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Stryker (NYSE:SYK)

Q4 2013 Earnings Call

January 22, 2014 4:30 pm ET

Executives

Kevin A. Lobo - Chief Executive Officer, President and Director

Katherine A. Owen - Vice President of Strategy & Investor Relations

William R. Jellison - Chief Financial Officer and Vice President

Analysts

Kristen M. Stewart - Deutsche Bank AG, Research Division

David R. Lewis - Morgan Stanley, Research Division

Frederick A. Wise - Stifel, Nicolaus & Co., Inc., Research Division

Kimberly Weeks Gailun - JP Morgan Chase & Co, Research Division

Derrick Sung - Sanford C. Bernstein & Co., LLC., Research Division

Matthew J. Dodds - Citigroup Inc, Research Division

Robert A. Hopkins - BofA Merrill Lynch, Research Division

Michael Matson - Needham & Company, LLC, Research Division

Raj Denhoy - Jefferies LLC, Research Division

Richard Newitter - Leerink Swann LLC, Research Division

Joanne K. Wuensch - BMO Capital Markets U.S.

Matthew Taylor - Barclays Capital, Research Division

Glenn J. Novarro - RBC Capital Markets, LLC, Research Division

David H. Roman - Goldman Sachs Group Inc., Research Division

Matthew S. Miksic - Piper Jaffray Companies, Research Division

Matthew O'Brien - William Blair & Company L.L.C., Research Division

Matthew Keeler - Crédit Suisse AG, Research Division

Lawrence Biegelsen - Wells Fargo Securities, LLC, Research Division

Joshua T. Jennings - Cowen and Company, LLC, Research Division

Steven M. Lichtman - Oppenheimer & Co. Inc., Research Division

William J. Plovanic - Canaccord Genuity, Research Division

Operator

Welcome to Stryker's Fourth Quarter 2013 Earnings Conference Call. My name is Adrienne, and I'll be your operator for today's call. [Operator Instructions] This conference call is being recorded for replay purposes.

Before we begin, I'd like to remind you that the discussions during this conference call will include forward-looking statements. Factors that could cause actual results to differ materially are discussed in the company's most recent filings with the SEC. Also, discussions will include certain non-GAAP financial measures. Reconciliation to the most directly comparable GAAP financial measures can be found in today's press release that is an exhibit to Stryker's current report on Form 8-K filed today with the SEC.

I'll now turn the call over to Mr. Kevin Lobo, President and Chief Executive Officer. You may proceed, sir.

Kevin A. Lobo

Good afternoon, everyone, and welcome to Stryker's fourth quarter 2013 earnings call. Joining me today are Bill Jellison, our CFO; and Katherine Owen, Vice President of Strategy & Investor Relations.

Following my opening comments, Katherine will provide updates as it relates to our recent M&A activity and Bill will then offer details on our quarterly results, as well as provide color on our 2014 guidance, which includes slides available via the webcast. We will then open up the call to Q&A.

Turning to our Q4 results. Organic sales growth, which excludes currency and acquisitions, was solid again this quarter, increasing roughly 6%. With the same number of selling days in the quarter, this represents strong growth with all 3 segments, Reconstructive, MedSurg and Neurotechnology and Spine, delivering year-over-year gains. Growth was also balanced geographically, with the U.S. up 7% and international increasing 8% in constant currency.

U.S. Reconstructive sales were up 9%, reflecting a 10% increase in hips and 8% growth in knees, a stellar performance, particularly given the tough year-over-year comparisons of 7% hip growth and 9% knees growth. And despite also facing challenging prior-year growth of 26%, which benefited from a competitor recall, U.S. Trauma and Extremities was up a very solid 8% this quarter. This business continues its multi-year momentum, and U.S. Foot & Ankle continued to roll, up an impressive 36%.

U.S. MedSurg was led by Instruments and Endoscopy, which increased 8% and 12%, respectively more than offsetting flat results for medical and a slowdown in Sustainability. Endoscopy's gains reflected across-the-board strength with solid growth in cameras, video and the capital-intensive Communications business, with the latter benefiting in part from easier prior-year comparisons.

Looking at Instruments, its U.S. performance picked up as signaled on our last call, achieving a strong 8% growth. And with the 510(k) we received late in 2013 for the Neptune Waste Management System as well as the FDA recently lifting its Warning Letter, our Instruments team is well positioned to continue to build on Q4's momentum.

Additionally, as Katherine will address in more detail, our planned acquisition of Patient Safety Technologies further expands Instruments' growing presence in the operating room, with products targeted at patient and caregiver safety.

Neurotechnology and Spine was up roughly 5% in the U.S., which was solid performance given the challenging comps. Interventional Spine led the group with strong double-digit sales growth.

Outside the U.S., Europe continued its momentum, with Q4 sales increasing for the third consecutive quarter, and we continue to see strong gains in emerging markets with very high-double digit growth. International performed well in all areas except knees, which were down 2% in constant currency. This was the result of disruption to our Asia business, which we referenced in our third quarter call.

We expect our international knee results to return to more normalized growth by the end of Q1 2014. We continue to be pleased by our Trauson results in China and look forward to launching these products in additional countries over the course of 2014. Similar to our performance in the first 9 months, fourth quarter operating cash flow increased roughly 13%, reinforcing the strength of our balance sheet.

M&A remains a top priority for our cash, and we are excited to have closed the acquisition of MAKO at the end of 2013. We will continue to pursue targeted acquisitions that contribute to our ongoing goal of organic sales growth at the high end of the med tech industry.

Combined with the December announcement of a 15% increase in our dividend, as well as modest amount of share buybacks in the quarter, we believe our capital allocation strategy will continue to help optimize shareholder returns.

Moving down the P&L. As expected, our adjusted gross margin declined sequentially, falling to 66.3% given lower overhead absorption in Q4, but came in for the full year with a 30 basis point improvement after adjusting for the medical device tax.

We continue to make solid investments in R&D, which was up nearly 8% in the quarter, representing 5.6% of total sales.

On a per share basis, Q4 adjusted EPS was $1.23. And as detailed on Slide 4, on a full year basis, we delivered EPS of $4.23 or at the midpoint of our $4.20 to $4.26 range. This represents a reported year-over-year increase of 4%. However, there were several non-operating items that impacted our EPS in 2013. Adjusting for the negative foreign exchange and the medical device excise tax, as well as the positive benefit from the tax extenders, our underlying EPS growth was approximately 11%, reflecting our commitment to driving leveraged earnings gains.

We are excited about the breadth of our product portfolio, which spans products and services, as well as implants and capital. Our ongoing investments in R&D, as well as our targeted M&A, positions us well to deliver innovation to our hospital customers. We will continue to focus on our strategy of top line growth, leveraged earnings gains and capital allocation that maximizes the strength of our balance sheet and our healthy cash flow.

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

Katherine A. Owen

Thanks, Kevin. My comments on today's call will focus on our recent BD activity, providing an update on the acquisition of MAKO Surgical, as well as the announced agreement to acquire Patient Safety Technologies. Both transactions reflect our commitment to deploying our capital to support our M&A strategy, which is primarily focused on our core markets, as well as key adjacent markets.

With respect to MAKO, we closed this acquisition in late December and believe, long term, it has the potential to transform orthopedic surgery through procedural advancements and improved patient experience and a new generation of implants. The MAKO robotic platform has already proven itself capable of achieving consistently reproducible surgical results.

As we continue to optimize robotic-assisted surgery, we believe it will further improve clinical outcomes. And longer term, by allowing for bone preparation and geometry and precision not possible with conventional manual instrumentation, there's a potential to develop new implant designs that are specifically enables robotics capability and functionality. In the near term, our teams are focused on leveraging Stryker's considerable sales and distribution capabilities to help drive adoption for MAKO's current applications. Two areas of initial focus, which we are currently evaluating, are enabling Stryker-marketed implants to be put on the robot software and starting the trial for a total knee application. Given the short time since the close, we are not prepared to provide specifics on these 2 items. However, we do anticipate starting the total knee trial in the first half of this year.

With close to 20% market share in the unicompartmental knee segment. We believe MAKO has demonstrated excellent market acceptance of their partial knee application. However, our analysis suggest there's a bigger opportunity in total hips and total knees to leverage Stryker's reconstructive implants. We look forward to sharing more regarding our plans for robotic-assisted surgery later in 2014. Additionally, our orthopedic growth will be the focus at our September Analyst Meeting Product Fair.

Shifting to our MedSurg group's BD activities. We recently announced the planned acquisition of Patient Safety Technologies, or PST, for $120 million. PST's innovative and proprietary product portfolio aligns with our Instruments division focused on customer solutions that enhance patient and caregiver safety. Specifically, PST's Safety-Sponge System helps prevent retained foreign objects in the operating room, thereby improving patient safety and reducing healthcare costs. The system includes bar-coded surgical sponges and towels and integrated barcode scanner and a unique compliance tracking software. RFOs are the most common surgical never event in the U.S., and sponges are the most common retained object with approximately 2,300 incidents reported annually at an average cost per incident of over $400,000.

With the SurgiCount Safety-Sponge System, we can provide our customers with a way to eliminate unnecessary cost from the healthcare system, while improving quality of care. Since its launch in 2006, SurgiCount has established a strong customer base of over 300 hospitals, including several of the leading medical institutions in the U.S. The Safety-Sponge System will augment Stryker Instruments' broad portfolio of products that are designed to optimize the perioperative experience by reducing hazards, streamlining operations and improving outcomes for patient and caregivers. Moreover, we believe our sales force can leverage our considerable established base of products, targeted perioperative patient and caregiver safety, including the recently 510-cleared Neptune Waste Management System and the Sterishield Personal Protection System.

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

William R. Jellison

Thanks, Katherine. As Kevin mentioned, we have included a few slides via the webcast, which summarized the 2013 sales and earnings performance and also reflects some additional insights on our 2014 guidance.

Sales growth was positive by 5.6% in the fourth quarter, including a negative 1.8% impact from FX translation. Constant currency sales growth was a positive 7.4%, which includes organic growth of 5.8%. Sales growth for the full year was a positive -- or was positive by 4.2% with organic growth of 5.1%, acquisition growth of 0.8% and a negative 1.6% impact from FX translation.

Earnings per share on a GAAP basis for the fourth quarter were $1.01 per share versus $0.71 last year in the fourth quarter, while adjusted earnings per share were $1.23 for the quarter versus $1.14 in the fourth quarter last year. This quarter's EPS includes negative impacts of approximately $0.06 per share from FX and $0.04 per share from the med-tech tax. EPS on a GAAP basis for the full year of 2013 were $2.63 per share versus $3.39 per share last year, while adjusted EPS were $4.23 per share versus $4.07 per share last year. FX negatively impacted the full year results by approximately $0.20 per share, and the med-tech tax had a negative impact of approximately $0.13 per share.

The income statement is exposed to both transactional and translational FX risks, while the balance sheet is just exposed to translational FX risk. We have begun a layered transactional hedging program, which will help us mitigate some of the transactional volatility caused by changes in FX rates. This program will start to have some effect in the first quarter of 2014 and will be more fully in place by the end of 2014.

The most significant non-GAAP adjustments in the quarter are related to a $99 million increase in the charges associated with the voluntary recalls of Rejuvenate, ABG II and Neptune. These charges may increase or decrease over time as additional facts become available and assumptions become more refined. No insurance proceeds that may potentially be available to cover some of these costs have been included.

Looking at sales in the fourth quarter. Our organic growth of 5.8% was comprised of a positive 7.3% from volume and mix, with price negatively impacting sales by 1.4%. Acquisitions added 1.5%, while FX had a negative 1.8% impact due to significant weakness in both the Japanese yen and the Australian dollar compared to the same period last year.

Looking at our segments. Reconstructive represented 45% of our sales in the quarter. Sales of Reconstructive products were up 5.8% as reported and grew 8% constant currency. U.S. Reconstructive sales grew 8.7% in the quarter. And despite facing challenging comps, Trauma and Extremities had another solid quarter in the U.S., with sales increasing 8.4%, led by new products, sales execution and continued strong growth in Foot & Ankle.

U.S. hips and knees had strong growth in the period of approximately 10% and 8%, respectively. We are especially pleased with our knee performance, as we are going up against 2 new competitive knees that are well into their launch periods. We are still dealing with the absence from the market of our ShapeMatch Cutting Guides. And as Kevin mentioned, we are also against -- up against strong year-over-year comps of 7% in hips and 9% in knees from the fourth quarter of 2012. We believe this reflects the strength of both our Triathlon Knee and our highly-motivated sales team. Our international Reconstructive business was up 6.9% in constant currency and had organic growth of 2.4%.

Next, our MedSurg segment represented approximately 37% of our total sales in the quarter. Total MedSurg sales increased 5.4% as reported and 6.6% on a constant currency basis. These results were led by both -- or by double-digit growth from our Endoscopy business and Medical had low-single digit growth, while Instruments have upper-single digit growth in the period. Instruments no longer had the Neptune comparison drag that it was going against in the first 9 months of this year and also had robust power tools sales in the quarter. We are pleased to once again have the Neptune product back in our portfolio of products as we move into 2014, now that we have the FDA approval.

Our final segment, Neurotechnology and Spine, represented 18% of our sales and delivered another strong quarter. Sales increased 5.4% as reported and 7.5% on a constant currency basis. Growth in this segment was led by our IVS and our Neurovascular business, which grew solid double-digit in constant currency. Spinal implant sales were up slightly on a constant currency basis and double-digit internationally.

In looking at our operational performance, gross margins on an adjusted basis in the fourth quarter of 2013 were 66.3% compared to 68.3% in the same period last year. As we expected and highlighted in our last call, the rate this quarter was negatively impacted by the lower overhead absorption in the period as inventory levels were significantly reduced in the quarter after a build, which occurred in the third quarter to support our fourth quarter sales. We were also negatively impacted by nearly a full percentage point in both the quarter and the full year gross margin rates from the med-tech tax. Product mix was more balanced in the fourth quarter, also slightly reducing the margin rate as MedSurg, which has a lower gross margin than the company average, performed well without the headwinds from the Neptune recall.

FX and price also had a negative impact on the rate this quarter, as we felt the full impacts of the weaker Japanese yen and Australian dollar in the quarter. For the full year, gross margins on an adjusted basis were 67.5%, down 60 basis points from 2012. However, the 2013 rate was negatively impacted by 90 basis points due to the med-tech tax. Excluding this item, the rate would have increased 30 basis points for the year.

Research and development expenses increased by 10 basis points to 5.6% versus 5.4% -- or 5.5% last year in the quarter. This represents a 7.8% increase in R&D spending over last year and continues to reinforce our commitment to invest in areas which we believe will help us deliver above market sales growth in each of our key product categories.

Selling, general and administrative costs represented 40.5% of sales in the fourth quarter, but this included approximately $99 million of cost related to the Rejuvenate, ABG II and Neptune recalls versus $174 million of similar cost in the fourth quarter of last year. On an adjusted basis, SG&A expenses were $838 million or 34% of sales in the fourth quarter of 2013 versus 36.2% in the prior year's fourth quarter. The improvements in SG&A in the period were primarily in general and administrative expenses along with some lower marketing expenses in the period.

Operating margins on an adjusted basis were 25.3% in the fourth quarter of both 2013 and the fourth quarter of 2012. The rate was negatively impacted by the med-tech tax and pricing. However, those impacts were fully offset in the quarter from the strength of our year-end sales, operational improvements and also from lower general and administrative and marketing expenses as a percentage of sales.

Other expense on an adjusted basis in the fourth quarter was $9.5 million compared to $12 million last year in the fourth quarter. This reduction in expense resulted primarily from gains on hedges and marketable securities. Our reported tax rate for the fourth quarter was 10.3% while the adjusted effective tax rate was 23.6% for the fourth quarter, which is higher than our full year adjusted effective tax rate of 22.3%. This compares to a 24.7% adjusted effective tax rate in the fourth quarter last year.

As we move into 2014, we expect the full year rate will run closer to 23% with a higher rate in the first half. Remember, an extra year of tax benefit resulting from the renewal of tax extenders were included in the first quarter of 2013. While our 2014 guidance anticipates renewal of the tax extenders, they have not yet been approved by Congress and renewal and timing of them is still uncertain and may negatively impact our tax rate early in the year.

We also anticipate tax benefits from the revised structure and move to a European headquarters location in the Netherlands. However, this is not expected to be in place until the second half of the year.

Looking at the balance sheet, we ended the quarter with $4 billion of cash and marketable securities versus $4.3 billion at the end of 2012. And we also have $2.7 billion of long-term debt on the balance sheet. From an asset management standpoint, accounts receivable days ended the year at 55 days, flat with the end of 2012 and 2 days better than the end of the third quarter. Days in inventory finished the quarter at 152, which was 33-day decrease sequentially and a 1-day reduction when measured against the prior-year quarter. Inventory levels significantly reduced in the quarter after a build, which occurred during the third quarter.

Turning to cash flow. We had a strong cash generation for the full year with cash from operations of $1.886 billion compared to $1.657 billion in the prior year, an increase of approximately 14% over 2012. 2013 cash flow benefited from improved operational performance and lower tax payments. Capital expenditures were $195 million in 2013. However, are expected to run closer to $250 million to $300 million in 2014, as some capital spending is carrying over into this year and we continue to invest in our operations and IT infrastructure.

Finally, regarding share repurchases in 2013, we repurchased approximately $317 million worth of our stock, and we will have nearly $700 million still available for repurchase under our current authorization.

Based on our solid sales achievement in 2013 and the current economic and market conditions, we are projecting organic growth or constant currency, x acquisitions, in a range of 4.5% to 6% for 2014. If foreign currency exchange rates hold near current levels, we anticipate net sales will be negatively impacted by less than 1% for the full year of 2014 and will negatively impact adjusted earnings per share by approximately $0.07 per share as we are further impacted by a weak Japanese yen and Australian dollar without the full benefit of our layered hedging program, which, as mentioned, won't be fully in place until the end of 2014.

In 2014, our adjusted earnings per share will now include an adjustment for acquisition-related intangible amortization expense. If 2013 included this adjustment, adjusted diluted earnings per share would have been $4.49 per share versus the $4.23 per share we reported.

Our 2014 guidance was -- for adjusted diluted earnings per share is $4.75 to $4.90 per share and includes an adjustment of approximately $0.35 per share for acquisition intangible amortization. To assist you further in your modeling, particularly in regards to our quarterly earnings progression, we are providing a few additional comments.

We expect 45% of full year adjusted earnings per share to be achieved in the first half of the year, with the first quarter facing the stiffest headwinds. In the first quarter, we will be negatively impacted by a greater negative FX impact based on current rate assumptions. The additional tax benefit received in the first quarter of last year, where we benefited from an extra full year benefit from the 2012 tax extenders and uncertainty around the timing of the reinstatement of those extenders this year, along with tougher sales comps, especially in Trauma, as we benefited from a competitor recall in the category in the first quarter last year.

Thanks for your support, and we'd be glad to answer any questions that you may have at this time.

Question-and-Answer Session

Operator

[Operator Instructions] Your first question comes from the line of Kristen Stewart from Deutsche Bank.

Kristen M. Stewart - Deutsche Bank AG, Research Division

I just wanted to understand just kind of the guidance, particularly what your assumptions are just around acquisition contribution because you just gave the organic number. So can you help us just to how to kind of think about how you guys are framing the benefit from the 2 acquisitions that you talked about earlier? And then, just to clarify your guidance, I just want to make sure I got the number right, $0.35 is what the acquisition of intangibles is excluded from the $4.75 to $4.90 number?

Katherine A. Owen

Hello, Kristen. The second part of your question, that's correct, the $0.35 is the number. The first part, we have been consistently guiding to organic sales growth, so the number that we're focused on internally is -- was organic growth excluding sales -- or excluding FX and acquisitions since, obviously, the -- our goal has been to accelerate that. We are not giving any forecast or target as it relates to acquisitions. MAKO, as you know, was obviously a publicly-traded company. I know many of the folks on the phone modeled it, and we haven't closed Patient Safety yet. So the goal -- the number that we're going to be focused on and we'll be providing guidance will be around that organic number.

Kevin A. Lobo

Kristen, what I'd add is each year, we will be doing the same thing. So at the beginning of next year, we'll provide organic sales growth. And obviously, that will include MAKO next year.

Kristen M. Stewart - Deutsche Bank AG, Research Division

Okay. Perfect. And then, I guess, just on MAKO, can you maybe just provide any additional color? I know the commentary on the third quarter call was somewhat limited just in terms of the deal not having closed. But just how do we think about it from a longer-term perspective in terms of opportunities for cost synergies or just -- I know you're not giving your thoughts about directionally to whatever extent you can comment on how you see it potentially accelerating the growth of the Recon business.

Katherine A. Owen

Well, without a doubt, we did the deal because we do believe it is potentially transformational on orthopedic surgery and will allow us to drive meaningful market share gains. And so, that is the goal. Right now, the teams have literally only been together for a few weeks, since we just closed late last year. They're actively assessing different options and prioritizing those options. We were able to share that we expect to start the total knee trial in the first half of this year. That is the biggest opportunity that we see for robotic-assisted surgery. We're going to continue to use our sales and distribution capabilities to build on current indications, but the long-term potential really is around total knees, optimizing total hips and, longer term, the potential to introduce the next generation of implants that aren't feasible with the current instrumentation. So we'll continue to provide additional updates. Right now that's the clarity we have as the teams are looking at different options, but they haven't finalized beyond the comments I just provided. And then, again, we'll have more details beyond that as it will be part of the focus of the product fair at the September Analyst Meeting.

Kristen M. Stewart - Deutsche Bank AG, Research Division

Okay. And just from a financial perspective, you did give some color when you announced the deal. Is it fair to say that the dilution associated with the deal is similar to what's embedded within your 2014 guidance? Or is it coming in a little less or a little bit more based upon the amortization that you're assuming, I guess?

William R. Jellison

Yes. So I think in general, we did give guidance upfront on the MAKO side. We, obviously, won't be commenting moving forward on both the sales side of MAKO or the overall operating performance of MAKO. As Katherine just mentioned, kind of, the teams are just really getting together, looking at the integration and really deciding, kind of, what they're ultimately going to be able to deliver on both from a sales, operational or a margin expectation and also some of the SG&A leverage.

Kristen M. Stewart - Deutsche Bank AG, Research Division

Okay. So no comment on whether the dilution is still similar to what you guys originally...?

William R. Jellison

Yes, we won't be really talking about, kind of, the MAKO-specific performance moving forward. But we did give guidance upfront on the initial call there.

Operator

And next, we have David Lewis, Morgan Stanley online with a question.

David R. Lewis - Morgan Stanley, Research Division

Kevin, one quick question on MAKO. You gave us the timing for the total knee trial. Can you give us a sense of -- is that simply total knee? And can you provide any, sort of, bi-cruciate timelines? And do you think you're going to need a separate trial for a bi-cruciate system?

Kevin A. Lobo

So I'd say it's a little early for the bi-cruciate. Honestly, we're just as Katherine mentioned, 3 weeks into the deal. And obviously, bi-cruciate has interest. Still, there's a long way to go yet to determine whether that will be more than just a niche. And so, later on this year, we'll be able to provide more color around our expectations, our timing. The teams are literally just going through their prioritization right now. If bi-cruciate does turn out to be a really big part of the market, we'll be delighted because, robotically-enabled, it's a very difficult procedure to do today just as the uni [ph] is difficult to do. So if it does become a big part of the market, we believe we'll be very well positioned. But it's just too early right now to comment on where that is in our portfolio and whether we'll need additional trials. That will be something that we'll provide later on the year.

David R. Lewis - Morgan Stanley, Research Division

Okay. And then, Kevin, maybe 2 more quick ones for you. First of all, just on Trauma. Obviously, the highlights for '13, Recon numbers are very strong in the fourth quarter. One of your competitors is talking about transitioning their Trauma strategy, post the large acquisition for more internally focused in '13 to more externally focused in '14, maybe you can sort of talk about what have been sort of the key drivers of the Trauma strategy and your thoughts on Sustainability?

Kevin A. Lobo

Yes. So this wasn't just 1 year in the making. So we've had a terrific strategy over the last 4, 5 years. We've been growing faster than the market consistently over those years, grounding out our product portfolio with primarily internally developed R&D projects. We also added the Memometal acquisition, which really helped turbocharge our Foot & Ankle division and Foot & Ankle results. But -- so this has been a progressive strategy of really making sure we have a complete offering, we have differentiated products and we've been winning accounts and converting business consistently over that period of time. So it wasn't a 1 year wonder, and it's something that we think we'll be very well positioned to continue to grow in the years ahead.

Operator

[Operator Instructions] Rick Wise from Stifel is online with a question.

Frederick A. Wise - Stifel, Nicolaus & Co., Inc., Research Division

I guess, my question -- let me start with the -- first with the EU. And you indicated that the EU turnaround, as evidenced, is continuing as positive for the third quarter in a row. Just any color there on where we are in the turnaround process and kind of growth you're expecting -- or we should expect in the year ahead?

William R. Jellison

Yes. So we're delighted with the performance in Europe. Frankly, it was a little ahead of our expectations as we started the year in terms of the turnaround. I would say we still have some challenges in Italy, which I've mentioned previously. It's still taking some time. Germany is the other country that's a little bit up and down. But other than those 2 countries, the rest of Europe is in really good shape, including Spain, which had historically been a challenged country. So pretty stable across all of our countries. Our leadership team is really performing well. They brought some real stability and closer customer connections. So now, we're looking for the next phase where we can really drive accelerated growth, primarily in the MedSurg area. So we really stabilized our implant business, but we still have opportunity to grow primarily in MedSurg. I'm looking forward to accelerated growth in the quarters and years ahead.

Frederick A. Wise - Stifel, Nicolaus & Co., Inc., Research Division

And, Kevin, just as a follow-up on the hip, knee and, for that matter, Trauma numbers. You're the third company in a row to report very solid numbers. Maybe just your latest thoughts on the market outlook for 2014. We've seen this unusual second half. I mean, can this continue into '14, or do you think it settles back?

Kevin A. Lobo

So what I'd say to that is we saw this last year in the fourth quarter, a big fourth quarter and I think we're really going to know at the end of this first quarter. And I really would like to compare the 6 months -- first quarter of this year, fourth quarter of last year to the comparative 6 month period from the year before we can really determine whether this is an overall uptick in the market. Since the middle of last year, I felt that the market has been gradually improving. But that's really -- we're not going to know for sure. We've had 3 companies report -- we still have some more to report. But really, we're going to really only know until the end of the first quarter.

Operator

And we have Mike Weinstein from JPMorgan online with a question.

Kimberly Weeks Gailun - JP Morgan Chase & Co, Research Division

It's actually Kim here for Mike. So I guess a couple of questions. The first is a little bit of a follow-up to Rick's question on the seasonality piece in the Recon market. So you talked a little bit about some of the factors weighing on your first quarter. And so, I'm just curious, how did you think about the Recon piece when you thought about the EPS guidance for the first quarter?

Katherine A. Owen

Kim, very similar to what we saw last year, there was seasonality in the first quarter, a little bit of softening in the first quarter. We have not baked in any extra effect whether it's due to uncertainty around ACA. It is possible that helps Q4 and will result in an offset. You're probably looking in the area of tens of basis points, which is again, why we go back. So just assuming it's the standard seasonality pattern and then we'll look at what those 6 month averages are to determine if we've seen some modest level of improvement in the recon market.

Kimberly Weeks Gailun - JP Morgan Chase & Co, Research Division

Okay. Great. And the follow-up is for Bill on the gross margin piece, and I apologize if I missed this, but how are you thinking about the gross margin trend into the first half of the year and then for the full year of 2014?

William R. Jellison

Sure. I think a couple of points there. I mean, first off, we really don't talk specifically about our gross profit expectations directly, but we generally talk about, kind of, our broader-based expectations on operating margins. And I think especially as -- based on the growth rates that we're talking about here, at this level of growth rate, we would expect and be driving for a certain amount of additional operating margin improvement. I think that's probably in this environment -- a little bit more of that is, obviously, coming out of the SG&A-related area versus the gross margin related area. But I think our expectations in general are for modest improvement on the gross margin rate and a little bit better improvement on the SG&A rates.

Operator

And we have Derrick Sung from Sanford Bernstein online with a question.

Derrick Sung - Sanford C. Bernstein & Co., LLC., Research Division

I was wondering if you could talk a little bit about the Instruments' performance this quarter. I appreciate that you've anniversary-ed the Neptune launch. How much of the -- did -- were there any Neptune sales embedded in here? And maybe you can remind us of, kind of, what the historic run rate of Neptune is and kind of the acceleration then that we would presumably see from this level moving forward with Neptune back on the market?

Katherine A. Owen

Hello, Derrick. What we stated last year throughout the quarter is [indiscernible] market impacting us in roughly the high teens vicinity in terms of millions of dollars. We were still selling to existing customers who had filed the appropriate paperwork necessary, but we couldn't sell any new system. So that revenue -- lost revenue is reflective of that. There were no new revenue associated with that in the fourth quarter. I would remind you, Instruments benefited from strong power tools that we had several new launches in the early part of the year, targeted to small bone segment that also helped the growth performance. Going forward into this year, clearly, Neptune will be a part of it. We're going to be focused on existing customers early on in upgrading them. And you should really think about it being in around the third quarter when we're back to kind of hitting on all cylinders as it relates to the Neptune relaunch.

Derrick Sung - Sanford C. Bernstein & Co., LLC., Research Division

Okay. Great. And on MAKO, I appreciate that you're not going to be breaking out sales. Can you tell us how you'll be accounting for MAKO sales moving forward? Do those go into your knee sales where, within reconstructive, do they go in or there's a separate breakout?

Katherine A. Owen

If you look within it, the hip sales will be in hips, the knee sales will be in knees as it relates to implants. The capital and any related service will be in our other line along with sports medicine, bone cement and the other products in that. So it will be in those 3 buckets.

Operator

And we have Matthew Dodds from Citigroup online with a question.

Matthew J. Dodds - Citigroup Inc, Research Division

First, on SG&A, you really cranked that down year-over-year and sequentially. I know you highlighted it as G&A and marketing spend. Could you give us a little more color on -- was one more than the other? Was there anything else in there that really pulled it down this much?

William R. Jellison

Sure. I mean, I'd say that the G&A was obviously the bigger piece of it, although marketing was some of it as well, too. I'd also say if you look at the broader based improvement that we had throughout 2013, which was in the neighborhood of 70, 80 basis points, that's kind of what you should be looking at within that space. And I think that, that also holds true if you look at, like, the second half of 2013. It's about the same level of improvement. So, yes, there's a lot of activities that's continuing to take place within that area. But I think that, that's probably more of a reasonable level of what you should have expected actually occurred in '13.

Matthew J. Dodds - Citigroup Inc, Research Division

And then, just one quick follow-up. Now you have MAKO, there's a lot more to talk about AAOS. Is there anything else in AAOS that you're going to highlight or you think is worthy of highlighting now?

Katherine A. Owen

Well, for the AAOS Meeting, we will do the traditional format that we've had, where we'll have the Group Investor Meetings and also the booth similar to prior years. There will be a number of new products that are either being launched or we anticipate launching shortly. I think you should think about them within the normal range of the type of largely incremental, but meaningful innovation for the various segments.

Operator

And we have Bob Hopkins from Bank of America online with a question.

Robert A. Hopkins - BofA Merrill Lynch, Research Division

So, Bill, just to start, on the guidance, on a cash basis, excluding amortization, it looks like you're, for 2014, guiding to about 6% to 9% EPS growth. And I was wondering if you could just walk through some of the things that are diluting that growth? I think you mentioned FX has a $0.07 hit, and there are still some -- even excluding amortization, I would imagine there's a little bit of MAKO dilution. Just what are the things that are, kind of, diluting that growth rate in 2014 that we maybe want to look through potentially?

William R. Jellison

Yes, I think a couple of things. It's really -- the 2 biggest areas are really FX, which we highlighted that it's about $0.07 per share. And then, also, from an overall tax rate perspective, a couple of things. One, you remember, in 2012, we actually had a double year benefit, 2012 and '13 benefit, from the reinstatement of the tax extenders that are out there. So for sure, we'll be 1 year less of those tax extenders. And right now, our guidance does include that we will have tax extenders in 2014. However, they currently aren't renewed by Congress. And so, the benefit of those will probably come later on in the middle of the year, hopefully. However, we still, obviously, need to watch that and make sure that Congress approves that. Those are the 2 primary areas that are out there.

Kevin A. Lobo

Yes. And, Bob, excluding those -- if you exclude those 2 impacts, the operational EPS improvement would be 10%, would be double-digit growth, which is kind of -- based on the organic growth rate that we're driving, that's the type of leveraged earnings gains that we're aiming for. And obviously, we're looking for benefits across the P&L, whether it's in the cost of goods area, in the SG&A area to be able to deliver that leverage. Unfortunately, based on the way the exchange rates have moved and the timing of getting our hedging program in place, if rates stay where there are, we are going to be negatively impacted and FX is certainly the biggest impact.

William R. Jellison

Yes. And then, FX impact will probably be much more prominent in the first of the year versus the second half.

Robert A. Hopkins - BofA Merrill Lynch, Research Division

Okay. Great. That's exactly what I was looking for. And then, as a follow-up on the hip and knee side, Kevin, I was wondering if you could talk a little bit more -- just remind us of what's going on in Asia on the knee side and why you have confidence that, that will come back? And I was wondering if you could just provide any sort of qualitative sense as to some of the earlier questions . Other companies have suggested that they're seeing backlogs build into 2014 and that, therefore, perhaps, we should be optimistic that some of these good growth rates we're seeing is probably more the economy than seasonality. I'm just wondering if you're seeing anything similar.

Kevin A. Lobo

Yes. So on the second question, Bob, obviously, we're in the middle of a quarter right now, and I'm not going to really comment on how things are going in January. There are a lot of anecdotes, I prefer not to really comment on anecdotes. And we'll -- let's see how the first quarter rolls before we really can reach a conclusion on whether this is a real change in the trend. Clearly, we're happy with our fourth quarter performance. There were a lot of expectations that our knee business would be under stress with competitive launches and having to overcome not having ShapeMatch on the market. Certainly, our knee has been a very, very well chronicled knee with very, very low complication rates with very, very low revision rates and our sales force has done a terrific job. So we're certainly growing, at least, with the market, and we feel very good about our performance.

Operator

And we have Mike Matson from Needham & Company online with a question.

Michael Matson - Needham & Company, LLC, Research Division

I guess, just given the description of where you're going to be recording the revenue from MAKO, it sounds like that's largely going to be housed in the Orthopaedics business. So are you going to have the capital reps stay in the Orthopaedics side of the business? I guess, how are you going to be selling that product, the capital? And then, how does that sort of fit with the Navigation products [indiscernible] Instruments?

Kevin A. Lobo

Yes. So the way it's being done right now, all of the sales from MAKO will be reported in the Orthopaedics group, and we have a separate capital sales force, which is the way MAKO was running their organization. A separate capital group selling the robot and implant sales reps. The separate capital group will be separate from Navigation. And again, these are different solutions. So there are surgeons that prefer to use standard instruments. There are surgeons that like to use cutting blocks. There are surgeons that prefer Navigation with intraoperative Navigation and remember that Navigation is the fastest-growing part of Navigation is actually in neuro, not just in the ortho area. And then, there are surgeons that like robotics. So we are going to have solutions for every surgeon preference. And we are keeping separate capital sales forces for the robotics group and the instruments group, and that will continue to drive its growth as it has done actually quite well this year.

Michael Matson - Needham & Company, LLC, Research Division

Okay. And you had -- you did a great job with working capital this year over $500 million. It looks like coming out working capital really helping your cash flow from operations. But it sounds like capital spending is going to be up, and that working capital performance is probably a hard act to follow, so is it reasonable to assume that free cash flow could be down in '14 over '13?

William R. Jellison

I mean, if you look at the free cash flow side, I think that CapEx is really the -- one of the key drivers associated with that, and we do expect capital expenditures to be running higher in 2013. So that's a fair statement. As far as the other components of the cash flow are concerned, we obviously have continued efforts on our working capital side of the equation. But we would expect our overall operating cash flow to show some improvements, but our overall free cash flow might be a little bit tighter just based on the CapEx that we're spending.

Operator

And we have Raj Denhoy from Jefferies online with a question.

Raj Denhoy - Jefferies LLC, Research Division

I wonder if I could ask about the Foot & Ankle business. I think I asked about it the last quarter too when you grew 39%. In this quarter, you were 36% again. I guess, how sustainable should we look at that? I mean, that business is not small for you anymore. It must be $150 million or so. Maybe you could just speak about the trends you're seeing there and again just that sustainability of that growth?

Kevin A. Lobo

Yes. We're really excited about our Foot & Ankle business. And because it's a market development where you're really going after podiatrists that never used implants, there's really a very, very big run way for growth, and we're experiencing that. Certainly, last year in the fourth quarter, we had close to 40% growth, another 36% growth on top of that in the U.S. So really exciting. Even worldwide, we're seeing very good growth. So I wouldn't have thought at the beginning of the year that we would have delivered a number this big coming off of last year, but when you're in new markets, it's a lot harder to predict than when you're in mature markets. So we're really excited. This is really about market expansion and getting these products into the hands of physicians that were not previously using implants. So we believe double-digit growth, for sure, for a number of quarters going forward. But again, given that it's market development, it's a little hard to predict; and we're, obviously, very pleased with our performance in this area.

Raj Denhoy - Jefferies LLC, Research Division

Okay. And then, maybe if I could just ask about Trauson. I think you made comments -- you have made comments about 2014 being the year where you'll look at expanding those products out of the Chinese market into other emerging markets. I don't think you've given too much detail beyond that and I don't know if you're willing to offer much more in terms of the markets you're targeting and really your expectations for that effort.

Kevin A. Lobo

For competitive reasons, I'd really rather not get into exactly which countries. It is an emerging markets play. So you can imagine that we'll be going into different emerging markets over the course of the year. And as we start to sell in those businesses, we'll keep you posted but not really willing to share more right now.

Operator

And we have Richard Newitter from Leerink Partners online with a question.

Richard Newitter - Leerink Swann LLC, Research Division

Just -- first, just related to the SG&A spending reduction or the cost control, can you talk about how much of that was related to any pullback in the direct-to-consumer advertising campaign that you had?

Katherine A. Owen

There was a portion of it. As we said throughout the year, each quarter we are reevaluating the mix, so we continued the DTC campaign, but I would say the prior quarter had more TD. This quarter -- or the fourth quarter of '13 had other less expensive mix of the median that is part of what was behind Bill's comments related to lower expenses tied to that.

Richard Newitter - Leerink Swann LLC, Research Division

Got it. And just with respect to MAKO and your strategy outside the U.S. or kind of what you're seeing initially -- and obviously, you have resources that are much more significant than what MAKO had outside the U.S. And I was wondering, is there anything that immediately you're identifying that you could be doing differently or how much of a near-term opportunity is there for you to capitalize on something that they just couldn't do?

Katherine A. Owen

I wouldn't say that's a near-term opportunity. Obviously, longer term, we think about these opportunities not just for MAKO, but other products from a global perspective. But near term, it's really focused on [indiscernible] educations, getting the clinical trials and evaluating the different options available to us. I would think that -- think about that as being the longer term opportunity.

Operator

And we have Joanne Wuensch from BMO Capital Markets online with a question.

Joanne K. Wuensch - BMO Capital Markets U.S.

Can we take a look at the capital spending environment? At your Analyst Meeting in September, you've highlighted that, that might be one area that benefits from the implementation of the ACA.

Katherine A. Owen

Long term, that is not reflected in our top line target for this year. Medical was obviously challenged in the fourth quarter. It will have a difficult comparison in the first quarter. We continue to be cautious regarding the capital spending for those larger ticket items, and that's clearly where medical falls in. If there's a benefit from ACA, we don't think we'll see it until later this year. But I wouldn't view it as a meaningful driver, certainly, not reflected in our 2014 guidance.

Joanne K. Wuensch - BMO Capital Markets U.S.

And my second question has to do with the Extremities sales. Once again, a 30%-plus quarter in the United States. You're taking share from somebody. Can you just comment broadly on what you see in that market?

Kevin A. Lobo

Yes. So again, I go back to -- really, we're focused on growing the market, much more than we're focused on taking share. Obviously, there's some cases where we are taking market share, but the bulk of our growth is really new physicians doing procedures that they were not using implants, they're either using K-wires or other approaches. So to us, this is much more a market expansion story than it is a market share story.

Operator

And we have Matt Taylor from Barclays online with a question.

Matthew Taylor - Barclays Capital, Research Division

I'm just curious. This is a small piece of your business, but I was wondering if you can give us any color around the slowdown in Sustainability Solutions and what's causing that?

Katherine A. Owen

Yes, we did have a slowdown in the quarter. That business is susceptible to the timing of OEM product launches, and there were several of those. And then, the teams have to go back and do the appropriate product development in order to get a corresponding reprocessed product on the market. We did launch some products late last year and anticipated additional product launches this year. You combine that with the still very clear compelling rationale for reprocessing products, we believe that business will get back to double-digit growth. But it will vary quarter-to-quarter because, obviously, we can't control the timing of some of those OEM launches.

Kevin A. Lobo

Yes. And with each OEM change, we have to resubmit a 510(k). So that's the timing difference. This occurred primarily in the energy area with 2 of our competitors that changed our products and has caused us a bit of delay. We've very excited and bullish about this year for Sustainability as we get those 510(k)s and return to the market.

Matthew Taylor - Barclays Capital, Research Division

Okay. Fair enough. And one area we didn't talk about yet was -- just if you could give us any comment on overall market health and dynamics of both Neuro and Spine markets? Have you seen anything changing there? It seems like, overall, we've seen pretty strong growth in Neuro and maybe some bounce-back in Spine, like we've seen in Ortho. But I'm curious to see if you see anything new there.

Kevin A. Lobo

Yes. So we really love being in the neuroscience space. It's a great market. There's still plenty of room for growth. That's one of our -- certainly our better and more attractive markets and pleased that we acquired Neurovascular to really round out our portfolio with our other divisions in this space. And Spine, clearly, the worst is, I think, behind us. It's bottomed down at least and it's starting to stabilize. Pricing is starting to stabilize. We're starting to see a bit -- a little bit of an uptick. So I think that's a market, certainly, not getting worse. It's, at least, stable and maybe modestly starting to improve.

Operator

And we have Glenn Novarro from RBC Capital Markets online with a question.

Glenn J. Novarro - RBC Capital Markets, LLC, Research Division

Just on the gross margin here in the fourth quarter down 200 basis points year-over-year, can you quantify the difference year-over-year? For example, was it 100% FX -- 100 basis points FX, 100 basis points lower plant utilization? Any color would be helpful.

William R. Jellison

Sure. As I mentioned, as far as year-over-year goes, it’s probably about nearly a full point just from the impact of the med-tech tax and then also with FX being the biggest hit in the fourth quarter of this year, FX was definitely another large piece of that. It was impacting us by over 0.5 percentage point on the FX side alone. So when you look at kind of the other aspects with some of the absorption side, that was lower but then also the mix, because of all the businesses performing well within the year and the MedSurg business actually having lower margins in general than our average business, those are probably the 4 big components of it.

Glenn J. Novarro - RBC Capital Markets, LLC, Research Division

And then, for 2014, we have the Japanese price cuts. So I'm sure that's in your guidance. What are you assuming there? And then, also, will we have the same number of selling days in 2014 as 2013?

Katherine A. Owen

Yes, the selling days are outlined in the slide of the webcast. You can see where they do vary and where they are same year-over-year. With respect to the Japanese price cuts, still pretty certain that they will be negative. It is reflected in our overall expectations for total price, which is typically down in the 1% to 2% range for the company. Exactly where it shakes out, we just don't know yet. We haven't heard any early rumblings yet, but we expect it to be consistent with prior years, give or take.

Operator

And we have David Roman from Goldman Sachs online with a question.

David H. Roman - Goldman Sachs Group Inc., Research Division

I want to come back to Trauson for a second. I think it's been about a year since you've closed that transaction either March of 2013. Maybe you could provide us some updates on how that business is trending and to what extent you've been successful in integrating that to expand your EM footprint. Kevin, I think, at a recent investor conference, you quoted EM sales at about, I think, 6% or 7% of corporate average. Maybe just any update on how that business is going both Trauson and more broadly EM.

Kevin A. Lobo

Yes. So we're really excited about the acquisition. Obviously, it's our first deal in China, first time getting into the lower-priced segment and really pleased that the business hit the acquisition model in their first year. So we're very pleased about that. We focused very much on China, making sure we kept the momentum in the growth going well in China. So in the fourth quarter, our emerging markets as a percent of total company sales was 8%. In 2012, in the prior year, it was 6% for the full year. This year, it's more in the 7% range. And obviously, it's been increasing throughout the course of the year with Trauson being the biggest driver. So you would expect next year when we report our full year results that emerging markets will be over 8% of total company sales. So we're on a march. And clearly, the goal is to get emerging markets not just because of Trauson but because we're also growing very well in the premium segment in China, in Brazil, in India and other emerging markets. So we're focused on both parts of the market. Clearly, our medium-term goal is to get that above double-digit percent of total company, while also maintaining good growth rates in the U.S. and picking up the growth in Europe. Clearly, the markets are growing faster, and we believe Trauson gives us a great entry into that low-priced segment. So, so far so good is what I would say on emerging markets, going from 6% a year ago with 7% this year to over 8% in 2014. So very excited about the progress.

David H. Roman - Goldman Sachs Group Inc., Research Division

Okay. And then, on the gross margin line, understandably, at any 1 quarter, there are going to be a number of moving parts. But just thinking longer term, how should we think about the trajectory of gross margins, particularly in the context of 1.5-ish-percent annual price decline that is $150 million annual headwind you have, you have the restructuring that you've talked a lot about mix will ebb and flow, I mean, is a lot of this just plus 1s and minus 1s that all kind of net out to flattish? Can gross margins go higher? And then, just lastly, on cash EPS, are you going to give us any more historical information than what you've provided today?

William R. Jellison

Sure. So I think, maybe the broader context is really kind of what I stated about kind of the full year gross margin rate. So if you look at the gross margins for the full year, it was 67.5%, which was down about 60 basis points for the year. But keep in mind, that included 90 basis points of an impact from the med-tech tax. So despite the fact that price also played a part in putting pressure on that -- on those rates, we actually would have been up about 30 basis points in gross margin rates this year despite the price if we had excluded the med-tech tax. So I think, in general, our expectations and some of the initiatives that we've got in our GQO area, which is our global quality and operations area, we believe that we've got some good programs in there that are continuing to take place over the next few years. And we're still driving for slight improvement in the gross margin rate as a contributing factor to our overall operating margin rate improvements.

Kevin A. Lobo

Just to add to Bill's comments, this is the second year in a row -- consecutive year where we had gross margin expansion. So regardless of the price pressure that we're facing, which we expect to continue, we've demonstrated now consistent ability to raise gross margins. This is part of our overall GQO program. We're well into the 2.5 years into this program, which is a 5-year program. We've delivered 2 years in a row now of gross margin expansion, and we expect to continue that. This is one of the levers that enable us to drive operational earnings at a faster rate in our top line sales.

Katherine A. Owen

And just to your follow-up, we do not plan to provide any additional historical information as it relates to the new adjusted EPS.

Operator

And we have Matt Miksic from Piper Jaffray online with a question.

Matthew S. Miksic - Piper Jaffray Companies, Research Division

I got one question and one follow-up. So one, Kevin, I think you mentioned, in looking at MAKO and rolling it out through your organization into your hospital and surgical customers, that there are some folks who are going to like robots, some folks like traditional instruments. On the other hand, as Katherine said, it's pretty disruptive technology, at least, potentially over the intermediate and long term. Do you envision yourselves as kind of leading the transition to greater use of robotic surgery in orthopedics? Or do you view yourselves as sort of -- this is part of your portfolio of advanced technology for the OR, orthostats or ShapeMatch and other things being part of that? And then, I have one follow-up.

Kevin A. Lobo

Yes. So obviously, we -- this move was made to really drive market share and become the clear leader in reconstructive surgery. So I would not assume we're going to be passive about the way that we sell this technology. But surgeons take different times to convert. There are some that will convert very quickly, early adopters. There's others that will wait a little bit before they'll start to convert, and there are some that will be very stubborn and want to stick to their tried and proved approaches. So we will have approaches for all types of surgeons. But without a doubt, we plan to rapidly move the adoption of robotic surgery. This is a big play that we're -- we've made, and we're not going to be passive about really taking this to the market. Certainly, our implant sales force is extremely excited about being able to sell the implants, so they can be associated with the robots, leveraging their own relationships. So, yes, I wouldn't assume we're going to be in a "sit back and wait" mode related to robotics. Again, only 3 weeks since close. But make no mistake, we're going to be leaning forward.

Matthew S. Miksic - Piper Jaffray Companies, Research Division

Well, I look forward to that. The follow-up I had was also on orthopedics on the knee side, you mentioned sort of looking to Q1 as sort of a benchmark to maybe see is this real, is the recovery real on the back of what were pretty great results in U.S. knees. What I'm thinking about Q1 as you mentioned in your presentation, there is an extra selling day. I know other folks are either going to have an extra selling day, or they're going to go against the quarter last year when they were missing a day or 2, do you expect, I mean, the setup is reasonably good for a pretty decent Q1 here?

Katherine A. Owen

I would just go back to the comments we made. We really tried to single out some of the headwinds that are more significant in the first quarter that when you go back and fine-tune your models, you should really think about reflecting particularly the EPS line, and I would just refer to those. We're really not looking for an exaggerated impact from seasonality in the first quarter. But there are some very clear specifics that are -- that we highlighted, whether it's FX, year-over-year comparables, tax extenders, all of which I would take a look at when you're updating your models.

Kevin A. Lobo

Yes. And maybe I'll just take the opportunity to also comment on hips since I've gotten a lot of questions on knees mostly because of the competitive launches and having ShapeMatch off the market. But I'm really pleased with our hip performance and that -- again, like our Trauma business, that has been 3 years in the making of consistently leading the market, especially in the U.S., but also great performance outside the U.S. So we're really pleased with our hip growth and which has been on the back of a number of new product launches and excellent execution in the field.

Operator

And we have Matthew O'Brien from William Blair online with a question.

Matthew O'Brien - William Blair & Company L.L.C., Research Division

I was hoping to once again go back to MAKO, but you guys mentioned the total knee trial that you're about to engage in and when we look at the uni knee opportunity, there was a wow factor there with a challenging case in terms of performing those procedures. And then, with the hip opportunity, cuff replacement [ph], was a big deal. But can you just tell us what is the big wow factor for total knees? Are we going to be able to actually gain market share versus converting your own physicians over there? And then, within there, I know you've done a lot of internal work on the robotics side of things. Should we expect that, that after case of new robots applications from Stryker going forward than maybe traditionally you performed -- or you execute at?

Katherine A. Owen

Yes. When we look at the total knee opportunity, which we think is the most compelling, it's around being able to improve the patient experience, patient satisfaction absolutely varies. It is not as high as it is in hips with respect to knees. It's about being able to drive consistently reproducible results regardless or not so much being tied to simply having the best surgeon doing the surgery. And longer term, we believe it's going to open up the opportunity that's not possible with manual instrumentation today regardless of surgeon expertise for a new generation of implants that will further improve outcomes, patient experience and also benefit the hospitals. So it's that combined effect that we believe will really be the wow factor. It's premature to start talking about the cadence of robotics product launches at this stage. Clearly, we believe we have expertise in this area that is helping to augment what MAKO brings to the table, and we also understand the implant and the capital selling process. But beyond that, we really again -- just a few weeks in, we've tried to share some of the early decisions that we've been able to reach, we'll provide more information as it becomes available and as we have agreement internally around what priorities we're going to focus on.

Matthew O'Brien - William Blair & Company L.L.C., Research Division

Okay. And then, just a quick follow-up. You talked about the -- I think, Kevin, you mentioned in the past, introducing a reverse shoulder system to augment what you have on the anatomical side. Any update as far as when you're going to launch that product? And then, I don't believe you have a specialized sales force selling upper extremity products. Is there a thought that you're going to go more aggressively down that path?

Katherine A. Owen

So as it relates to the launches that you're talking about, we do anticipate getting the reverse shoulder out starting in the second quarter, but it will really be fully launched around the third quarter of this year. There's a big gap in our portfolio. We have not traditionally been strong in the shoulder market. We have a hybrid approach in many of the areas where we compete, where we have dedicated reps and we have a full-line reps. We believe it's something that really helps us, be it Extremities, Trauma, as well as Reconstructive. We'll be leveraging a similar format as we look to gain increased traction now that we've rounded out the reverse -- or the portfolio on shoulders with the addition of the reverse later this year.

Kevin A. Lobo

Yes. So just to provide a little more color. So the early launch will be in selected hospitals. That will start towards the end of the first quarter, beginning of the second quarter, full launch towards the end of the second quarter.

Operator

And we have Bruce Nudell from Crédit Suisse online with a question.

Matthew Keeler - Crédit Suisse AG, Research Division

This is Matt in for Bruce. First, can you maybe share with us what the different segment growth rates are there embedded in your 2014 guidance?

Katherine A. Owen

If you're talking about as it relates to Recon, MedSurg, Neurotech, no, we don't provide that level of granularity. Kevin commented around Neurotech being a higher growth area, and I think people have their various estimates related to the biggest segments, but we're just providing a top line number and that was reflected in the comments on the call.

Matthew Keeler - Crédit Suisse AG, Research Division

Okay. Or maybe, if not that, what are some of the puts and takes to get you to the edges of that range?

Katherine A. Owen

When we tried on the call to give some color around some of the headwinds and as well as tailwinds, some of the comparables, some of which are more challenging in certain areas of the quarter. I will give you, for example, because given the breadth of our product portfolio, all the different divisions, I don't think it's feasible or realistic to go through all the different puts and takes. But something like our Trauma business, as they can continue to maintain momentum throughout the year despite tough comps, despite the J&J that's further into their integration, that's a potential extra that could be reflected, but I could also list off a bunch of headwinds that could be more challenging. We tried to do that and look at all of those which is reflected in the range that we gave. If more of those break positively, we'll be closer to the high end of that range. That's always the goal. But at this point, we've learned pretty clearly over the years there's always something that surprises us in any given year. So that's all reflected in that 4.5% to 6%.

Kevin A. Lobo

Yes. What's encouraging from our standpoint though is that this is a step-up in our organic growth rate versus the guidance we gave a year ago. So we are overall feeling better about our performance in terms of organic sales growth. The overall range is a step-up, and it's a very good growth rate, especially when you consider this does not include MAKO, which we will be aggressively going after in 2014.

Matthew Keeler - Crédit Suisse AG, Research Division

Sure. Then just one quick follow-up, as far as the guidance this year, do you assume pricing as roughly consistent with what you saw in 2013? Are there any changes?

Katherine A. Owen

No, same expectations, negative 1% to 2%, usually bounces around in that range.

Operator

And our next question comes from Larry Biegelsen from Wells Fargo.

Lawrence Biegelsen - Wells Fargo Securities, LLC, Research Division

So on MAKO, we saw the Q3 results. They were a little bit weak on the system sales. Can you give us any color on whether that rebounded in Q4? And I just have one follow-up.

Katherine A. Owen

We had really minimal sales, obviously, reflected given the timing of the acquisition in our numbers, so it wasn't material. I'm not going to get into color on the full quarter sales. I know you guys got a lot of details for MAKO when they went public. But given the size of it is relative to Stryker, for example, we don't break out our Navigation systems sales either in entirety or by indication and we're not going to get into that level of granularity. We will try to provide more color as it becomes more significant. But at this point, it's just not material enough for us to be breaking it out.

Lawrence Biegelsen - Wells Fargo Securities, LLC, Research Division

On the build -- on the R&D tax credit and what you're assuming in the guidance, just to be clear, it sounds like you're assuming it's renewed later in the year. So from a modeling standpoint, you're going to get the whole benefit of 2014 in Q4, or should we be assuming equal benefit by quarter? It's just a little bit unclear how you're handling that this year.

William R. Jellison

Sure. So our expectation is that it will get approved as we move through this year. When it gets approved is the question. So as you watch and see when that actually occurs. If it, for example, doesn't happen until the second quarter, we would pick up, in essence, a 0.5 year benefit in the second quarter and the rest of it in each of the last 2 quarters. If it gets approved in the fourth quarter of this year, then we wouldn't pick up any of that tax rate benefit really until the last quarter, and we pick up a full year's benefit of that. If, for whatever reason, they decide not to extend it, then obviously that would be a negative impact on, at least, the guidance that we currently got out there.

Operator

And we have Josh Jennings from Cowen and Company online with a question.

Joshua T. Jennings - Cowen and Company, LLC, Research Division

I was just hoping you could share with us -- your 4.5% to 6% organic top line guidance -- growth guidance, if you could share with us your assumptions. We don't want to get ahead of ourselves with some of the positive trends we've been seeing. But were your base case assumptions for Recon growth in the U.S. for hips and knees?

Katherine A. Owen

I would -- the way we're looking at it right now, going back to Kevin's comments about feeling like it was modestly, medium modestly in the tens of bps vicinity, modest improvement starting in the second half of the year. We're going to look at the average between Q4 and Q1, compare it year-over-year and I think what you'll see is a modest, again, tens of bps improvement in the recon market, and that's largely reflected in our sales guidance. But I will tell you that I wouldn't assume 20, 30, 40, whatever it is, bps as a meaningful impact in that range. It's reflected in it.

Joshua T. Jennings - Cowen and Company, LLC, Research Division

Great. And then, just a follow-up quickly on your views on the threat of generic reconstructive joint implants coming into the market in -- potentially in midyear by a larger player, how big of a threat is that? And then, lastly, just on share count expectations, with the stock price where it is, share count is basically flat '13 over '12. Is there any way to give some guidance on share count expectations for 2014?

Katherine A. Owen

Yes. I'll jump in and take the last part of it. You, obviously, have our EPS guidance and I will just emphasize, our capital allocation strategy has been and will continue to be focused, first and foremost, on acquisitions to help drive organic sales growth. We're also committed to growing the dividend at rates above the growth of earnings rate and then buybacks. Now buybacks will vary from quarter-to-quarter, but that's a long-term strategy we have in place around a 3-pronged cash strategy allocation.

Kevin A. Lobo

Yes, you should assume each year is a certain level of buybacks, not unlike the kind of buyback level that we had this year, but it does -- it will range based on what's happening in the marketplace and where our cash position is. Really to the first part of your question -- and I really don't see generic hips and knees as being really a viable option in the near term because the procedures are very difficult to do. So until the procedures are de-skilled, which has been the case in some other parts of med-tech, when a procedure is very easy to do and you don't need a sales rep performing the high level of services that's required to enable patient outcomes, then generics take off. There's a reason why, in China, you have a low-priced segment that does not include hips and knees, and it does not include hips and knees because these procedures are very difficult to do. That low-priced segment, which we are now participating in through Trauson, is a Spine and Trauma market. And so, I don't really perceive this as a major threat. We're always going to keep our eyes open. But frankly, until you de-skill these procedures, the sales force representation is extremely important. At Stryker, we don't put sales reps in OR to help sell power tools every time a surgeon is using a power tool because the surgeon doesn't need a rep helping him use the power tool. The surgeon does need reps when they're doing hip and knee replacement whether they are primary procedures and certainly when there are revision procedures.

Operator

And our next question comes from Steven Lichtman from Oppenheimer.

Steven M. Lichtman - Oppenheimer & Co. Inc., Research Division

Kevin, just in MedSurg, obviously, you've had a strong new product cycle in Endo and in Instruments in the past couple of years. As you look to '14, have those rollouts completed now, or do you expect them still to be incremental driver this year versus 2013?

Katherine A. Owen

If I would know -- in power tools, in large power tools, we've just anniversary-ed the launch of the System 7 and you typically see 3- to 4-year life cycle there. And obviously, the growth starts to slow as you get to the latter part. Conversely, we launched our new products in the early part of '13 within Instruments, the Cd4 and the Sabo. Those are targeted at small bone and are seeing very nice growth, which helps contribute to that 8% U.S. gain in the quarter. We'll have additional products that we'll be launching in '14 and some of those which we'll highlight at the upcoming AAOS Meeting.

Kevin A. Lobo

Yes. And I would tell you the Instruments group is extremely excited because Neptune, although we've been servicing our existing accounts, we haven't been able to sell new capital. So in some ways, you might want to think of that almost like a new product because we're now going to be bringing back capital equipment to the market. Obviously, in the first half of the year, we have to service our existing accounts. We need to retrofit their equipment, but they're really going to be looking to go after that. In addition, Patient Safety Technologies, which we expect to close some time in the first quarter, will give Instruments another shot in the arm as a brand-new product, which frankly with all the relationships and them knowing how to sell patient and caregiver safety, just ideally positioned and those should be an engine for growth, even though once again that growth in this year is outside of our guidance, it certainly will help our top line performance.

Steven M. Lichtman - Oppenheimer & Co. Inc., Research Division

Got it. And then, Kathy, you mentioned relative to fourth quarter MAKO contribution for overall corporate obviously not material. But just to clarify, on the individual product lines that you guys reported or talked about on the call in knees and hips, did that include some MAKO in the fourth quarter or are those just pure Stryker year-over-year growth?

Katherine A. Owen

There was some. But I will stress, we closed very late in the year. It was not meaningful whether it's total Stryker or even if you look at the hips and knees. We're very pleased with the growth we put up even adjusting for the very, very modest impact from a few days of selling.

Operator

And our next question comes from Bill Plovanic from Canaccord.

William J. Plovanic - Canaccord Genuity, Research Division

First, just on Extremities, do you have a total ankle or one in the works? And then, secondly, as we look at the MAKO, when specifically would you expect to have the Stryker implants compatible with the software for MAKO?

Kevin A. Lobo

Okay. Thank you. I'll start with the total ankle. So, no, we do not have a total ankle currently in our portfolio. As you know, the total ankle market is not growing at a very fast rate. It's certainly not slowing down our growth whatsoever. Over time, I think we will want to have a total ankle within our portfolio. We've evaluated a number of different options, and we frankly discounted some of them because when we do come to market, we want to make sure that it's going to be with a product that is a really compelling product whether we do that through internal development or whether we do that some other way, we'll keep you posted. But it's not something we feel a burning desire for. We don't need it today. Where -- you can see our performance has been outstanding in Foot & Ankle without the total ankle. But over time, just like we saw with hips and knees, in the early days, joint replacement takes time to build up clinical track record, to build up experience, to get the right materials. So it's still -- longer term, it's of a high interest to us. It's not something that preoccupies me in the short term.

Katherine A. Owen

And I would just say that more to come on the timing for when we would look to launch and which areas Stryker implants on the robot. It's clearly a part of the long-term value proposition. But we're just going through with the R&D team's working jointly together and looking at those in the -- at the timing, et cetera, associated with that. So more to come.

Operator

There are no further questions at this time. I will now turn the call over to Mr. Kevin Lobo for any closing remarks.

Kevin A. Lobo

Thank you, all, for joining our call. Our conference call for the first quarter of 2014 results will be held on April 17. Thank you.

Operator

Thank you, ladies and gentlemen. This concludes today's conference. You may now disconnect.

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