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Executives

Stephen MacMillan – Chairman, President, and CEO

Katherine Owen – VP of Strategy and IR

Curt Hartman – VP and CFO

Analysts

Bob Hopkins – Bank of America

Mike Weinstein – JPMorgan

David Lewis – Morgan Stanley

Joanne Wuensch – BMO Capital Markets

Derrick Sung – Sanford Bernstein

Rick Wise – Leerink Swann

Matt Miksic – Piper Jaffray

Douglas Schenkel – Cowen and Company

Vivian Cervantes – Maxim Group

Raj Denhoy – Jefferies

Michael Matson – Wells Fargo Securities

Bruce Nudell – UBS

David Roman – Goldman Sachs

Matt [ph] – Barclays Capital

Ben Andrew – William Blair

Glenn Novaro – RBC Capital Markets

Jeff Johnson – Robert W. Baird

Bill Plovanic – Canaccord Genuity

Sameer Harish – Needham & Company

Stryker Corporation (SYK) Q2 2010 Earnings Call July 20, 2010 5:30 AM ET

Operator

Good day, ladies and gentlemen, and welcome to the second quarter 2010 Stryker earnings conference call. My name is Emity and I'll be your operator for today. At this time, all participants are in a listen-only mode. Later, we will conduct a question-and-answer session. (Operator Instructions).

Certain statements made in today's conference call may constitute forward-looking statements. They will be based upon management's current expectations and will be subject to various risks and uncertainties that could cause the company's actual results to differ materially from those expressed or implied in such statements.

For information concerning these risks and uncertainties please see the company's filings with the United States Securities and Exchange Commission, including the company's annual report on Form 10-K and quarterly reports on Form 10-Q.

The company does not undertake any obligation to update or revise any of its forward-looking statements. Today's conference call will also include a discussion of constant currency sales performance and adjusted diluted net earnings per share for the year ended December 31st, 2009.

Further discussion for these non-generally accepted accounting principles financial measures, including generally accepted accounting principles reconciliation appears in the company's Form 8-K filed today with the SEC. The company’s SEC filings may be accessed from the “For Investors” page on the company's website at www.stryker.com.

I would now like to turn the call over to your host for today, Mr. Stephen MacMillan, Chairman, President and CEO. Please proceed.

Stephen MacMillan

Thank you, Emity, and good afternoon, everyone. Welcome to Stryker’s second quarter 2010 earnings report. With me today are Curt Hartman, our Vice President and Chief Financial Officer; and Katherine Owen, Vice President of Strategy and Investor Relations.

Turning to our Q2 results, I’ll offer perspective on some key achievements in the quarter and an overall assessment, before turning the call over to Katherine and Curt for more details. Having completed Q2 with constant currency sales growth coming in at 7%, which is clearly towards the higher end of our targeted range for the year, we feel well positioned to deliver on our 2010 sales commitments.

With an ongoing focus on operating expenses and solid gross margin, we realized a 15% increase in operating income, while still driving a mid teens increase in R&D spending year-over-year and a net earnings increase of 10%, putting us on solid footing to achieve our targeted per share earnings goals that we outlined back in January of $3.20 to $3.30, up 8% to 12% year-over-year, despite facing a larger foreign currency revenue headwind. And we’re clearly pleased with our demonstrated ability to execute on our sales and profit outlook.

Perhaps more importantly, Q2 was highlighted by the resolution of the remaining two FDA warning letters which follows the previous lifting of the biotech and Mahwah warning letters. The removal of the warning letters is an important milestone that validates the multi-year efforts of countless people within our organization and reinforces our commitment to executing on our companywide initiative. It has allowed us to redirect some of our R&D resources that were focused on remediation and resolution of the warning letters, back to more traditional R&D activities. And we probably can’t overstate the fact that as it does relate to our quality journey, there is still work to do and we’ll continue to invest in quality on an ongoing basis. We know we have made significant improvements in our systems and our culture and we look forward to continuing to work with FDA to realize our objective of a best-in-class quality system.

As many of you on the phone well appreciates, given the diverse nature of our 18 mid tech franchises, coupled with our broad geographic presence, in any given quarter, there are parts of our business that perform ahead of our initial expectations, while others that lag.

With respect to the former, we are particularly pleased with the results achieved by all four of our MedSurg franchises, led by medical, which posted an impressive 21% year-over-year US sales increase, better than expected, even adjusting for the favorable comparisons. And after working through some challenges in Q1 tied to our quality initiative, instruments posted strong quarterly growth of 12% in the United States.

On the flipside, our reconstructive implants business was below our expectations in the quarter, while international also struggled to a greater degree than we anticipated. And, while US implants were still in positive territory on a year-over-year growth rate, the low single digit increase was disappointing.

Although, we’re very encouraged by the early reception to our new hip products, as those of you who have followed the orthopedic industry for sometime are well aware the full impact if new reconstructive implants takes a number of quarter to realize, given the significant training and education, coupled with rolling out of the needed instrumentation.

Looking at our international results, as we’ve discussed the decision we made to discontinue certain products and distributors in late 2009 is causing some short-term sales disruption. And it’s worth underscoring that our commitment to the objectives of our overall quality and compliance initiatives, require us to proactively make decisions across all our businesses in order to achieve our goal of becoming a best-in-class organization.

Although, from time-to-time, this can create sales disruption, we are fundamentally strengthening our organization for the long term. At the same time, it’s fair to say, that we’re seeing better momentum across our MedSurg franchises, a trend we expect will continue throughout 2010, underscoring the inherent strength of our diverse product portfolio, the latter of which reinforces our conviction in our ability to deliver on both the sales and earnings goal we outlined at the start of the year.

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

Katherine Owen

Thanks Steve. Consistent with prior quarters, I’ll provide some additional commentary and perspective on several key topics, including our quality initiative, our international Q2 performance and our spinal results.

On the regulatory front, as was previously announced, Q2 was highlighted by the resolution of the remaining two initial four FDA warning letters. Although, there has been some investor speculation that this may result in the ability to lower the magnitude of our investment in our quality initiative, there is no change to our outlined three year and roughly $200 million quality spend which began in earnest in the second half of 2008.

Rather, warning letter resolution is an affirmation of the plan we outlined is moving in the right direction. As we move to the second half of 2011, we expect a downtick in the spending as one-time investments associated with the three-year plan are completed.

However, as we discuss, there will continue to be ongoing investments in quality on the annual basis. We have not quantified what portion of the $200 million is one time in nature, but we would expect to redirect that spending into R&D, sales force expansion or to help offset the expected increase in cost associated with healthcare reforms.

Looking at our international Q2 performance, we noted that impact from our decision to discontinue certain products and terminate specific distributors is greater than anticipated. As move into Q4, we should be through the bulk of that drag created by these actions. More importantly, although there’s been some short-term disruption in top line impacts, we believe the decisions we made back in Q3 put us in a much better position both the quality and efficiency standpoint in the long run.

Lastly, looking at our spinal results, we are continuing to see the multi-pronged impact from competitive in-roads, increased pricing pressure combined with reimbursement delays and the early stage of our new product rollout. Importantly, there continue to be tremendous opportunity for innovation in the spinal market given the unmet medical need for many patients with back pain and we believe we have a significant opportunity to bring differentiated products to market.

Admittedly, we’re being negatively impacted by some competitive product offerings, which have allowed in-roads in certain accounts and shared gains with some of the more basic spinal implants. Combined with the delays in some of our new product introductions, we have seen our spinal business come under pressure. We are addressing some of the product gaps with the ongoing role out of two new cervical plates. Although, as we discussed previously, we would anticipate that our spine franchise will still be facing pressure for the remainder of 2010.

With that, I’ll now turn the call over to Curt.

Curt Hartman

Thanks Katherine. Overall, companywide second quarter results finished inline with our expectations. Sales increased 7.6% on a reported basis and 6.9% excluding currency, generating diluted net earnings per share of $0.80, an increase of 9.6% over Q2 of 2009. On the revenue line, the Ascent acquisition contributed 2.4% to our reported growth and for the first half has contributed 2.2% to our 10% reported gain.

On the earnings side, a particularly strong gross margin and a sustainable impact on some of our 2009 operating expense management efforts allowed us to deliver a very strong EBIT performance. Balance sheet remains very healthy and we again demonstrated strong cash flow generation in the quarter. Finally, after completing the first half of the year, we liked the P&L trends. And, more importantly, we remain on track to achieve our full-year company objectives.

In reviewing our second quarter performance, as Steve noted in his opening comments, we’re pleased with the MedSurg results and trends appear to be running ahead of expectations. Inversely, there was two areas that came in below the targeted levels. Specifically, reconstructive implants, and broadly speaking our Europe business.

And addressing these areas, our teams are focused on three key initiatives, including, one, completing the approval process of the OtisMed product offering to address the growing demand for shape matching technology in the knee market. Two, the continuation of the two new hit launches, which have not yet had a meaningful impact on sales, but require investment in time by our sales force to train and educate doctors. And, three, the impact from our decision to discontinue certain products in Europe and terminate certain distributors.

On the OtisMed front, we have filed the 510(k) and we are working diligently with the FDA towards an approval in 2010. In the hip area, the ADM and Rejuvenate offerings will be fully rolled out as we exit 2010 and head into 2011. The early feedback here remains very positive. Lastly, in the internationally marketplace, the discontinued products and terminated distributors are having both the direct and indirect impact on our European results.

We have experienced some sales disruptions beyond the discontinued products from certain customers, who were unhappy with our obsolescence plan. Although, we anticipated some short-term sales challenge, we would remind you though over long-term, these actions will allow us to operate more efficiently than a higher state of overall compliance.

Turning to some specifics in the quarter, and starting with foreign currency; in the second quarter, currency contributed to an increase in top line sales by approximately $11 million and improve the company’s overall reported sales growth by seven-tenths of 1%. Through the first six months, reported sales have been increased by approximately $69 million or 2.1% from currency.

Looking to the third quarter, currency moves through headwind. And if rates fall near quarter-end levels, we would expect third quarter sales to be unfavorably impacted by approximately 1% to 2% when compared to 2009. Again using quarter-end rates to full-year currency impact on top line sales would be a decrease in a range of flat-to-down 1% when compared to 2009. This is clearly a big change from the original expectation of a favorable impact of 1.5% to 2.5%.

Next, I’ll spend a moment on the impact of price and volume mix from the top line. In the quarter, companywide selling prices declined 1.5% on a worldwide basis, largely consistent with the first quarter, but keeping in mind that this is the first full quarter to reflect the new Japan price cuts. Volume and mix added 6% to recorded sales growth. The number of selling days was effectively equal to 2009 in most markets.

Reviewing the business segments, I’ll start with Orthopedic Implants, which represented 59% of our sales in the quarter. Total Orthopedic Implants recorded a 2% increase on a reported basis and a 1% gain in constant currency. Hip and knee growth slowed in the quarter to the low single digit range. Although, with new product underway and the Q4 anniversary of the discontinued products, terminated distributors in Europe, we are confident in the outlook for improving performance in the coming quarters.

At the segment level on a worldwide basis, our hips slowed in the quarter with a growth of 3% as reported in dollars and 2% in constant currency. In the US market, hip sales were up 2%. To reiterate, we are encouraged by the reception of both the ADM and Rejuvenate products. While sampling, training and conversion to these platforms unfavorably impacts near-term performance, we are confident these transitions will leverage our growth in the quarters ahead. This is consistent with our experiences in the initial stages of the highly successful Triathlon launch as well as other implant launches. In the international markets, hip sales increased 1% on a constant currency basis.

Our global knee segments slowed in the quarter reporting a 1% gain that was flat on a constant currency basis. US knees posted 4% reported growth, where our OUS knees were down 7% on constant currency basis. The global trauma segment recorded a 7% increase in dollars and a 7% increase in constant currency. Our US trauma segment recorded its third consecutive quarter of double-digit growth delivering a 13% reported increase, while our international trauma sales were up 3% on a constant currency basis in the quarter.

Our global spine segment continued to face challenges in the quarter, reporting a flat performance on both the reported and constant currency basis. Our US spine sales decreased 3% as recorded versus prior year and a solid sales performance in the international spine markets delivered constant currency growth of 7% in the quarter.

Next, I’ll turn to the MedSurg group which represented 41% of our sales in the quarter. MedSurg today is comprised of our instruments, endoscopy, medical, and the Ascent Healthcare business. In total, MedSurg sales increased 16% both as reported and on constant currency basis. The Ascent acquisition added 6% to the reported increase, while the core MedSurg business segments delivered 10% reported growth in the quarter.

Sales for the global instruments segment rebounded from the slow first quarter start growing 9% in the second quarter as reported and 8% in constant currency. In the US market, the instrument segment reported a 12% gain, paced by sales in the neuro, spine and surgical navigation markets. Internationally, instrument sales were flat in constant currency.

Our endoscopy segment reported a sales increase of 8% and advanced 7% on a constant currency basis. In the US market, endoscopy sales continued to improve recording 9% growth. While our OR suite communication solution remains slow, nice advances in endoscopy services, general surgery and video products were recorded. Internationally, endoscopy sales also delivered positive results recording a 3% constant currency gain.

Finally, our medical segments, our global sales improved 20% in the quarter as reported and 19% in constant currency. US medical sales increased 22% in the quarter on a strength of increasing shipments across beds, stretchers, and our EMS offering. Our international medical sales increased 9% in constant currency. Overall, we’re pleased with the results and trends from our MedSurg business segments in the quarter.

I’ll now turn to the remainder of the income statement, starting with our gross margin performance. Gross margins were particularly strong in the quarter at 69.3%, which represented a 210 basis point increase over second quarter 2009 levels. This improvement was paced by lower costs associated with inventory charges, higher absorption and the favorable currency impact on cost from our Euro-based manufacturing network.

So while Euro-based sales and resulting profitability did take a hit in the quarter, the non-Euro denominated sales in currencies like the Yen, Aussie Dollar, and US Dollar, experienced higher gross margin performance from the lower cost of Euro manufacturing goods. Simply put, the multi-currency mix of our manufacturing and distribution activities prevents correlating currency moving on the top line with that of gross margin and profitability across quarters.

Finally, while Q2 was a large uptick over Q1 levels, it is worth recalling that Q1 was negatively impacted by both the Ascent inventory step-up acquisition accounting and the low margin one-time medical conversion order. For the first half, gross margins of 68.5% are inline with expectations and we expect future quarters to remain in this range, given all the variables mentioned above.

Research and development spending represented 5.4% of sales in the quarter, while increasing 15% over 2009 levels. For the year, R&D is now at 5.2% of sales and up 13% over 2009 levels. Our expectations remain at full-year R&D spending will finish in this range as a percentage of sales as we continue to ramp up our innovation efforts.

Selling, general and administrative cost increased 7% over 2009 levels, while decreased 20 basis points to 37.6% of sales versus 2009. We continue to believe our actions in 2009 are having a positive impact, while also allowing us the flexibility to make the appropriate investments. Again, we remain comfortable with fluctuations in these categories as opportunities in the related spending materialize.

On the 7% constant currency sales growth, operating income increased 15% and the operating margin increased a robust 160 basis points versus prior year to 25.5% of sales. Other income and expense reduce pretax income by $6 million in the quarter. Components of this included investment income of $12 million, offset by interest expense of $16 million and FX transactional losses of $2 million. Lower investment yields continue to limit earnings on our invested cash even with higher cash balances. Finally, the company’s effective income tax rate was 27.9% for the second quarter of 2010.

In terms of the balance sheet, we ended the second quarter with $4.03 billion of cash and marketable securities of $1.07 billion from yearend of 2009. As a remainder in the first quarter, we completed our $1 billion debt offering. Asset management remains an area of focus and our results remain in the tight range.

Accounts receivable days ended the quarter at 57, which represented a decrease of three days compared to the prior year. Days in inventory finished the quarter at a 163, which while up 12 days sequentially versus first quarter was down four days against the prior year level.

On cash flow, we continue to perform well with cash flow from operations of $327 million and free cash flow of $290 million. On the share repurchase program, we did not execute any additional repurchase in the quarter. Year-to-date, we have purchased 2.1 million shares at an average price of $51.74, for a total spend of a $111.1 million under our currently authorized $750 million share repurchase program.

In closing, we feel good about the outlook for our MedSurg franchises, including the recent Ascent addition to the Stryker portfolio. Additionally, we have identified the key issues to be addressed to accelerate momentum in our reconstructive and our international businesses.

Against this background, our financial forecast for 2010 remains unchanged. We are maintaining our outlook calling for net sales increase of five day percent in constant currency, diluted net earnings per share are anticipated to be in the $3.20 to $3.30, representing an increase of 8% to 12% over 2009, adjusted diluted earnings per share. At the close of the market today, First Call consensus estimates stand at $0.77 for the third quarter. We view this as a reasonable estimate.

In summary, our Q2 results keep us firmly on track to deliver our full-year guidance, while obviously noting we have some segment and geographic market issues to resolve in the quarters ahead. Through the first half, we think our results lineup nicely with our full-year expectations.

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

Stephen MacMillan

Thanks Curt. In summary, we continue to believe that our unique product footprint is an important competitive advantage and it provides us with significant opportunities for share gains, new product development, and acquisitions. Combined with our considerable cash balances, our tremendous cash flow generation, and the overall strength of our balance sheet, we are highly encouraged by our prospects to deliver continued top and bottom line growth.

With that, we’ll now open it up for Q&A. So I’ll hand it back to you Emity.

Question-and-Answer Session

Operator

(Operator Instructions). Your first question comes from the line of Bob Hopkins with Bank of America. Please proceed.

Bob Hopkins – Bank of America

Hi, can you hear me okay?

Stephen MacMillan

Yes Bob.

Bob Hopkins – Bank of America

Great, okay. So, thanks for taking the question. First question, I’d like to ask, it’s just very sort of simple big picture question on hips and knees. Steve, can you talk a little bit about why you think the growth in your hip and knee business slowed sequentially from what we saw in the first quarter? And then, now that we’ve seen Biomed and J&J and you guys have reported, do you think the hip and knee markets have slowed a little bit here in the second quarter? And, if so, why?

Stephen MacMillan

Sure. Bob, it’s obvious that people are going to look at the headline numbers on hips and knees and may be a little more concerned. Let me tell you why we feel pretty good and why we are not as concerned. I mean, simply, the overall number, we’re a little disappointed, yes. But I think here’s where we are. We’re in the midst of rolling out a great new – basically two new product lines in the hip franchise. And we saw this with Triathlon, it takes us three or four quarters to get going.

We used the analogy back in the early days of Triathlon. If you remember, starting a new product launch for us has been like getting a freight train going. It takes a little while, while we’re out educating, surgeons are trying it and going through that. And once we get rolling, we get rolling.

And all the feedback we’re hearing from the field, the confidence that we have in our team is very, very good that we think our hip franchise will be well poised. It would have been nice to taken off a few more points in the quarter, yes. But I think the market frankly, we also think was just ever so slightly slower this quarter. I think even there bring it up to a higher level.

We think right now hips and knees are mid single digit grower. In any given quarter, they’re up or down a little bit. We still feel good about those fundamental markets and our ability to take share. We’re in that transition to new products in hips. And on the knee side, frankly, I think, we’ve got some pent up excitement for OtisMed and probably some guy is just waiting for that to come on to the market hopefully later this year and they’re spending some extra time on hips. So if we didn’t have those product launches coming in hips and OtisMed sitting out there in knees, would we be a lot more concerned? Yes. But knowing what we’ve got going, I’m just thoroughly convinced our teams are taking the right efforts.

The other piece I’ll tell you just to give a little more perspective on the whole international piece. We’ve discontinued some products that certainly hurt us on the reported sales growth line. They are going to dramatically help us going forward here on the gross margin line and there are tradeoffs there that as we get rid of some of these products that we’ve been serving individual markets and have been consuming a lot of inventory, a lot of plant time, a lot of resources, getting rid of those has little pain in terms of your reported sales growth.

But we feel very confident that this is going to payoff down the road for us and you start to see it, you know, that’s not the whole liftoff obviously in gross margin, but it’s a contributing factor. So I think we feel better than the numbers for this particular quarter suggest and still feel very good about the longer-term trends.

Bob Hopkins – Bank of America

Did the Japanese price cuts take a little off in terms of the overall – your overall growth rates for this quarter, might that have accounted for a point of it? Or – and I guess, what I’m getting at is, if the market softens just a little bit, you know what was the source, was it weaker pricing, was your Europe a little weaker, again not Stryker-specific question, but just from a market perspective I’m curious, where you might have seen a little bit of incremental weakness. And do you think you’re losing a little bit of share?

Stephen MacMillan

We don’t think. Based on a at least J&J’s numbers this morning, I don’t think we think we’re losing share, certainly not in the US. We’re probably losing a little share in Europe, while we go through the digestion.

As we’ve Curt acknowledged and Katherine acknowledged, we lost some customers as a result of discontinuing some of the products. We think we might have lost a little bit on knee share in Japan in the quarter that we think we’ll get right back overtime here. But, overall, I think we’re feeling all right. Katherine.

Katherine Owen

Yes, I would just add, we’re not seeing anything different on the pricing trends in terms of the pricing pressure that existed in the recon market. I’ll just say, if the recon market overall is mid single digit grower, which we think it is, I think you have to view that as a plus two, minus two bracket in any given quarter, because these numbers are never perfectly near.

So growing low single digits in the market we think is mid single digits, not where we want to be, but not so much of an outlier that we sit and question, is there something fundamentally different with the market this quarter and we’ll have to see how the subsequent quarters shape up, but going back to the product launches that Steve spoke to.

We feel pretty good about our ability to gain market share, recognizing there’s nothing that points to a market growth that’s going to be significantly different overall on a multi-quarter basis in that mid single digit range.

Operator

Your next question comes from the line of Mike Weinstein with JPMorgan. Please proceed.

Mike Weinstein – JPMorgan

Thank you. Steve, you're probably going to get beat up over the course of this call about the performance in the hip and knee business and overall ortho. So I know you're not necessarily surprised by that. But the two key performance in US hips and knees was I think your – probably your lightest performance in a long, long time.

And I just want to understand, particularly on the knee side of the business, the drop-off momentum. I know there was no difference in selling days, it sounds like pricing was relatively the same versus what you saw in the first quarter, the last couple quarters. Is there anything else you could point to as to why you would have lost that much momentum this quarter versus the last several quarters?

Stephen MacMillan

Sure, I think Mike, as you well know, first off, I think we’ve proven ourselves over the last five years that we’ve been growing our knee business well above the market and certainly been hopefully a share taker in that business. I do think what we had going on in this quarter is with OtisMed, if the approval process, so that’s going kind of out there a little bit.

And for the first time in, call it five years, our sales force actually has some hip products in the bag that they’re excited about, it was probably focused on selling hips than necessarily knees. And, you know, we’ll get that right back. So I think as we’ve been doing the extra education on the hip line, probably we might have taken our eye ever so slightly off the ball in knees. I think we’d also like to see where the rest of the competitors report.

We think anecdotally in the US, the both hips and knees, the market may have been a little bit softer this quarter. And again don’t think people should overreact and see the market is slowing down. But, I think, you know, we’re always quick to beat ourselves up on what we can be doing better and trust me we’ve always get that list. I think when the dust settles, we’re not going to be that far out of where even the market settled out for the big companies.

Mike Weinstein – JPMorgan

Just with your own internal – disregard the market growth rate, so internally are you going to be surprised that, if you do believe there might have been some distractions this quarter, if you don't see a bounce back in the third quarter?

Stephen MacMillan

We would hope to bounce back somewhat, but I’d probably temper the expectations a little bit. I think the next big catalyst in knees for us is OtisMed. We’re probably the only company out there without a shape fitting option on the market right now. And we think those are important, we actually think we’ve also got a real game changer in OtisMed, we need to get that through the FDA. Once that gets through, I would expect you will see a very quick re-ramp to our knee business.

Operator

Your next question comes from the line of David Lewis with Morgan Stanley. Please proceed.

David Lewis – Morgan Stanley

Good afternoon.

Stephen MacMillan

Hi David.

David Lewis – Morgan Stanley

I just maybe switchover from recon for a second here and focus maybe Curt on gross margins. I know you try to provide some visibility, but obviously a much stronger trend we expected and you’re saying it’s sustainable above a level we would have expected. Can you help us understand given sort of to some negative mix in recon more specifically maybe in terms of basis points, the different gives and takes driving that number higher?

Curt Hartman

David, you’re right. I did try to give some visibility and it is an immensely complex topic when you look at a network of 21 manufacturing plants. And I think if I go back to my opening comments here, a large percentage of our manufacturing is Euro cost based.

As currency moves, as the dollar appreciated against the euro and as you look at relative sales of our US – in the US market and as you look at our other markets where you saw currency fluctuation against the Euro like the Aussie Dollar or the Japanese Yen, when you look at those relative currency movements, when you look at the mix of products what they have in the markets, the uptake on those currency moves that hit the profits and the gross margin performance are far more significant than the downside pressure that you feel from that simple currency movement in the European market.

And I think if you go back to our 2009 10-K, and I think it’s note 15, we break out the EMEA sales is roughly just below 20% of total sales. And keep in mind that’s entire EMEA and you should assume Euro-based sales are smaller percentage than that. If you just that as a percentage to think about or the majority of our sales and therefore the majority of our profits are you can see a decrease and the manufacturing costs are going to have a substantial impact on the gross margin level.

I don’t know if that helps you or confuses you. I can tell you it also gets in another factor that plays in here is the inventory turns by business unit and how those flow through. So there is progressive layering of the puts and takes as currency moves in any given quarter that are impacting the gross margin line across these various selling entities.

Stephen MacMillan

David, I’ll probably just give a – a little other perspective on it. If you go back and you look at the years of, call it, ’05, ’06, ’07, you know we were on steady march up on the gross margin piece. We then obviously took a detour as we invested heavily in our quality and compliance initiatives. And I think where we’re hoping is we’ve been saying is some of those investments would start yield additional benefits overtime.

And, you know, to me one of the real takeaways and the strengths of this quarter, people will look at and say, now wait a minute, there was a much higher mix of MedSurg, a lower mix of implants, and look at the margins we’re getting. It does make us feel pretty good without overselling this particular quarter which was certainly unusually high that there’s still a lot of power in this and I think that’s certainly what you’re getting at.

David Lewis – Morgan Stanley

Okay. Steve, maybe, I’ll ask you the recon question different way. There really are two issues as I see it. There was European disruption, distribute disruption, and then there was obviously delayed product cadence. At this point, where do you see greater visibility? Do you see greater visibility in regaining share or re-stimulating growth because of new products or you see a quicker fix to some of the European distribution disruption?

Stephen MacMillan

I think we feel not great about the quarterly results, but very good about the direction we’re on. And I think the visibility will become clear certainly in the second half of this year. Should our hip business start to be building momentum here in the third quarter? Yes. Is it going to suddenly leap up to double-digit growth? No.

This is going to be a freight train getting going on hips in the US, much as Triathlon did. I think you’re going to see the same thing at Europe, I would dare say we think second quarter was the bottom for Europe and that’s probably going to be – and I hate to use the Nike swoosh again, but I think we see probably our European business coming out in a swoosh like fashion again off the third quarter probably certainly better than the second, fourth quarter will be incrementally better than that.

Not a tremendous bounce back, but I like the programs that our teams are putting in place, the product flow that we have, the basic execution and we’ve proven ourselves to be pretty good at. So it’s really going to probably be both, but neither of them will be a third quarter this incredible bounce back.

Operator

Your next question comes from the line of Joanne Wuensch with BMO Capital Markets. Please proceed.

Joanne Wuensch – BMO Capital Markets

Thank you very much. I have two questions. The first one has to do with OtisMed. I understand you’ve submitted that to the FDA. Where are you in terms of your conversations with them, if you can give us any idea? And then, part of that question is, where are you in terms of thinking about product rollout? Do you need to staff up sales force and all that kind of good stuff?

Katherine Owen

On the – hi Joanne. On the OtisMed we have filed the 510(k). I would say that our hope in what we’re working towards with the FDA is to get approval or clearance sometime this year, but beyond that, probably won’t go into any specifics on the discussions, but that’s certainly the internal goal and expectation. And then, your second question was –

Joanne Wuensch – BMO Capital Markets

Well, my second question has to do with pricing. I mean, we’re beating this to death on every other company call, so why not here. Can you parse out some of the pricing that you’re seeing and say your hip, your knee, your spine, and then get a little more specific on the MedSurg portion of the business, how hospitals are reacting to that division. Thank you.

Katherine Owen

Yes, we – the short answer is we’re not going to go into detail by division, by franchise. We’ll try to give some color commentary in that. We haven’t seen any major changes in trends on our implant pricing. Clearly, it’s being offset by better pricing and other businesses on the MedSurg to get to that total company price of down 1.5% and you can assume it’s a little bit higher than that on the recon implant side. But, again, no major departure from what we’ve seen in prior quarters.

Operator

Your next question comes from the line of Derrick Sung with Sanford Bernstein. Please proceed.

Derrick Sung – Sanford Bernstein

Hi, good afternoon. Thanks for the questions. Turning to the bright spot here in your sales which is MedSurg, can you talk a bit about what you’re seeing is driving the growth first off on the hospital bed side of the business, what are the implications of your numbers towards hospital CapEx spending, are you construction starts comeback, what are you kind of hearing from your customers there? Any color would be great.

Curt Hartman

Derrick, I think the story overall in MedSurg and you can apply this somewhat to medical is, number one on the disposal side, the volume trends there remain consistent. They remain at or above what I would call overall procedure trend, so that really has an impact on the endoscopy and instruments business.

On the capital side, which is where we felt most of the pressure at the end of ’08 and certainly into 2009, we are seeing a return on the capital side, the capital equipment sales and purchases, I think that’s evident both in the instruments and the endoscopy side, absent on the endoscopy side, the OR communication suites which have a longer build out.

And then, clearly, for our medical business, we noted that that we’re seeing a consistent return on capital sales on beds, stretchers and the EMS platform. And I think what this is indicative of is these equipment segments that we sell into really on instruments and endo are part of the procedure, you can delay those purchases for a while, but as hospitals return to a more financially sound position, they’re electing to reinvest any equipment that’s generating the procedural volume.

In the medical side, it’s the upgrades, it’s the perhaps defined as smaller purchases than we may have seen mid 2008, but certainly the volume of purchases of capital expenditures is going up. And then, the internal metrics that we use to define hospitals in the state of capital liquidity has certainly improved over the first and second quarter of 2010. So overall, we like the trend. Again, we’re being very cautious here. I don’t see it returning to 2007 levels, but we certainly see a far more willingness to engage in conversation in purchase on the capital equipment side.

Derrick Sung – Sanford Bernstein

Okay, thanks. And then as a follow-up, turning back to Europe recon sales, I'm specifically wondering about your perspective not just on your particular – your specific business and issues that you’re facing there, but broader market, there has been concerns around the austerity measures that some of the countries are taking, whether that’s going to impact healthcare spending and ultimately trickle back down to impacting overall either procedure volumes or pricing on the orthopedic front. Can you comment on what your expectations are there through the end of the year into next year and like you’re seeing and hearing from your customers out there?

Katherine Owen

I think we’re hearing a lot of the same rhetoric in terms of – clearly there are some budget pressures that are resulting on some of the various governments. There’s been discussions around austerity measures. However, that yet hasn’t translated into any real changes as it relates to reconstructive implants or any key measure that we can quantify at this point. I think it does point to the fact that just the overall economic environment in Europe is going to be challenging.

And as we’ve talked about, we have our own specific issues that we’ll be working through for the rest of the year that probably suggest that there is a huge offset from a more robust European market. But we haven’t seen any significant changes in procedure volumes as it relates to austerity measures.

However, the actual implication or what comes out of some of that rhetoric I don’t think has really played out yet. So it’s kind of something to watch, not something we can quantify that reinforces the fact that we’re probably going to see pressure on our European business this year.

Operator

As a reminder, we ask all participants to please limit themselves to one question and one follow-up question. Your next question comes from the line of Rick Wise with Leerink Swann. Please proceed.

Rick Wise – Leerink Swann

Good afternoon, Steve.

Stephen MacMillan

Hi Rick.

Rick Wise – Leerink Swann

Maybe I’ll touch again on spine. A couple of questions; could you go into, help us understand maybe some of the three components that you talked about, the competitive inroads, the pricing and the early-stage issues? And maybe help us understand what was so significant and maybe what’s going to change and just the large spine question? Do you need to do deals to get the spine business going or is the existing pipeline and your strategy sufficient to make this a stronger performer again? Thank you.

Stephen MacMillan

Sure. Yes, let me take that pricing piece of it first. I think our pricing was similar to the last quarter, which is down. Pricing has gone negative in spine. I think that is going to put a little more pressure on that market have it growing a little slower. I think we also saw little bit of procedural slowdown, but we’re not totally sure whether that’s us or the market.

You know, from a competitive standpoint, I think what you got a little bit going on in spine, you know there I say is I think that the large companies that are very compliant and have a robust sales and marketing compliance programs, you know, I hate to say, I think are seeing some slightly slower growth than some of the smaller ones. And then in terms of launches, we obviously had some gaps in our portfolio certainly in the cervical plating line.

We’re filling those this year, those are rolling out. And so we’ve got I think a strength in pipeline, coming I’d say this is probably a transitional period for us for the better part of this year as we’re transitioning in and getting some new products out the door. And, ultimately I think we think we’re of sufficient scale to be able to complete and don’t need acquisitions to get bigger in that space. You know, we feel like we’re one of the bigger companies in the area.

Rick Wise – Leerink Swann

Okay, just the last quick follow-up. There was a little bit of surprise in the quarter on the recon side in terms of exact magnitude and performance. Just thinking back to the sense of the environment was stabilizing that you talked about at the May analyst meeting. Did you – was June unexpectedly weak or is June, July – are we start of seeing, if you will, the double-dip effect on procedures happening, is that what’s going on? Thanks.

Stephen MacMillan

We never want to quake it into monthly, monthly reporting as we much as I know actually if I got a weekly reporting. I think the whole quarter just turned out to be a little bit softer Rick than probably you know what we were expecting or anticipating and we spend a lot of time try to figure it out.

We do think certainly on the other results that were reported earlier in the day, we’re worried as we always do. Are we outliers? We don’t think we were as much outliers. We – it felt like just procedures were down a little bit on the margin. Katherine, I don’t know if you want to add anything.

Katherine Owen

The only think I’d add is that going back to is you agree with the assumption, this is a mid single digit type market growth. We grew in the low single digit. It’s not dramatically off and it’s awfully tough and very challenging, we’ll try and read too much into one single quarter’s trend, especially when there’s been no real change in the environment, no new real change in procedure options for these station.

It’s a fairly predictable patient population, a fairly predictable surgical approach, nothing really significant we’re seeing on the pricing side which leads us to believe this is just one of those quarters that happened to be somewhat below that mid single digit growth, but it’s tough to read too much into a major change in trends from that based on one quarter’s results.

It’s not meant to sound like an excuse for us growing weaker in the market to the degree that we did, but I also just think you have to take a step back and realize it’s probably not far off, that mid single digit number and there’s going to be quarters where it’s above or below that range.

Operator

Your next question comes from the line of Matt Miksic with Piper Jaffray. Please proceed.

Matt Miksic – Piper Jaffray

Hi, thanks for taking our questions. I’ve got one a couple of follow-ups I guess and some of the topics that have been covered, one on spine and then one on ortho. And one other things that one of your larger competitors talked about today I think for the first time, we’ve heard about pricing pressure before, we’ve heard about sort of modest volume slowdown before in spine. But, you talked a little bit about reimbursement as being an issue. Have you seen anything like that in your spine business? Can you think of you know where that might apply to, has it impacted you at all?

Katherine Owen

I think we’re – if what you’re referring to we made some comments on that. There has been to some degree some pushback about some of the payers on certain procedures primarily in the thoracolumbar area. And whether or not that creates a backlog or not, I think it’s just too early to know, but there’s probably been some dampening effect on procedure volumes high to that for that specific segment of the market.

Matt Miksic – Piper Jaffray

So it would be like pre-certification, that sort of thing, might push out procedures. But, I guess, is there anything like denial of coverage or other things going on for sort of the core procedures that you do, lumbar fusion, cervical fusion, anything like that?

Katherine Owen

I can’t say that is not happening anywhere, but I wouldn’t point that being a major trend or something that we would quantify.

Operator

Your next question comes from the line of Douglas Schenkel with Cowen and Company. Please proceed.

Douglas Schenkel – Cowen and Company

Hi, good afternoon, and thanks for taking my questions. First, you guys provided a decent amount of commentary on why recon was slower in the US and it's been obviously something that's come up a decent amount in the Q&A. In the context of the Q&A, you mentioned that spine volumes may have slowed down a bit in the quarter, maybe it's a little too early to say that it's just you guys or the market.

But with that as a backdrop, I was wondering how confident you are that there was no real new economic impact on volumes in the quarter, say maybe people rolling off of COBRA or a decline in consumer confidence or something else, so that maybe if you could just comment on that as my first question? And then second question relates to metal on metal. I was just hoping if we could get an update on your thinking as to your ability to maybe benefit from what seems to be an accelerating move away from metal on metal. Thank you.

Stephen MacMillan

Sure. I think the – in terms of the first one, any macro issues, we’ve not heard or really picked up any macro things. I continue to feel, I want to say this the right way that I know from the analyst community, you spend a lot of time focusing on quarterly movements that so often times a couple of companies had an extra selling day, one quarter, a few extra selling days or the way the days fell that these quarterly variations look much great than what really plays out in the long-term trends. We still feel very good about the long-term trends of the business.

And, back to our own business, and metal on metal, I think we feel really good about where our hip business should go over the coming quarters. This quarter, again, everybody is going to look at it and we figure you’re going to look and everybody is a little disappointed. Back to the fact that the metal-on-metal segment is no longer growing and in fact is probably starting to turn south.

And our ADM rollout coming right into this, we think we’re in the right place at the right time, the coming quarters will tell that. But, again, I think it’s what keeps us from being more concerned and nervous if we weren’t sitting here with a great product rollout going into to offset that metal on metal decline is likely to be hitting. And we didn’t have something in the shape fitting area on our knees, it’d be a very different tone. But, again, I think we feel really good about a couple of those major trends and our position in them. And, again, the coming quarters will tell.

Curt Hartman

And, Doug, I think on that note, it’s instructive to look at the overall company results in the second quarter. Even if we are a little bit disappointed with some of the individual segments or geography risks, I think it’s important to recognize that company delivered pretty sound results relative to our outlook and relative to our guidance. So it should underscore some of the strength of the mix of the company.

Operator

Your next question comes from the line of Vivian Cervantes with Maxim Group. Please proceed.

Vivian Cervantes – Maxim Group

Hi, thank you for taking the question. I appreciate your comments on spine and that you noted no real change in the macro. I'm hearing some comments about a review on the reimbursement front for kyphoplasty and vertebroplasty from I believe Noridian. Any color you could share with us on that and how it might impact your (inaudible) business or products?

Curt Hartman

Sure Vivian. The review of both for vertebroplasty and kyphoplasty and the acceptance or non-acceptance by payers, but from our chair, it’s not necessarily a new dynamic, certainly did hear that Noridian was taking a harder look.

And we believe that across the various markets that, number one, we stay highly engage with payers, we stay very connected to directional trends there, and we have our clinical resources that we try to lineup, help educate payers on the – on number one, the clinical outcomes that are derived from these procedures and the overall benefit to the healthcare spend system that company sees procedures when you look at the other option.

So certainly we know that there are pressures in both for vertebroplasty and kyphoplasty, various payers come up, changer their reimbursement outcomes and decisions on a somewhat frequent basis. So we’re used to dealing with those challenges and we certainly respect their right to change those decisions and we continue to maintain our offense to educating both payers as well as physicians, clinicians and patients.

Vivian Cervantes – Maxim Group

Thank you, that's helpful. And for my last question, I appreciate the fact that you're building up gaps within your portfolio and we see that in hips, we see that in spine and in knee. Do you feel that there are any other gaps that you would like filled in at this point or do you think that you've covered all the bases currently?

Stephen MacMillan

We feel we’re in pretty good shape. There’s always specific opportunities that we don’t go into Vivian, because as soon as we do, people will start to speculate about acquisitions or other things. So I think what we feel is we’re at sufficient scale in every business that we’re in and we’re always looking to supplement as well.

Operator

Your next question comes from the line of Raj Denhoy with Jefferies. Please proceed.

Raj Denhoy – Jefferies

Hi, thanks for taking the question. I wonder if I could ask about the MedSurg business. Two quarters now you've posted close to 10%, or just about 10%, kind of ex-acquisition growth there. Is that a sustainable number now, 10%? Do you think there's even a chance you could accelerate that back? Or where do you think we are on a run rate basis there?

Curt Hartman

Raj, we definitely like the trends in the first and second quarter. I think we'll probably be a little reserved in our comments relative to sustaining or perhaps increasing. But I think it is safe to say we have seen a return on the capital side of those businesses, not fully returned.

And we do like the momentum that all the organizations are demonstrating and that momentum is very contagious in those businesses and certainly as we look at procedure volumes, that natural inherent replacement cycle with a lot of our capital equipment is starting to materialize.

So, you couple the factors of hospitals a little bit more sound financial footing, a little bit more willing to invest in the capital dollars they have available or have access to, a great product offering across our businesses and highly engaged sales – selling organizations. We like that combination and it’s starting to materialize, favorable results.

And then to the previous comment, we continue to add new products here. Not ones that I would call overnight game changers, but ones that continue to engage our selling organizations, as well as our customers so that they are advancing the state of the art technology in those procedures.

Raj Denhoy – Jefferies

So, you feel pretty confident that the trends in that business is sustaining, I guess?

Stephen MacMillan

We like the trends and I think they point us in the right direction.

Operator

The next question comes from the line of Michael Matson with Wells Fargo Securities. Please proceed.

Michael Matson – Wells Fargo Securities

Hi. It sounds like there's a lot of excitement about the OtisMed product. And I guess I was just wondering, what your thoughts are kind of on that product category overall. Are you seeing your competitors actually starting to get traction there? And where do you see these custom instruments sort of fitting in with navigation there and robotics and these other technologies that are out there?

Curt Hartman

I think that real simple answer, Mike, is we’re encouraged by the technology. Otherwise, we would not have entered the space and that's a very simple statement to make. And I think as you look at the concept over all of shape matching and what it enables, which we wanted to some length at the analyst meeting in terms of custom approach, the speed with which the procedure can be accomplished and all of those other indications that we believe exist with this technology. We're excited that about the future and think that the orthopedics organization is excited about the opportunity.

In terms of continuum of care, if you think for a minute about the knee space today the market is largely defined by what I would call the traditional digs, fixtures and instrumentation, kind of the metal. On the other end of the continuum, you have kind of like the surgical navigation, which takes that metal and puts it into bits and bites, and it's really for more of the leading edge orthopedic surgeon, who enjoy the interaction with the technology, while also driving a phenomenal clinical outcome.

And shape matching, it's somewhat a blend of the two parts in that you're taking that instrumentation, you're making it a customized, unique approach for the patient for the doctor, but you're also enabling some of that alignment depending on how you are use the technology, their anatomic or mechanical. You're enabling some of that more specific alignment that you perhaps give out of the navigation side of the business. So, I think it fits very well in the broad continuum if you define that knee continuum as starting on one end with metal and with finishing on the other end with software.

Operator

Your next question comes from the line of Bruce Nudell with UBS. Please proceed.

Bruce Nudell – UBS

Hi. Thanks for taking my question. I guess Stephen Curt, I guess the fear that J&J kind of instilled in everybody or should have instilled instead insurance companies, commercial-insurance companies are going to kind of lower the payment-to-cost ratio for commercial in certain cases, or changed the carve-out and markup formulas for implants. Your trauma results certainly don't suggest that.

Is there anything systemic going on and in our hips and knees can be treated any differently than spine, for instance, or do you think this is just the luck of the draw in terms of the quarter? But no structural change in terms of reimbursement formulas?

Stephen MacMillan

We think this is more luck of the draw. There’s clearly, the long-term trend is that slightly lower growth rates and a little more pricing pressure. We continue to think there's going to be volume and there will still be premium's renovation. So, I think, we think people are probably going to overreact as they typically do to bigger movements. Sometimes to the upside, too. We've said this another quarter from – people thought there was a secular shift to up and we’ve said, “Hey, hold your horses. We don’t think it's necessarily a secular shift up. We don’t think this is a secular shift down.

Bruce Nudell – UBS Investment Bank

Looking at the spine market, if like volumes or case growth of mid-single-digits, and so you think that some positive mix in the long-term trend line is still possible, where you can get a 7% market out of five points of units?

Stephen MacMillan

Absolutely.

Operator

Your next question comes from the line of David Roman with Goldman Sachs. Please proceed.

David Roman – Goldman Sachs

Good evening and thank you for taking the question. Just maybe could just talk a little bit about the use of cash during the quarter? Curt, I think you said you didn’t repurchase any stock. May be you could just sort of elaborate on your thoughts with respect to how we could think about the share count, particularly with the stock having moved down from the levels where I think you commented you had repurchased year-to-date.

Curt Hartman

Sure, David. I think what I would first do is take you back to our introductory comments when we did announce the share repurchase authorization, that this repurchase authorization was intended to be used to offset dilutive effects of share-based compensation and other opportunistic buy-in moments, if you will. I would couple that with the other comment that we've been making for quite some time now that our preferred use of cash is M&A.

So, I think we've tried to instruct people that the goal here is to not rush out and filled the $750 million authorization as quickly as possible, but rather, use it at our disposal at our discretion. Certainly in the quarter, there was some movement in the stock price. In some instances, it was below the average of the previous shares purchased. But it was again program at our discretion and decision made at that moment in time; it was not in our best interest to purchase shares.

David Roman – Goldman Sachs

OK to maybe just look at R&D spending year-to-date. You’ve had a pretty significant increase and maybe some of that come from savings as it relates to compliance spending. Is there more of a shift through that you’re trying to signal that there's better opportunity to develop products internally versus making larger acquisitions and deals that we'll see you do will be more technology and in nature, and that over time, we should see R&D growth grow faster than revenue?

Curt Hartman

David, I wouldn't read too much into the relationships here. I think again as we headed into 2010, we try to be very clear that R&D as a percentage of sales should be right in the middle of that historic 5% to 6%. And in the quarter, we were at 5.4% and I think it's safe to read into my comments that the R&D spent should finish the year right in the midpoint of that 5% to 6% range. And certainly as a percentage increase over 2009 levels, it's going to be double digit and probably ahead of sales.

I think we have high degree of confidence in our R&D teams as they move out of what I would call more of the remediation work that into the more direct product development as more and more products kick up, you should see this number go up and we’ll continue to make appropriate choices and therefore the appropriate investments here. I don't think it's a mandate on our feelings about M&A.

Operator

Your next question comes from the line of Adam Feinstein with Barclays Capital. Please proceed.

Matt – Barclays Capital

Hi. This is Matt [ph] for Adam. Can you hear me?

Stephen MacMillan

Hey Matt.

Matt – Barclays Capital

Hi. I have two quick ones. The first one is on OtisMed again, assuming that you get an approval near the end of the year. How big of a percentage of the business do you see that for you guys and if the hip launches our freight train, what is this? Is this like commuter rail, it looks at speed as a launch?

Stephen MacMillan

When Otis gets approved, we think we'll get a fairly quick ramp because the number of doctors that had some experience with it, and waiting for it to come. So, I think that will be a quick train leaving the station. Hip launches are more of the cross-country freight train with a whole bunch of cars behind it, slow to get going, and once it gets going; it should be hard to stop.

Matt – Barclays Capital

And do you see that converting accounts for you or is that more of a positive mix?

Stephen MacMillan

That hip one? That will be, hip, really both will help convert accounts and be mixed. We see both of them as having opportunities to make competitive inroads.

Operator

Your next question comes from the line of Ben Andrew with William Blair. Please proceed.

Ben Andrew – William Blair

Hi. Good afternoon. Just a quick question on Ascent. Could you give us a sense kind of what the early lessons have been in the US now since you’ve been closed now for a couple of quarters? Maybe a little more and then how do you see the process unfolding in terms of going international and when we might expect to see some revenue contribution there?

Stephen MacMillan

We like it, off to a very good start in the US and I would say for at least the first year, so we're really focused on mining that business, learning as much as we can about it before, we start to really go, too far abroad. There's so many individual regulations country-by-country, even within the EU that there's a lot of regulatory heavy lifting that we'll have to occur around the world before that becomes more of a global business.

Ben Andrew – William Blair

Okay. And Steve has there been any change in FDA relative to process in terms of getting new indications here in the States?

Stephen MacMillan

For Ascent or anything in general?

Ben Andrew – William Blair

Percent, but if you want to comment in general, obviously there’s been some changes there.

Stephen MacMillan

Not that I’m aware of on the reprocessing front, and in general, obviously everything is done with the FDA right now. It's certainly getting probably higher degrees of scrutiny than historically.

Operator

Your next question comes from the line of Glenn Novaro with RBC Capital Markets. Please proceed.

Glenn Novaro – RBC Capital Markets

Thank you. Two questions. The first is I think coming into today most of us thought that knee and hip volumes would be okay based on the Biomed results that we reported last week. But, Biomed there a different fiscal year and I think they're fiscal quarter just ended on May 31.

So, I'm wondering, I'm trying to correlate the difference between what Biomed reported and what you and J&J reported. And I'm just wondering is it possible that June was just an awful month for implant volumes? Or did you guys just see weakness every month of the quarter? So that's question one.

And then secondly, you mentioned Europe was weak because of these distributor issues. Should we assume that underlying European trends are okay, volume trends? And could you quantify what the distributor and sales distraction good for you guys in Europe in the quarter? Thanks.

Katherine Owen

On the recon side, I would go back to our comments throughout this call. We haven't seen anything major in terms of changes and whether it be procedure volume. We haven’t seen anything major in terms of changes in pricing. We're not going to go into the monthly commentary because then you get into, “Okay, well, which company had more Mondays in there quarter than the other company because more procedures are done on Mondays or how many – who had extra selling days.” There's a lot of different variables if you're going to start to get down into that level of granularity.

So, I think overall, this is just a modestly weaker, low-single-digit growth quarter for us on the recon side versus what we view us market as mid-single-digits, but again still well-positioned given the new products being rolled out that we've talked about fairly extensively, at this point, as it relates to longer-term growth.

In Europe, I would say that overall market is probably challenged just by the economic environment and we have not broken out the revenue impact from distributors or discontinued products and probably not going to go there but that certainly a portion of the weakest that we saw in the quarter.

Operator

Your next question comes the line of Jeff Johnson with Robert W. Baird. Please proceed.

Jeff Johnson – Robert W. Baird

Thank you. Good evening. Stephen or Curt you mentioned that Japan may be lost some share in knee. If you could provide any color there that would be helpful.

Curt Hartman

Two comments on Japan. This is the first quarter where they experience the full impact of the price cuts. That was really the lead comment. And I think anyone of the Q&As, we commented that perhaps we lost a little bit of share in knees in Japan and that's about as straightforward as I can get. Nothing fundamentally underlying that, no, direct blowup that caused that. I think we would put that more in the operational and execution category than any particular event.

Jeffrey Johnson – Robert W. Baird

All right, that’s helpful. And then just cycling about the cross currency impacts and all that, obviously tough to track all those different currencies, so I won't even try from that standpoint. But dollar really starting to or the Euro really started to fall off, I guess if I think about it that way, earlier this year and that, but coming back to the 130 level. But it sounds to me like you think those gross margin benefits just when that just cross currency issue could probably continue at least next two to three quarters. Is that a fair comment?

Curt Hartman

Well, I think what I was trying to allude to is the way our inventory turns through our system in various products that inventory turns that impact month over month continues to layer up on the gross margin line. Some months, you have a positive variance. Some months, have a negative variance and it’s the netting of all that that really drives your gross margins. But my comment relative to the rest of the year was that we felt the first half margin of 685 represented a very stable forward look.

Operator

Your next question comes from the line of Bill Plovanic with Canaccord Genuity.

Bill Plovanic – Canaccord Genuity

Great, thanks for taking my question. Just kind of curious as you look at MedSurg of US. it seems to be recovering a little slower in the US and given what's going over on over there on the macro issue, would you expect that recovery to take longer in general?

Stephen MacMillan

A little bit, I think the bigger issue is the US fell off faster and is therefore coming back faster. Europe never fell quite as deeply as the US and probably isn't therefore recovering quite as much.

Operator

Your next question comes from the line of Sameer Harish with Needham & Company. Please proceed.

Sameer Harish – Needham & Company

Hi, guys. Good evening. Just kind of a follow up on some of the previous comments on terms of recon and spine. It seems like you’re talking about common themes in terms of pricing pressure and competition and a refocus on the new product cycle, but we haven't seen as much detail on spine in terms of what those new product are going to be. Are the two new cervical plates enough to get to back into a growth trajectory or kind of – is there more behind the play there?

Katherine Owen

If you go back to some of the comments on the call the two cervical plates that we started launching in the first quarter but will take several quarters to fully rollout really fill some gaps in the bag, but they were important gaps in terms of really being able to have a full offering with customers. So, we wouldn't call those game changing innovations. We’d call them important products to maintain a competitive product offering.

There's clearly more in our pipeline and new products that we expect to introduce and feel really good about the opportunities for innovation and spine. We haven't got into any details there or in really with any of our products that's really more just for competitive reasons. But that's not the end of the R&D story in spine, but it's the bulk of what will be rolling out this year. And again, going back to my comments I think you can assume spine is going to be facing some challenges for the better part of 2010.

Sameer Harish – Needham & Company

OK. And second question, I think some of your competitors have begun talking about of opportunities outside of the US and Europe as material contributes to growth in forward years. Where are you guys in terms of thinking about some of those other markets and when do you think they may start contributing?

Katherine Owen

We do have some efforts, but they're very much in the early stages under way and emerging markets. We are really refocusing in terms of the specific target markets that we're going to focus our efforts on. From a revenue contribution, it's not a material at this standpoint, but clearly just given the size of the opportunity and emerging markets, we’re very much focused on leveraging our product portfolio and – but again at this point, it's still very much in early stages.

Stephen MacMillan

The reality is for all the pressures on the US, we still feel very good about the core US market. We have year-to-date double digit growth in the United States and we think there’s great opportunity outside the US but we’re not taking our eye off the US ball either.

Operator

Your next question comes from the line of Mr. Matt Miksic with Piper Jaffray. Please proceed.

Matt Miksic – Piper Jaffray

Hi. Thanks so much for circling around. I did have one additional follow-up and if I may, I’m going to make that two follow-ups just so I don’t get cutoff again. There was one question on beds, I think as someone drilled into the strength in the bed segment and

Curt, you gave some color and I appreciate that, but I didn't pick up a sense of to what degree construction is maybe picking back up or to what degree that was a factor. And then again, I have one follow-up.

Curt Hartman

Matt, you didn't miss it and you didn't pick it up because I didn't offer it.

Matthew Miksic – Piper Jaffray

Any color that you'd like to offer?

Curt Hartman

It's what I would call simply unqualified color. We have anecdotal information that there has been some re-emergence of reconstruction. It principally comes from those health systems that financially have been on and remain on some financial footing. It's certainly not at the level of '07, '06 and '05.

Matthew Miksic – Piper Jaffray

OK. And then the follow-up on orthopedics and with apologies for beating like being this dead horse, but I remember going back a couple of quarters, there was some talk about, and I remember hearing from folks in the surgeon community about some sense that patients were kind of in a, “Let's get this procedure done before health care reform changes everybody's coverage,” and we heard about that in December. We heard about it again in Q1 and now both of those quarters turned out to be pretty strong.

As Katherine mentioned, you guys have looked at this from all angles to try to figure out what the slowdown might be due to. Is that something you considered? Is that a factor at all, so we’d be kind of in the middle of a little bit of a pause as we kind of catch back up midyear? Any color or thoughts would be appreciated.

Katherine Owen

I think as we look at the whole economic impact whether it was patients or patients losing jobs and not getting procedures done or worried about losing jobs and not getting procedures done or then the "catch-up" that may have an impact or have had an impact in any given quarter, but we've really view it on the margin. It's not something that we’ve seen that's to any degree that we could really quantify it and call it out as that's causing some disruption in the quarter.

So to that point, as we get out a couple of quarters, could it look on the margin a little stronger and some of those patients come back and it's possible. We've really going to look at, “Is there's some change in underlying patient demand? Is there some change in options for these patients as it relates to hip and knee procedures? Is there some big change on pricing?”

And the answer to all of that is, no, which is a big part of what reinforces our belief that the, “Yes, in any given quarter, you'll see some anomalies around that mid-single-digit growth, but nothing that suggests we’re seeing a real deviation away from it on a multi-quarter basis.”

Operator

I would now like to turn the call over to Mr. Stephen MacMillan for closing remarks.

Stephen MacMillan

Thank you, Emity. Obviously, a lot of questions on certainly the recon side. I think we pulled a lot of people's attention back to our full-year, full company results that we feel very good about the plan we are on. Every quarter has full ups and downs. We certainly have a few this quarter and we'll be back to report on our third quarter 2010 operating results, that call will be held on October 19th, later this year, 2010. So, thank you, everybody.

Operator

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

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Source: Stryker Corporation Q2 2010 Earnings Call Transcript
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