knees were a bit light of our forecast while OUS hips were a bit better than I expected, reversing trends from at least the last few quarters, if not years. Can you provide some color on the reversal? Is this largely a function of comps, reverse into the mean, change in strategy or something else, and is this dynamic expected to continue over the next few quarters.

Curt Hartman

I do think on international hips we are thrilled with the 9% operational growth in the first quarter. I would tell you if you delve back into the first quarter of 2008 you would see that the comparable was relatively soft. We are encouraged, however, about our European hip results and there has been some additional focus in that market on the recon product offering.

Over on knees, internationally the comparable from the first quarter of 2008 was in the mid-single digits so year-over-year the 4% is not going up against what I would call an arguable tough comp.

And overall I don’t have any good rational reason why the number dropped to the 4% range that we reported. Outside of the selling day impact that we experienced in the first quarter and a few what I would call minimal issues related to product supply as we continue to work through our remediation efforts on various aspects of the knee systems.

Doug Schenkel - Cowen and Company

And my follow-up is a bit of a high-level question. I think back in January you indicated that you expected double-digit sales growth and at least 15% EPS growth in 2010 and beyond. Independent of what you described regarding an uncertain outlook for the tax treatments, is there any reason to believe that there’s been change in your thinking on longer-term goals?

Stephen MacMillan

No. You know, clearly the short-term environment is worse than what we anticipated but I think it gets back to we continue to feel great. Now think about it this way. Each franchise we’re in, we can look at every single one of them and say, you know what? We can grow each of these businesses a lot, both in the U.S. and internationally. And there’s not one business we’re in right now that I would say we would get out of.

What’s really interesting if you actually dig a little deeper and look into some of the numbers, almost everyone of our franchises had double-digit local-currency growth in either the U.S. or international in the quarter. Hips and knees were the only two that didn’t.

So I think we continue to feel very good about the longer term and we are in a little bit more short-term challenging but still feel good about the ability to be a top line, double-digit-growth company and solid EPS growth north of that as we go forward.

Katherine Owen

The one follow-on comment I would make is there have been some positives that have come out of what has clearly been a challenging, not just for us but the markets overall. It has prompted us, as we talked about, to really take a very hard look at a lot of our spending. Some of that is short-term in nature to deal with the environment, but as Steve alluded to earlier, a lot of that is taking a look at some of the inefficiencies that have come out our decentralized structure. Certainly don’t want to lose the decentralization. It’s a big part of what drives this organization but when you look at our vendors, our suppliers, the benefits that come out of the investments and the remediation, there’s going to be some longer-term leverage driven out of this P&L that doesn’t go away simply because the market environment starts to get better.

Stephen MacMillan

If you look over the 8 years or so, we feel like we’ve built a great footprint. That footprint has been working beautifully for us. Right now in the very short term it’s probably working a little bit against us but as soon as the fundamentals, you know, we get through this short-term period, we continue to feel that the long-term fundamentals of the footprint that we have plus the cash position we have, the culture we have, are going to continue to distinguish us as market share gainers and growing faster than most of our competition.

Operator

Your next question comes from Kristen Stewart - Credit Suisse

Kristen Stewart - Credit Suisse

I wanted to go back to the guidance, but kind of the recalibration from 6 to 9 to 2 to 5, is that just solely due to MedSurg expectations or you also recalibrating a little bit what to expect in orthopaedics?

Katherine Owen

We really tried to walk through a lot of the assumptions back in Curt’s earlier comments. I will just reiterate them briefly. We talked about expecting to see the pressure on the elective procedure markets as it relates primarily to hips and knees and spine, trimming a couple of points off the overall market growth for those businesses. That’s what we saw in the first quarter and that’s what we are assuming continues to play out throughout 2009.

The bigger changes relative to our prior thinking really goes back to our MedSurg businesses. We talked about, to give you specifics that help in modeling, Curt referenced that we expect medical to be relatively stable on a dollar basis, on a quarterly basis, going forward, based on incoming order trends, based on some of the intelligence we’ve been able to gather from our sales force as well as from some our customers that we track on a weekly basis.

Recognizing tough third quarter comps for that business and tougher comps for the instruments business in the second quarter. So the bigger change relates to those two franchises within that search. And with some residual, or more modest impact on the ortho businesses.

Kristen Stewart - Credit Suisse

Okay, because I thought last time there was some haircut in the numbers already for ortho so it sound like maybe a little bit more this time around.

Katherine Owen

Yes. We changed the range down so I think that’s a fair statement.

Kristen Stewart - Credit Suisse

And then just thinking about the orthopaedics, you were saying that there was an extra selling day this quarter but last quarter a year ago you had obviously talked about Easter having a negative impact. So is it kind of net-net, kind of equivalent effective selling days?

And I know in the hip business you had the recall a year ago as well, so have you looked at what the growth rates may be kind of excluding that Easter effect and excluding the hip recall a year ago.

Curt Hartman

We have looked at all of that and a little bit more. If you looked at the first quarter of 2008 there is actually a day in there for Leap Year and you lose a day because of Easter. If you look at the first quarter of 2009 and you look at the Stryker vacation calendar, we use a day for New Year. So when I normalize everything and look at the average day sales rate and I reconstructed implants, it’s a little higher than our reported rates because of those various day changes year-over-year.

So I really didn’t want to get into all that detail because it sounds like excuses and I would rather just report a really good strong recon number.

And we did talk that the Trident, really the impact of that recall was felt in the March through June timeframe, when you look at supply disruptions and refielding of that product.

Operator

Your next question comes from Glenn Navarro - RBC Capital Markets.

Glenn Navarro - RBC Capital Markets

I have a question on marketing spend behind knees and hips. Your top competitor, Zimmer, is out talking about spending more to educate physicians and then hopefully rebuild market share. I understand that you’re looking to slow down SG&A spend but can you comment about the spend that you’re going to put forward in 2009 behind knees and hips to maintain, if not continue to gain, share.

And as a follow-up, let’s just assume that Zimmer is successful later this year in regaining market share. Is there some wiggle room in the Stryker numbers that will allow you to spend more in the back-end of the year if you need to preserve market share?

Curt Hartman

I think on the spending categories, we have not historically delved into the various divisions respective marketing plans. I think on those two categories you identified, our orthopaedics division both in the U.S. and internationally, under the plans that were outlined and approved through the federal monitor, have weighed out training programs as it relates to hips and knees. This would also apply to our spine and other orthopaedic implant franchises. And there has been no reduction in those plans.

The targeted spending that we are looking at really relates to items that are on the periphery that as an organization that’s decentralized like Stryker has grown, have crept up into other areas of the business. And those are the ones we are really focused on.

And so I don’t think you should assume that things that are germane to growing the business are first on the radar screen to be cut and remove from our plans. I think you should assume that those things on the edges are the things we are going after aggressively and working to remove out of the plan.

And as it relates to the second half of the year, if we thought that there was a great marketing plan that would drive our revenue in any of our product segments, we would probably by targeting that, especially considering the external forces at work in the market.

And I think fundamentally what we have seen over time drive product growth, is a combination of highly innovative products and great sales people. And we’re going to stick to that model for the time being.

Operator

Your next question comes from Jeff Johnson - Robert Baird.

Jeff Johnson - Robert Baird

Spending rate on OP-1, can you put any color around what you’re spending currently in that area?

And also, any change at all in the quality investments. Is 2009 still be planned to be the peak year of spending that incremental $5.0 million to $40.0 million I think you talked about last quarter? Or should we still expect to see that tick down in 2010?

Stephen MacMillan

We’re not going to get into the detail on OP-1. Once we sort that out we’ll talk more about that.

In terms of the quality, I do think this is probably the peak year. We will continue to be making major investments beyond that but the delta, in terms of the increases, this should be the peak year for that. And then ultimately, ideally, some of what we’ll be learning at is getting better and more efficient in the years ahead.

Jeff Johnson - Robert Baird

The percentage level on SG&A, you talked about that maybe staying at this level but the absolute dollar coming down. As I look at your revenue line that’s just I think being reversed. Am I thinking about something incorrectly there?

Curt Hartman

You have it right. It will be up modestly on an absolute basis.

Jeff Johnson - Robert Baird

So the correct part of your statement, Curt, was that the percentage stays around this level?

Curt Hartman

Yes.

Operator

Your next question comes from Bill Plovanic – Canaccord Adams.

Bill Plovanic – Canaccord Adams

Just one follow-up on OP-1, does the panel of recommendation have any impact on the HDE that you currently have in place, or could it have an impact on that approval?

Stephen MacMillan

No, Bill. Hey, by the way, congratulations. I think you nailed our sales forecast, I think to the exact penny, from what I recall.

But now, it does not affect HDE status.

Operator

Your final question comes from Greg Halter - Great Lakes Review.

Greg Halter - Great Lakes Review

Last call you had mentioned some raw material costs and challenges and so forth in cobalt chromium and so forth. Just wondered if you could provide some color around that specifically and others generally. And what you’re seeing there.

Stephen MacMillan

Right now we would not be calling out any specific raw material issue from a cost standpoint that are having meaningful impact on our overall business. And I think we’re going to leave it with that comment. The diversified nature of our business, we’re going to have pluses and minuses across any one of these raw materials, be it resins, be it cobalt chrome, be it shipping rates and fuel surcharges. These things are going to move up and down over the course of the year, across the various businesses and right now there is nothing of substance impacting our ability to deliver our P&Ls.

Greg Halter - Great Lakes Review

And I believe you had anticipated capital spending for 2009 to be $150.0 million to $190.0 million. Any thoughts that that has changed at this point?

Curt Hartman

I think that’s in the safe to high-end of the range right now. Obviously as we build an annualized capital plan some of those expenses are targeted our geared toward what I would refer to as plants, capacity expansions, or operational efficiency improvements, and to the extent that any of these plants have seen meaningful slowdowns we’re probably going to hold back on those spending.

Conversely there may be other categories that are targeted at a special market that we now have an opportunity to go after. So I think the range is still appropriate, if not perhaps a little bit lower.

Greg Halter - Great Lakes Review

Can I presume the Impression product is somewhere in a facility where you don’t need to spend?

Stephen MacMillan

It’s pretty minimal.

Curt Hartman

I think you can assume that’s pretty well taken care of at this point.

Stephen MacMillan

Just as a quick reminder to everybody, May 20th will be our analysts meeting so we’ll give a little more light into a lot of what’s going on at that point in time. And then a reminder, July 21st will be when we report our second quarter. And thank you all very much.

Operator

This concludes today’s conference call.

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Source: Stryker Corp. Q1 2009 Earnings Call Transcript
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