Stryker's (SYK) CEO Kevin Lobo on Q2 2014 Results - Earnings Call Transcript

Jul.18.14 | About: Stryker Corporation (SYK)

Stryker Corporation (NYSE:SYK)

Q2 2014 Results Earnings Conference Call

July 17, 2014, 2:30 pm ET

Executives

Kevin Lobo - President, Chief Executive Officer, Director

Katherine Owen - Vice President - Strategy and Investor Relations

Bill Jellison - Chief Financial Officer, Vice President

Analysts

Mike Weinstein - JPMorgan

Rick Wise - Stifel

Bob Hopkins - Bank of America

John Demchak - Morgan Stanley

Matt Miksic - Piper Jaffray

Bruce Nudell - Credit Suisse

Joanne Wuensch - BMO Capital Markets

Matthew Dodds - Citigroup

Derrick Sung - Sanford Bernstein

David Roman - Goldman Sachs

Glenn Novarro - RBC Capital Markets

Larry Biegelsen - Wells Fargo

Matthew O'Brien - William Blair

Kristen Stewart - Deutsche Bank

Jeff Johnson - Robert Baird

Matt Taylor - Barclays

Mike Matson - Needham & Company

Richard Newitter - Leerink Partners

Operator

Welcome to Stryker's second quarter 2014 earnings conference call. My name is Adrienne and I will be your operator for today's call. At this time, all participants are in a listen-only mode. Following the conference, we will conduct a question-and-answer session. (Operator Instructions). This conference call is being recorded for replay purposes.

Before we begin, I would like to remind you that 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, the 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 will now turn the call over to Mr. Kevin Lobo, President and Chief Executive Officer. You may proceed, sir.

Kevin Lobo

Good afternoon, everyone, and welcome to Stryker's second quarter 2014 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 an update on our M&A activity and preview our upcoming Analyst Meeting. Bill will then offer details on our quarterly results before turning to Q&A.

We continue to see solid topline momentum with organic sales growth up 5% in the quarter. After adjusting for one less selling day. this translates to underlying organic growth of over 6%. All three of our business segments, Reconstructive, MedSurg and Neurotechnology and spine contributed to our Q2 performance.

Starting with U.S. Reconstructive. Trauma and extremities continue to achieve market leading growth, up 13%, despite challenging comparatives from last year. This was powered by foot and ankle, which once again achieved outstanding growth, increasing over 30%. Both hips and knees registered solid performance and accelerated from Q1, with 6% and 7% growth, respectively. Note that the impact of one less selling day is most pronounced in our hip and knee business, which would have added roughly 150 basis points of growth. These businesses also benefit from improving trend in MAKO which we expect to continue in the back half of the year. Katherine will operate on this shortly.

Turning to U.S. MedSurg. We had strong performances in instruments, endoscopy and medical. Instruments increased 7%, driven by continued uptake of the Neptune Waste Management System. Endoscopy growth of 17% was aided by recent acquisitions but even after adjusting for these, still grew at an impressive 9%. Medical remained steady with a 3% increase. Sustainability solutions had negative growth in the quarter, but has recently received five 10-K approvals that will return it to positive growth starting in Q3.

The U.S. Neurotechnology had another strong showing of 8% growth with neurovascular NSE and CMF all performing well. U.S. spine results were soft this quarter, down 6%, reflecting pricing pressure and some sales force disruptions. We believe that a number of measures, including strengthening the leadership team and bolstering our product pipeline along with our recent acquisition of CoAlign should get this business back to its normal rhythm by year-end.

International constant currency growth of 5% reflects sustained improvement in Europe, as well as excellent performance in China, Australia, South America and India. These strong performances were partially offset by weak results in Japan as we continue to work through a challenging ERP implementation as well as the biannual price cuts. Most product categories had good performance although hips and knees were negative, owing to the Japan issues and from tougher comparisons, particularly in Europe, as we anniversary our turnaround. The small market issues in Asia, which we have alluded to on past calls are largely behind us and should no longer be a drag in the back half of the year.

Turning to the P&L. Gross margin declined year-over-year owing to a modestly tougher pricing environment, product mix and negative foreign exchange. R&D increased in both absolute dollars and as a percent of sales, reflecting our commitment to internally driven innovation, coupled with the impact from our acquisitions. Our focus on delivering greater SG&A efficiencies helped drive the year-over-year improvement in operating expenses. Combined with a lower tax rate we delivered adjusted EPS of $1.08.

For the full year, we are narrowing our guidance on sales and EPS. We expect full year organic sales growth to be in the range of 5% to 6% and adjusted EPS in the range of $4.75 to $4.80. These changes reflect first half performance, our expectation of accelerating sales growth and the impact of acquisitions on EPS.

Looking ahead to 2015, we will provide specific guidance at the end of January as we do each year, however, given the recent opening of our European regional headquarters we wanted to alert you to additional benefits that will accrue in 2015 versus 2014. We expect our 2015 effective tax rate to improve by roughly two percentage points or $0.10 to $0.15 per share. Of this benefit, we plan to reinvest about half to accelerate our topline growth and drop the other half to the bottomline. Therefore, we would expect an additional $0.05 to $0.80 per share improvement beyond our normal target for 2015. Bill will share more about the European regional headquarters later in the call and we will discuss the reinvestment plans later this year.

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

Katherine Owen

Thanks, Kevin. The focus of my comments today will be an overview of the recently announced planned acquisition of SBi, an update on the performance and expectations for our major recent acquisitions and a preview of our upcoming Analyst Meeting.

Starting first with SBi. We announced the planned acquisition of this key player in the small bone extremity market in late June for a net consideration of approximately $285 million. Through SBi's focus on the total ankle as well as the upper extremity small joint replacement segment, we are meaningfully supplementing our small bone fixation portfolio with a comprehensive product offering.

Importantly, there is minimal overlap with our existing products and we are well positioned to leverage our considerable sales and marketing infrastructure to access the various surgical specialists that focused on extending procedures. SBi's STAR Total Ankle Replacement, which represents roughly 50% of sales is the only PMA approved, cementless mobile bearing total ankle in the U.S. With these products we will expand our customer base with fellowship trained foot and ankle surgeons.

Additionally, roughly half of SBi surgeons are not currently customers of Stryker's T&E products. While we do anticipate some level dis-synergies in 2014 at we integrate the company, we expect to return to solid topline growth with a five year anticipated CAGR beginning in 2015 of over 20%, and with the recent success of our specialized foot and ankle sales force as well as the strength of our traditional branch agent sales channel, the timing is optimal for our organization to leverage this acquisition.

Moreover, the addition of upper extremity small joints will allow the opportunity to focus on this important sub-segment, a market estimated at over 200 million globally. In sum with the recent launch of our internally developed reverse shoulder, our expanded offering in small joint is answering a key gap in foot and ankle with at the STAR Ankle, we fully anticipate building on our clear success in the extremities market.

We closed the Berchtold acquisition on April 15, which is in the communications business unit of our endoscopy division. For this year, our commercial integration is focused on customer lead sharing with Stryker Communication sales team shared operating room table leads with their Stryker Berchtold counterpart and in turn for Berchtold to share operating room integration system leads. To date, the partnership between the sales forces have generated over 100 new leads. We anticipate maintaining separate sales representation between the existing Berchtold and Stryker portfolios through year-end at which point they will move into a single sales team.

We have been pleased with the initial results of the Pivot acquisition, which closed on March 7 and is reported within the sports medicine business unit of our endoscopy division. Stryker successfully completed the transition of the product sales to our direct sales force during the first 90 days of operation while maintaining very strong double-digit growth. Since close, we delivered the requisite product and procedural training to all reps and sampling to those reps that covered the existing 350 plus Pivot customers. We will sample the balance of the sales force by the end of Q3.

Turning to the acquisition of Patient Safety Technologies which provided us with the SurgiCount Safety-Sponge System and is now part of the instruments division. This deal was closed on March 24, and we have begun sampling the system and training our sales reps. Since the close we have added roughly 100 new customer contracts mainly through further expansion in our existing customer base, as well as in new accounts. Installations are ongoing that will increase the install base of customers to over 400 by the end of the year.

With respect to Trauson, which provided us with a leading brand in the fast-growing lower-priced segment of the Chinese market, we are now well into our second year and are pleased with the performance and success of the integration in China. With dedicated leadership for both the premium and lower-priced segment, we believe we are optimizing the market opportunity, while remaining focused on the specific attributes of these two distinct markets for Q2 growth in emerging markets with strong double-digits led by China, Brazil and India, and partly offset by ongoing market conditions in Russia.

Turning to MAKO. We closed in late 2013 and worked through much of the first quarter on the integration plan, which we rolled out to our sales force at the start of April. During Q2 we were focused on training our existing reps on the technology and its benefit. We have now trained roughly 20% of our 1,000 reps in the U.S. and are expanding the MAKO training capabilities to cover the remainder of our selling organization by year-end. While the integration proved to be more challenging than anticipated, we believe we are gaining momentum as robust sales in Q2 improved with six points in the quarter. Importantly, our order book has strengthened and we anticipate continued sequential acceleration and robust placement. We are also encouraged by system utilization which improved during Q2. We remain on track to launch a total knee system in 2015 and also plan to launch our key hip systems on MAKO next year.

Finally, we would be hosting our Analyst Meeting September 17 at our orthopedic headquarters in New Jersey starting at 10:30. We are restructuring the meeting's agenda to provide greater visibility into certain businesses or key opportunities for the company. Specifically, the meeting will include a surgeon panel focused on the MAKO opportunity, which will be moderated by David Floyd, Group President of Orthopedics. Tim Scannell, Group President of MedSurg and Neurotechnology and Spine will focus his comments on our instruments division, including the relaunch of Neptune and our recent acquisition of Patient Safety Technologies.

For the international perspective, Ramesh Subrahmanian will highlight our expanding presence in China. Lonny Carpenter Group President, GQO will detail the benefits of our European regional headquarters, which went live on July 1. With this focused presence in Amsterdam, we are excited about the opportunity which include continued strengthening our European presence and organization, the ability to co-locate leaders in a central location to increase collaboration, drive greater efficiency and to simplify and improve the customer experience.

And as Kevin mentioned and Bill will cover in more detail, we also expect meaningful savings as a result of our RHQ. Following the formal portion of the Analyst Meeting, we will once again have a product fair at the Homer Stryker Center. This year, the focus will be on orthopedics, including reconstructive, MAKO, sports medicine implants, trauma and extremities. In addition to the opportunities in many of our products, including recent launches and acquisition, the broader orthopedic leadership team will be in attendance and look forward to your question. We hope you will be able to join us.

With that, I will now turn the call over to Bill.

Bill Jellison

Thanks, Katherine. Sales growth was positive by 6.8% in the second quarter including a negative impact, slight impact from FX translation. Constant currency sales growth was a positive 6.9% which includes organic growth of 4.8%. We had a negative impact from one less selling day in the quarter and on a days adjusted basis, core growth exceeded 6%.

EPS on a GAAP basis for the second quarter were $0.56 per share, flat with last year, while adjusted EPS were $1.08 per share for the quarter versus $1.07 per share last year. This quarter's EPS includes a negative impact of approximately $0.02 per share from FX and if foreign exchange rate stay at current level, the back half of the year should see only a slight negative impact per quarter.

The most significant non-GAAP adjustment in the quarter are related to $160 million increase in the charges associated with the voluntary recalls of Rejuvenate & ABG II. These charges may increase or decrease over time as additional facts become available and assumptions become more refined, and again no insurance proceeds that may potentially be available to cover some of these costs have been included.

Looking at sales in the second quarter, our organic growth of 4.8% was comprised of a positive 6.8% from volume and mix with price negatively impacting sales by approximately 2%. Acquisitions added 2.1%, while FX had no material impact on sales in the quarter.

Looking at our segments, reconstructive represented 44% of our sales in the quarter. Sales of reconstructive products were up 6.5% as reported and grew 6.3% constant currency, and increased 3.6% organically. U.S. reconstructive sales grew 10.7% in the quarter. Trauma and extremities once again had another solid quarter and sales in the U.S. were increased by 13.2% and grew 9.2% internationally, with robust growth in our foot and ankle business as we continue to have great success in an expanding market.

U.S. hips and knees growth in the period of 6.3% and 7.1% were partially offset by declines in international markets of 2.7% and 5.6%. In the prior year quarter, our international growth was 5.9% in knees and 10.4% in hips, which were challenging comps.

Next, our MedSurg segment represented approximately 38% of our sales in the quarter. Total MedSurg sales increased 8.8% as reported and 9% on a constant currency basis and increased 6.7% organically. These results benefited from high single digit growth from our instruments business and a high double-digit growth in endoscopy which included incremental revenue from recent acquisitions.

Note that endo has a much tougher comp in the third quarter, however, instruments will have a much easier comp in the period as Neptune had a greater negative impact in the back half of last year. Medical had low single-digit growth again in the period against some strong prior year performance. Our instruments division has the Neptune product back on the market and should see additional improvements in the back half of the year, compared to last year. International sales were strong, up 13.2% in constant currency benefiting nicely from both organic and acquisition growth.

Our final segment, Neurotechnology and spine which represents 18% of our sales increased 3.8% as reported, 3.9% on a constant currency basis and 3.7% organically. Growth in this segment was led by our neurotechnology businesses and IVS which grew strong single and low double-digit in constant currency, respectively, while spinal implant sales were down low single digits.

In looking at our operational performance, gross margins on an adjusted basis in the second quarter of 2014 were 66.2% compared to 67.7% in the same period last year. Foreign exchange rates continued to pressure margins and prices declined approximately 2% in the quarter, while product mix also was a factor in the year-over-year decline. As mentioned, the negative FX impact should continue to lessen in the back half of the year.

Research and development expenses increased to 6.7% of sales versus 6% of sales last year in the quarter. This is a 19.7% increase in R&D spending over last year, reflecting a higher level of R&D spending tied to recent acquisitions and our commitment to invest more actively in few key areas which we believe will help us deliver above market sales growth, including our Neurotecsh businesses.

Selling, general and administrative costs represented 43.9% of sales in the second quarter. This included approximately $166 million of cost related to the Rejuvenate and recall matters. On an adjusted basis, SG&A expenses were $841 million or 35.6% of sales in the second quarter of 2014 versus 36.7% in the prior year's second quarter as we continue to focus on driving greater operational efficiencies.

Operating margins on an adjusted basis were 23.9% in the second quarter of 2014 compared to 24.9% in the second quarter of 2013. The rate was negatively impacted primarily by pricing and foreign exchange rates in the quarter, along with higher R&D spending partially offset by operational improvements and also from lower selling, general and administrative expenses as a percent of sales.

Other expenses on an adjusted basis in the second quarter were $30.3 million compared to $21.3 million last year in the second quarter. This increase in expense resulted primarily from higher interest expense and these expenses are expected to run at a similar level throughout the rest of this year.

Our reported and adjusted tax rate for the second quarter was 22.4%. This compares to a 23.5% adjusted effective tax rate in the second quarter last year. We expect the full year rate will be approximately 22.5% with a slightly lower rate in the second half of the year. The renewal of the tax extenders is still reflected in our year-end earnings forecast, which if approved will help reduce the second half tax rate. No renewal benefit has been included in our first half actuals.

While our 2014 guidance still includes approximately $0.05 per share for the renewal of the tax extenders, it has not yet been approved by Congress and renewal and timing of them is still uncertain. We also expect some tax rate benefit from our European regional headquarter move beginning in the third quarter of this year. We officially opened our new European headquarters in Amsterdam in the beginning of this month and will be ramping up activities and transferring some intellectual property to the Netherlands as we move through 2014 and into 2015 which will require some local tax country repayments.

This move will also generate some tax benefits which are expected to further reduce our overall adjusted operating tax rate in 2015 by approximately two full percentage points from 2014's full year rate. Currently, we are expecting to reinvest approximately half of these savings directly into our business.

Looking at the balance sheet, we ended the quarter with $4.7 billion of cash and marketable securities. We also have $3.9 billion of debt on the balance sheet at the end of the quarter. From an asset management standpoint, accounts receivable days ended the quarter at 57 days or about one day better than the end of the second quarter last year. Days in inventory finished the quarter at 177 days, which was an 11 day increase compared 166 days in the second quarter last year. While inventory levels increased in the first half of the year, partially in support the Japanese ERP implementation and recent acquisitions, we do expect some improvements in the back half of the year.

Turning to cash flow. Our cash from operations in the first half of 2014 were $572 million compared $592 million in the prior year. First half cash flows were slightly lower than last year as inventory increased in the period including amounts to support the ERP implementation in Japan. Our capital expenditures were $124 million in the first half of the year, compared to $96 million last year.

We still have over $600 million available for share repurchase under a current authorization as $60 million of share repurchases were made in the quarter as we focused on and closed a few acquisitions in the period. As Kevin mentioned, our 2014 sales guidance includes organic sales growth in the range of 5% to 6% and adjusted net earnings per share in the range of $1.12 to $1.16 and $4.75 to $4.80 for the third quarter and full year, respectively. This guidance includes the negative $0.02 per share impact of recently announced acquisitions. Also as mentioned previously, the renewal of the tax extenders remains in our guidance, however, if these are not renewed it would have a negative impact on our current guidance of approximately $0.05 per share for the year.

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

Question-and-Answer Session

Operator

(Operator Instructions). The first question comes to Mike Weinstein from JPMorgan. Please go ahead.

Mike Weinstein - JPMorgan

Thank you and thanks for taking the questions. Let me start with just the guidance change for the year. Since the street was already there, someone from the streets, that's a bit of a surprise, but they are going to range. So maybe you could provide a bridge from your own plan to where you are? Where you are up to date? The year-end $0.02 of that was from the recent acquisitions but maybe you can provide the rest?

Kevin Lobo

Sure. I think that the primary reason on our guidance, as you saw, in the first half of the year, our performance was a little bit softer than what we would like to have seen. Again we had $0.02 that we just recently announced as a negative impact from some of the recent acquisitions that we have got and pricing has been running a little bit stronger, a little bit higher from a negative impact perspective, or at least at the top end of our 1.5% to 2% range that we have typically given. Also as you have noted, in the first part of this year, FX has had about a $0.06 to $0.07 negative impact on us year-over-year at this point in time.

Mike Weinstein - JPMorgan

Okay. Can you spend a minute, Katherine on SBi, to adding people, the sales there have kind of flattened out for over a bit, but your outlook has been pretty optimistic. So can you just talk about what takes that from a business that's not growing right now to one that has that 20% growth potential?

Katherine Owen

Yes, and you are correct. We are receiving some sales force or some sales dis-synergy as we integrated into our business and there was clearly some distraction they had as we were working through this transaction. It really is a playbook as we saw with Memometal and other deals where we take great products and this is a terrific upper extremity portfolio really led by the STAR ankle, which is a meaningful gap in our foot and ankle portfolio and leveraging our considerable sales and marketing infrastructure, the demonstrated strength of the hybrid sales channel that we have that really allows us to touch base with all the various surgical specialists that participate in this market segment. So we really think we can reverse this trend with a tremendous amount of momentum as you are seeing right now in extremities and foot and ankle and adding this key gap to the portfolio and also further broadening out our upper extremity offerings. We feel very confident about the ability to return momentum there, which is why we are targeting that north of 20% CAGR for this segment.

Operator

The next question comes from Rick Wise from Stifel. Please go ahead.

Rick Wise - Stifel

Good afternoon, everybody. I guess, first with knees. Can you help us understand a little more clearly. Maybe actually I will start again. Can you talk a little about the knee market environment? One of your competitors is talking about the environment being soft or slow. Maybe you can give us some general perspective there?

And the follow-up with that, what would knee growth have been excluding Japan or maybe help us understand the impact of pricing and ERP implementation on worldwide knees? Thanks.

Katherine Owen

Rick, I will take the first part. I would say whether its hips or knees, we are continuing to see a market that's very stable. We did see sequential improvement in our business as you would anticipate given the challenges that existed for the industry mainly due to weather in the first quarter, but overall the market trends are very stable. We did have contribution from MAKO but even excluding that, our underlying growth in both hips and knees was solid. So we are pleased with the performance of those business. We did comment that pricing has gotten incrementally tougher which is behind the total pricing being down at the high end of our anticipated range. But that really doesn't reflect any significant changes in the market. It's much more of a function of the timing of product launches, where we are, for example, with Accolade II and that impacts that pricing from quarter to quarter. So I wouldn't view that as some type of fundamental change in the market, which we continue to view both segments as very stable.

Kevin Lobo

Also keep in mind that as we noted earlier, this quarter does have one less selling day in it as well too. So the organic growth rate that we talked about are on a straight basis. And those are not a days adjusted number.

Katherine Owen

And then you made the comment. We did have the price cuts in Japan which was part of the pressure on that business and as well as Kevin noted the ERP implementation. So those have been two of the more noteworthy challenges for that business.

Kevin Lobo

And ERP implementations, as you all know, can be challenging. And for us, it had a disproportionate impact on our reconstructive business because of the sets and being able to track all the inventory. So we put more resources on it right now. In fact, I also hired a new CIO for all of Stryker, Bijoy Sagar, who came from Merck KGaA. He joined us in the second quarter. We are really excited to have him onboard. We do also have another ERP planned for our instruments division as we modernize all of our IT systems. But having a new CIO, I am extremely excited about. We do have a lot of work to do. We made progress in addressing the ERP over the quarter, but it did have a disproportionate impact on hips and knees, and we are optimistic that we will have that sorted out in the third quarter.

Operator

Our next question comes from Bob Hopkins from Bank of America. Please go ahead.

Bob Hopkins - Bank of America

Hi. Thanks very much for taking the question. I have got a question to start for Bill and then one for Kevin. First for Bill. I was just wondering if you can go back to beginning of the year? Your guidance has been at the lower end of the range. You have revised it to the lower end of the range a few times and I am just wondering, is this all really surprises on currency and the $0.02 from the deal? Or is there something else going on?

And then on the 2015 outlook, which we appreciate, does that suggest a little upward bias to consensus, which is now forecasting 11% growth?

Bill Jellison

So I would say that you are exactly right in the first half of the year. So the $0.02 that we just talked about on the acquisition that we highlighted as far as having $0.02 of an impact as we move into the back half of this year is one piece of it. The other piece is some slight additional impact on FX in comparison to what we had in our original guidance as we talked about. Most of that, obviously, is impacting really the first part of this year as FX rates have actually improved a little bit, except for in some of the emerging market areas now. And then on the third piece is really that the pricing impact primarily in the recon area was probably a little bit higher, at least within the first half of the year than what we really expected.

Katherine Owen

And then, Bob, just in terms of your question, we will give our guidance in January. So it would be premature for us to comment regarding what the consensus expectations are. But you are correct. You should view the $0.05 to $0.08 that we referenced as being incremental to the normal targets that we will set out at the start of the year.

Operator

Then next question comes from David Lewis from Morgan Stanley. Please go ahead.

John Demchak - Morgan Stanley

Hello, this is actually John Demchak, in for David. I wanted to follow-up on some of the prior guidance questions with focus, I guess, a bit more on the organic growth adjustments. Numbers show the company's average roughly 4% to 5% organic growth in the first half of the year. Obviously the increased seasonality and weather had a pretty large impact in the first quarter. Are expectations that organic growth should stay more at the 2Q levels heading into the back half? Or are there some puts and takes that we should be thinking about that could drive organic growth a bit higher?

Kevin Lobo

So a couple of points. First, keep in mind that the Q2 growth that we just talked about was on a one day less selling day basis. So the adjusted basis in the second quarter was actually north of 6%. And I say that if you look at our organic growth in the first half, which was just under 5% as reported, and we just now obviously raised slightly the broader-based or near the range on the top end to 5% to 6%. That obviously implies that our second half growth rate is expected to be higher than what we have experienced so far in the first half. One of the reasons associated with that, as I mentioned, is on the instruments. The impact of Neptune on the back half of last year was obviously stronger than the first half and obviously as we are moving in through this year, our Neptune sales should actually be stronger in the second half of the year than they were in the first half of the year. So that's one piece that's helping to drive that but I think that we are feeling good and confident in a number of our different business areas to continue to take market share.

John Demchak - Morgan Stanley

Thank you. Very helpful. And just wanted to follow-up on U.S. knee growth. As earlier competitor reports showed weaker growth in U.S. in knees than we would have expected, but your numbers showed some pretty nice sequential improvement, especially when you factor in the selling day. I was wondering if you could discuss what you see in the market competitively and if you expect growth to pick up further later in the year with increased seasonality?

Katherine Owen

Yes. I would just go back to our prior comments. The market feels very stable. We obviously don't have the benefit of everybody having reported results right now. But for us, we are very pleased with the sequential improvement. And we are happy also with making progress on MAKO. So both underlying and with MAKO, we are seeing improving trends. I wouldn't say we have seen an acceleration in the underlying average growth for the recon market. It feels very much like a market that's been growing at fairly consistent rates, recognizing we have the variability between Q4 and Q1 that exists.

Operator

The next question comes from Matt Miksic from Piper Jaffray. Please go ahead.

Matt Miksic - Piper Jaffray

Hi. Thanks for taking the questions. So one follow-up, if I could, on MAKO. If you are providing a little more colors to and you see the rollout playing out nest year with knees, and then also with hips. I would love to understand, you mentioned sales trading, what's the model going to look like? Perhaps if you could shed any light on maybe how you are integrating the robot sales with recon sales and the support, as well as whether you are anticipating any significant upgrade to the hip software. That kind of color would be helpful. And then I have one follow-up.

Kevin Lobo

So I will take this questions. So what I say is, at the Analyst Day we are going to provide a lot more insight into MAKO. What I would tell you is from a sales force structure, we have a dedicated capital sales force that's within our orthopedic group that sells capital and that implants are being sold by our entire implant sales force. So that is now of course a much larger sales force than MAKO had initially. They all have gotten the same compensation plan starting April 1. So we didn't have that benefit in the first quarter. The training that Katherine alluded to in her section relates to training of the implant sales force on the benefits of MAKO, so they can be prepared to sell the implants that go with the robot. And of course going into 2015, those implants will include the Stryker implants and we will share more specifics on that at the Analyst Day.

Matt Miksic - Piper Jaffray

Great, and the follow-up, I guess, I appreciate the color on the ortho sequential growth. It seems very encouraging. Spine, on the other hand, still having trouble getting going and as you mentioned some sales disruptions, I am wondering maybe if you have any timing as to when we can start to see that curve bend up a little bit on the spine business.

Kevin Lobo

Yes. So up to now, up until this quarter, we have been really holding our own very well in spine, growing at least at the high-end of the large multinational. So not the spine only companies. We have been actually holding our own and actually running a very good business from a top and bottomline standpoint. We have had some sales force disruptions that the market is incredibly aggressive out there. That obviously hurt us in the second quarter. This market is still a market that rewards innovation and we are seeing that already with the early response to CoAlign. So getting our pipeline back on track is really going to be critical to us to not only retain the sales force that we have but also to drive growth. So I would say it's going to take us a good part of this year to really get ourselves back on a strong footing. And then I really look forward to a much more optimistic 2015 in spine. But it's a tough market, certainly especially in the United States. Outside the U.S., it's frankly not nearly as competitive and the markets are lot more stable.

Then getting back to your first question. I don't think I answered the last part of your first question around the hip. I would say, the recent hip software launch on MAKO is actually really good. So the software itself, the early iterations certainly had some challenges, but we now have actually a very nice software iteration. The issue for us is now getting our implants on to the robot. And as Katherine mentioned, we plan to do that in 2015.

Operator

Our next question comes from Bruce Nudell from Credit Suisse. Please go ahead.

Bruce Nudell - Credit Suisse

Good afternoon. Thanks for taking the question. Kevin, at AAOS last year, you were incredibly bullish about MAKO and you kind of went through the line of arguments as to why it provides a better option with modestly modified implants. Now you have a little experience under your belt. Could you kindly give us the elevator pitch for knees and hips with MAKO and what's really resonating with customers?

Kevin Lobo

The elevator pitch is the same elevator pitch I gave at the academy. I honestly feel as bullish as I did then and now and obviously we have got integration, we have issues with our sales force getting them all of up-to-date but I would say the promise of robotic surgery is the same. Its precision, its reproducibility, its consistent results and we are seeing in terms of the knee in particular, which is much more challenging than hips, we see this as really having a tremendous potential and we are obviously in the midst of our trial right now on the total knee and anecdotally we have a certain amount of feedback around being able to do intraoperative adjustments. It just provides a much better solution to the procedure, which we know is a very complex procedure, which has high, high variability and not the same degree of patient satisfaction. So obviously, there's the link to improving patient satisfaction is a long link but we believe the surgeon experience will be a tremendous with that. So there is nothing thus far in terms of the integration that's caused me to feel any less optimistic. Mind you, this is going to take time. It takes time to sell the capital. It takes time to put the implants that we want the robot and we would be rolling that over a period of time. But I remain extremely bullish on the opportunity long-term.

Bruce Nudell - Credit Suisse

And just on financially philosophical basis, I guess you guys have engineered a mini inversion of sorts with a nice tax advantage that should be sustainable, but with regards to access to ex-U.S. cash, how big a lingering problem is that and how big an enticement is inversion, generally speaking?

Kevin Lobo

Inversions are, obviously, in the news a lot lately, but from an overall perspective, we think we have made some very good progress on our RHQ structure related activities, which is primarily focused on the business itself and bringing the benefits of being able to grow our overall European business. But it does have some benefits to us within the tax side of the equation as well and we are very confident that we are going to be able to deliver on the results that we just talked about. Those results are on an ongoing basis. So we are continually focused and obviously minimizing our tax rate within that area and operating our of business as effectively as we can. We think we still have good opportunities in the future.

Bruce Nudell - Credit Suisse

Thanks so much.

Operator

The next question comes from Joanne Wuensch from BMO Capital Markets. Please go ahead.

Joanne Wuensch - BMO Capital Markets

Thank you. It's Joanne Wuensch. Can we focus on two things? First gross margins. What is the take to turn those? Or should we think of the 66% level as the go forward rate? Then my second question has to deal with (inaudible), and I appreciate the organic growth rate of up 5% to 6%, but you made a bunch of acquisition in the last six months, in six to 12 months. How do I think of what that may add on top of that? Thank you.

Kevin Lobo

Let me answer the last question first and I will go back to the first question. But from a growth rate perspective, keep in mind the organic growth rate that we are talking about excludes those acquisitions, with the exception now of Trauson is beginning to be included in our organic numbers, because that's an annualized acquisition. All the other recent acquisitions that we have are not in our current organic growth rate, but obviously should help improve our overall organic growth rate as we continue and move forward over the next number of years. From an overall perspective, on the margin rate side of the equation, I would say that our expectation for the rest of this year is still that the gross margins will probably be softer than they were last year throughout the rest of this year. However we are still expecting that our SG&A related activities will also run much better as well than they did last year. The biggest pressure on the margin rates right now is really price. The price impact was probably about not quite half of the total impact in that margin rate at this stage and we think the back half of this year, at least from a pricing perspective should be a little bit better than what the first half ran.

Katherine Owen

And Joanne, just maybe a little bit more color commentary. We talked about the sequential improvement in MAKO going to fix placements in the quarter. You should assume that's going to accelerate in the back half of the year as we train the remaining 80% of our reps on the technology and that's part of what is driving the accelerated revenue expectations. Also try to give some color on some of the key data points, whether its new contracts we have added or expanding our customer base with some of the other acquisitions, recognizing the revenue contribution there is certainly lower. So we tend to focus on organic growth since it really is the best indicator of our underlying gains but there is clearly an expectation for an acceleration in the contribution from the acquisitions with the exception of SBi given the dis-synergies we noted in 2014.

Operator

The next question comes from Bob Hopkins from Bank of America. Please go ahead.

Katherine Owen

Sorry about that, Bob. We dropped you off before you asked your second question. Our apologies.

Bob Hopkins - Bank of America

No problem, and I had a problem with my phones. So thank you, and I understand there has been some discussions around inversions. But I wanted to ask Kevin a question specifically, and obviously there has been a lot of press lately about inversions and day before yesterday, we had some statements out of President Obama's administration. I am just wondering if those comments about inversions, if that might cause, in your view, companies might be considering inversion to be less likely to move forward, given the changing political environment? Just love your views on that, Kevin.

Kevin Lobo

Sure. Thanks, Bob. I think it really depends on the main reason for doing the transaction. As you know, some of the deals that been done have been done really largely for financial reasons. In those cases, I think those companies would probably, it's a cause for pause, if the main driver of the deal is financial. However if the deals are more strategically driven, I really don't see it having much of an impact at all until legislation is actually enacted and what we are seeing in the press is the likelihood of near-term legislation doesn't seem very probable. So again, I would bifurcate into two areas. Those that are very financially driven, I think those companies will pause a little bit. Those that really are strategically, that's a bigger part of the logic and then as an inversion as maybe icing, I think those will continue to be pursued.

Bob Hopkins - Bank of America

Great, I really appreciate your perspective. Thanks for letting me back in.

Kevin Lobo

Okay. Thank you.

Operator

The next question comes from Matthew Dodds from Citigroup. Please go ahead.

Matthew Dodds - Citigroup

Good afternoon. On the pricing side, Bill, should we think about this as being geographically an issue at Japan and then hips and knees are the rest of the product lines geographies kind of stable or holding in there?

Bill Jellison

Well, I would say that Japan was one piece of it. But I would say that and it's within our general range. We expect the price is going to be somewhere in the 1.5% to 2% on average in any year. I think the first half was probably a little bit higher toward the top end of our range, but the whole year, I think it's probably still going to be in the 1.5% to 2% range. But I think that if you look at where the business related impacts are, while Japan is a piece of it, I think the broader recon group was probably at least beyond the higher impacted area of our business.

Matthew Dodds - Citigroup

Okay, and then Kevin on foot and ankle, you gave another big growth rate number. But you didn't say this time to caution us to not expect it going forward.

Kevin Lobo

You know what, you just defined my expectations. Honestly, it is hard to predict, these new markets are hard to predict. And I keep waiting for the comps to start to catch up with us and the team keeps executing. So I will be honest. They are exceeding my expectations and I am really delighted with the results.

Katherine Owen

But with that, we do remind you the comps will get tougher.

Matthew Dodds - Citigroup

The quick question is, why do you think the market growth is still above 10%, though, in extremities broadly?

Kevin Lobo

Yes, I would say we tend to estimate it around between 10% and 15%. We are certainly outperforming in the lower extremities. Obviously the upper extremities, shoulder has been a soft spot for us historically and we now have our reverse shoulder out, which we are very excited about. But that's an area we are playing catch-up in upper extremities. But obviously in the foot and ankle area, we are just having a great time so far and obviously the total, that was about the total ankle. We have been growing 30% pretty much quarter after quarter for a number of quarters without a total ankle and we believe we have got a fantastic total ankle through this acquisition. Of course we haven't closed yet but we will be closing soon, and we really believe that's a perfect solution for us and frankly gives us access to a lot of us the surgeons that we haven't had access to the fellowship trained foot and ankle surgeons. We have been kind of on the sidelines. So it really does give us a shot in the arm.

Operator

Our next question comes from Derrick Sung from Sanford Bernstein. Please go ahead.

Derrick Sung - Sanford Bernstein

Hi. Thanks for taking my question. Just a follow-up on that discussion right there with the total ankle in your lower extremities portfolio. Now that you have filled out your last remaining gap, do you think that, and now that you see this great opportunity in front of you, do you feel that the current sales force that you have is sufficient or do you expect to make further investment into your sales force to drive that growth moving forward?

Katherine Owen

We do have a hybrid model and we also have distributors as well as direct agents and that model has worked very well between our trauma, our reconstructive hybrid reps and our dedicated foot and ankle reps. Over time, we will look to possibly reevaluate the approach in upper extremities and it's possible but at this point as we analyze all the call points we have and the breadth of the various aspects of our selling organization, we think we are pretty well covered. So we don't believe we need to set up another dedicated sales force given the moves we have already made on that front.

Kevin Lobo

Certainly for the lower extremities, foot and ankle, we may add a rep here or there, but we don't need a radical change. We have a really well organized footprint a couple of years ago when we decided to create a dedicated sales force calling on the podiatric surgeon, that we have the right numbers, more or less. Again we may add a few reps here or there to fill out certain areas, but I wouldn't expect anything significant from a sales force investment standpoint. This is just getting great products and plugging it right in to our existing sales force.

Derrick Sung - Sanford Bernstein

Got it. Thanks. For my second question, I wanted to turn over to the MedSurg business and in particular, I was wondering if you could comment a bit on the capital, the CapEx spending environment for the hospitals? We have seen, it looks like their bed business picked up a little bit, but maybe if you could just comment there on what your outlook is for the remainder of the year and what you are seeing in the marketplace. Thanks.

Katherine Owen

Thanks, Derrick. I would tell you right now, that the capital environment still remains pretty stable. And by that, I mean it's still challenged as it relates some of the prioritization that our hospital customers do. And this is most relevant for our medical business which is 90% plus capital. We did report 3% growth. So it remains stable and we are pleased with the performance on a relative basis, but I wouldn't tell you we have seen any change in underlying capital demands on a high level as it relates to whether it's from ACA. That said, we are seeing very solid growth with our 1488 camera and have strong double-digit gains there and as well as System 7. So all capital is not the same, but as your comments are really towards the bigger tick at capital, I would say it's stable but no signs of an acceleration or increased investments by hospitals there.

Operator

Our next question comes from David Roman from Goldman Sachs. Please go ahead.

David Roman - Goldman Sachs

Thank you. Good afternoon. I wanted to come back to the topic around orthopedic pricing. I think that J&J talked about this pretty explicitly within the U.S. business. Maybe you could just offer a little bit more perspective on, if there are any significant structural change you are seeing in the pricing environment? I think if you look at other MedTech markets, there were pretty good leading indicator to see when pricing was going to turn negative, like high levels of physician employment and vendor consolidation. But is anything that you are seeing really change in the market? And what would you be confidence? Is this sort of a one-off flip or something that could worsen from here?

Katherine Owen

Yes. Thanks for the question, and you could imagine, we do a lot of analysis as we see how pricing trends are changing and it's clearly in the range of 1.5% to 2% but it's at the high-end and obviously if we think this is indicative of a fundamental change in the pricing environment, it's going to require us to think about things differently. So we really go into the next level of analysis and see the impact of the timing of product launches, expected product launches going forward and we feel very confident that what we are seeing is the normal quarter-to-quarter variation that occurs. We get price premium when we launch something like Accolade II, which had a very nice ramp up. But we have anniversaried that. So it would start to see the impact on pricing as a result of that. So all of that analysis that we do throughout the quarter, leads us to believe that this is consistent with the normal quarter-to-quarter variability that can exist. We tend to look over a rolling four quarters, because that gives you the best sense of the underlying trends but we don't think we have seen some fundamental change in the pricing environment that suggest we are going to see a significant step down in recon pricing.

David Roman - Goldman Sachs

Okay. That's helpful. Maybe a follow-up on the neurovascular business, which continues to do extremely well. Maybe you could just give us some update on end-market trends. I know back in March, there is that New England Journal of Medicine article that caused some disruption at your competitor, but you have powered right through that. So maybe if you could just give us sense in where end-market dynamics are right now and how we should think about that business on a go forward basis?

Katherine Owen

Sure. If I focus on the neurovascular part, because that's clearly the biggest piece of the overall neurotech business. We continue to be really pleased. We participate in both the hemorrhagic and ischemic segment. Although hemorrhagic is really the revenue growth driver and it's really the target line that continues to-date additional share in each geographic region. We have added four line extensions since the original launch of the Target coil a few years back and that still is the bulk of the neurovascular market, upwards of 40% and we have absolutely taken meaningful market share year-over-year in the coil market. We are also launching into new geographies with the product lineup, whether it's the Target XL which is the larger size or the Target Nano, which we are introducing into the Japanese market. So it's really continuing to execute on that plan.

The ischemic segment, it does take more investment to help develop that market and make sure you are getting patients to the right mode of care and it's really an emerging market, very much so, as it relates to the mechanical-based treatment of stroke segment. But we are very excited about the longer-term prospects. So we are going to continue with that playbook. I am just very pleased with the pace of product rollout and our ability to continue to launch them into new geographies.

Kevin Lobo

Yes. I would just like to add. We have an absolutely outstanding management team in neurovascular and you have seen our R&D spending, as a company, has certainly ticked up. Part of the reason for that uptick is spending that we have done in neurovascular, which is clearly yielding benefits and we still have a robust pipeline beyond the products that Katherine alluded to that we had already launched. So we feel very, very bullish about this business going forward.

Operator

Our next question comes from Glenn Novarro from RBC Capital Markets. Please go ahead.

Glenn Novarro - RBC Capital Markets

Hi. Good afternoon. Two questions on spine. First, you called out pricing pressure in your spinal segment. Can you tell us what that pricing pressure was and how that compares to the overall market, given your pricing was? Was the pricing more severe?

And then second, strategically in spine do you feel like you have now all the technologies to be competitive with, for example, a J&J or Medtronic or is this a segment where we should anticipate more M&A? Thank you.

Kevin Lobo

Yes. So firstly on pricing. It's not a new trend. It's been a consistent trend where pricing is worse in the U.S. than it is globally, kind of down in the mid-single-digit range and globally, maybe low single-digit or more stable pricing. Our challenge in spine really is, that our position in MIS segments, and clearly the CoAlign acquisition was one step to help plug some of that gap. We were really well represented in broad-based in the scoliosis procedures, pedicle screws, the standard spinal fusion products. We are very well represented but in MIS areas, we have been launching a series of new products over the last 18 months. We have more products to come but those won't be launched before the end of this year. So it will have more of an impact in 2015. So I would continue to expect that either through internal innovation or through potential acquisitions that that's an area that we will be focused on, growing our presence in MIS portion of spine. And frankly, that's what caused us some of our challenges.

Glenn Novarro - RBC Capital Markets

Okay. Thank you, Kevin.

Operator

Our next question comes from Larry Biegelsen from Wells Fargo. Please go ahead.

Larry Biegelsen - Wells Fargo

Good afternoon. Thanks for taking the question. I will try to be brief. So Kevin, you guys have done a lot of acquisitions in the first half of the year. Just on the same M&A topic, should we expect you guys to be active in the second half as well?

Katherine Owen

We would tell you that our BD activity ebbs and flows. There have been periods, if you go back a couple of years, where we did one transaction in the entire year despite having dedicated BD people in every one of our division. So it's impossible to time. We are focused on BD. We have it throughout the organization and we will probably have periods where a lot happens all at once, because that's just the nature of BD. But there is no change in the underlying strategy. M&A, for us, is the use of cash, dividends and buybacks.

Kevin Lobo

You know that our organization, the way we are structured, is we have business development people in each of our division. So they are always scouring the market and constantly looking at targets. We are not stopping that activity. That doesn't predict that we will do a certain number of deals, but the ongoing activity doesn't stop. Whether a division is ready to absorb another one is obviously one of the factors that will be considered, but we have so many divisions within the company that we can take on multiple deals at one time.

Larry Biegelsen - Wells Fargo

Thank you, and then lastly, on the shoulder launch. Could you just give us an update on where you are with that? Thank you.

Katherine Owen

We launched the reverse shoulder during Q2 and really going into Q3 as we start to get it out there. It's a different market than the other extremity areas, foot and ankle, for example, that is very much a market expansion segment. So we are seeing growth as we gain share, but also just the overall expansion of that market. That's not the case for shoulder. You have got more established players there and a much lower underlying growth, but it was a key gap in our portfolio. It was very difficult to go in without having the full product offering that a surgeon may need and you have only got one option for them. So we are excited about the ability to introduce that product to our hybrid reconstructive sales force, but I would have more tempered expectations, just given the nature of the market and the establishment of existing players.

Kevin Lobo

And really in the second quarter, it was more on a limited launch basis, with a certain set of surgeons. The full launch will really occur sometime by the end of the third quarter.

Operator

The next question comes from Matthew O'Brien from William Blair. Please go ahead.

Matthew O'Brien - William Blair

Afternoon. Thanks for taking the questions. Kevin, I was just looking across your portfolio, it seems like you have a pretty well-rounded product offering across recon, MedSurg and elsewhere. I am just curious about your thoughts on the need in areas where you are already participating to get a lot bigger versus just continuing to internally invest in those areas and organically growing and if you have ever seen a situation where one of your bigger competitors, like a J&J, just given their larger say, in trauma, has been able to cloud you across you out because of their size, rather than just their product offering?

Kevin Lobo

Well, I think the only example of trauma that you highlight is actually good example because their size and strength would simply certainly isn't slowing us down and our ability to grow. If you look at our growth over the last eight quarters, being number two hasn't really been a problem for us. We are growing at a very robust rate. So the key is you want to be one of the leaders in a segment and we like to be very strong in orthopedics and it narrows service line of hospitals, especially in surgery. We want to make sure we have very strong position or a path to be in a strong position. So you know our portfolio, you know within some of our portfolio, we don't have a number one or two position, and in those areas you can imagine that we are going to want to get to that kind of position over a period of time, whether it is through internal innovation. Trauma is a story of around internal innovation, largely, but one small acquisition of Memometal for the most part internally, we pulled away from the pack five years ago. Synthes was the dominant number one and then everybody else was tied for two, and we completely pulled away from the pack and we did that internally. Sometimes we will have to do it through acquisitions, and we are not going to disclose which of the approaches we will use in those segments where we are lower but for the most part, most of our portfolio, we feel that we are punching at our weight and we are really in a strong position to compete. In the case of hips and knees, we obviously felt that robotics was going to be a really key lever for us to drive above market growth. That may be different in other spaces where we might choose to do an acquisition just to increase our scale. But we have very few areas where we are really at a distant gap from the leaders and in those segments you can imagine that we will be active.

Matthew O'Brien - William Blair

Okay. Thank you and then just one more on the spine side of things. You mentioned a pretty competitive environment as far some of your sales force disruptions go. Is that a function of some of these guarantees getting to be fairly high levels? And is that coming from some of the really small providers out there or some the bigger multinational multiproduct companies?

Kevin Lobo

I would say absolutely, you are right on with the guarantees. That's the big reason that we are having some sales force departures, are very large guarantees, and frankly it's coming from multiple players. So it's not just smaller spine only. It's even some of the other players. So that hit us in towards the middle to end of the first quarter and that had more of an impact in the second quarter. It's a tough market. It's not a new tough market. It has been a tough market for a long time. It will continue to be a tough market and we are just to make sure that we stay focused. We made some adds to our leadership team that I feel really positive about and I think will be in good shape going forward.

Operator

Our next question comes from Kristen Stewart from Deutsche Bank. Please go ahead.

Kristen Stewart - Deutsche Bank

Hi. Thanks for taking the question. You guys have been making pretty good progress on reducing SG&A and I was just wondering to what extent you feel that this level of reduction is sustainable given all the initiatives underway and if the European headquarters will also have an impact on any sort of SG&A spending there?

And then separately, you mentioned giving back some of the incremental offsets on the taxes. Where exactly are those investments going to go? Are those internal or through acquisitions?

Kevin Lobo

So I would say, a couple things. As you look toward the back half of this year, we still feel very good about what type of improvements that you should see from an SG&A perspective year-over-year. So you should continue to see nice improvements there. And I think that from an overall perspective, especially if we can continue to drive above market growth, which we are doing on a number of different product related categories, that obviously helps us to continue to leverage that space and I think you should expect that as we are moving forward.

From an overall perspective on the tax comment that we made, I think it's more of an awareness that one, we are expecting some nice improvements from the tax rate side of the equation and our expectation is that we are going to be spending some of that as we move forward but I think that's more of wait and see related response based on how well the business is doing and what type of areas that we think that would like to invest in and I think you will get more color on that as we move through the back half of this year.

Kristen Stewart - Deutsche Bank

And with respect to tax, should we look at this as just the start of what could be additional reduction beyond 2015? Or is this one step function and that's basically it?

Kevin Lobo

Well, I would say, that we have made very good progress in the tax area to begin with. This project is just another big step associated with that and the improvements that we are expecting to get over the next couple of years, we are obviously still driving to maximize that level and it will take us kind of a couple of years to truly get the full benefit associated with even the projects that we are currently working on. Moving forward, beyond that, obviously while our efforts will be strong in that area, there is also many, many pressures around the world through a number of different jurisdictions and trying to increase different tax revenue in different areas. So that's a challenging environment, but I think that we are well positioned and I think we still have a lot of good opportunities.

Operator

Our next question comes from Jeff Johnson from Robert Baird. Please go ahead.

Jeff Johnson - Robert Baird

Thank you. Good afternoon. Kevin, I was wondering on the extremities market, your comment of 10% to 15% market growth. I was wondering if you could maybe go even a little deeper in the weeds there on the ankle replacement market? Maybe how you see the ankle replacement market itself growing in the U.S. and Europe? And then on your comments on STAR, on that ankle product. We have been hearing about maybe some early revisions with that product, a decline in utilization because of that in some markets. Obviously you see a lot more of that business than the few anecdotal conversations we had. So maybe you could set me straight on some of the things we have been hearing out on the field on that product?

Kevin Lobo

Yes. So first thing I would say is, if you look at the total joint replacement in general, the ankle is one of the late bloomers. So you have knees and hips and shoulders and it took time before it really started to get traction before the growth really kicked in and a lot of people predicted the total ankle would take a much, much larger percentage of the procedures which today, as you know, is mostly fusion. People predicted that five, six, seven years ago. We now really see the market starting to be primed for a take off.

Now predicting these take offs, as we have proven with our own foot and ankle, those other products, is not easy to predict when it will take off and what pace of take off. But we really believe that this is like the early stages of hips and knees. That's kind of what's been happening in the total ankle market. We believe the market is really primed to start to improve.

This is the most published ankle on the market. It has tremendous data. So the anecdotes, as you hear a lot of the anecdotes at least from our point of view, it really relates to the sales force execution and the service and we really believe we are getting a fantastic product out there. It's the most published by far. The data is long-term in nature and very, very solid.

You always hear anecdotes about different products. A lot of times, our competitors are the ones that will throw those anecdotes around and so we are not worried about it. We have done our due diligence. Believe me, we have known we have a gap in total ankle for some time and we have been very deliberative about making sure we make the right choice. We believe we made the right choice and having a cementless PMA approved total ankle, we believe, is a real competitive advantage and now putting it in our sales force's hands will change the story in terms of the growth trajectory that's currently being pursued in the market.

Jeff Johnson - Robert Baird

Yes, understood. Thank you. And then, Katherine, maybe for my follow-up. I just wanted to be clear on what you are saying on MAKO and your implants. You are saying jus the Stryker hip itself by 2015, I think is what you are saying, and I think that's a little bit of a change in the path. I think you have been little coy on whether it would be Stryker implant or the Restoration implant, what might get approved, not approved on MAKO. Can you just set me straight on Stryker implant, hip, knee, timing of expectations on that again?

Katherine Owen

Yes, you correct. It's incremental information. We really tried to say that as we get better clarity, we will share information with you. So at this point, we do feel comfortable that we will be launching, Stryker hip on the MAKO system in 2015. We will probably get into more specifics at the Analyst Meeting, and regarding specific hip systems. The knee system, there is no change. The trial is underway. We continue to expect to launch a total knee on the MAKO in 2015. We haven't got any more specific on the timing of that yet. The trial is being done with the pipeline knee that was MAKO's knee system. We do believe there is a regulatory path that may not require a completely new trial to bring our own knee systems on to the MAKO robot in 2015. But I would say, the probability of that is less than pipeline which is the knee being used in the trial. So new information on hips, more details to come in September and no change to our thinking on knees.

Operator

Our next question comes from Matt Taylor from Barclays. Please go ahead.

Matt Taylor - Barclays

Hi. Thanks for taking the question. I had two more strategic questions. So I guess the first one is, you made some comments over the past few months over the benefits of scale but maybe not scope yet. And I was just curious, over the past couple of years, you have made a lot of acquisitions to diversify away from recon. How do you view the benefits of scale in recon and how do think that the Zimmer. Biomet deal could impact your business positively or negatively, if it does close?

Kevin Lobo

So the characterization that we did a lot of acquisitions to diversify away from recon, certainly since I have been the CEO, it's really about strengthening our businesses. Strengthening our businesses within orthopedics, within neuro and within specialty surgery. And I am really agnostic about how we strengthen those businesses. So MAKO is a deal that's absolutely within reconstructive. Trauson is a deal that's a orthopedic deal. Then we have done deals that are outside in endoscopy and in another division. So I would say, certainly I wouldn't want anybody to think that our focus on acquisitions is to diversify away from. It's really to strengthen all of our existing businesses. Certainly, this consolidation within recon is something that we have been anticipating. It's not a big surprise, the Zimmer, Biomet, that that would happen. Having five competitors in a market that's not growing close to double digits normally would lead to some form of consolidation. So it's not totally surprising. The market has been pretty well disciplined thus far and we expect that that will add extra discipline to that. And I think that's about all that I would say on that.

Matt Taylor - Barclays

Thanks, and then just a follow-up. Your earlier comments on China, I thought were interesting and you have kind of a tiered structure there and some strong presence in both the premium and value segment. I guess I am just curious as you look out over the next couple of years, how are you going to continue to grow and defend your share? Are you concerned about emerging market players or your "generic orthopedic devices" or is that too small to be concerned with at this point?

Kevin Lobo

Yes. We feel really excited about the prospects within China, because certainly regardless of what happens with China's overall GDP, the healthcare market in China will be very healthy for the future and there's significant growth to be had both within the premium segment as well as in the value segment. Local players will continue to pop up in the lower-priced segment, but to have a well-rounded and very, very diverse product bag is critical. A lot of the business happens through tenders and to be able to win the tender, you need a strong brand, a strong local brand, which we have with Trauson, that has very, very broad product portfolio and registration times are not easy. The reason we moved towards acquisition was, we could have done it ourselves, it would have taken us six or seven years and we probably wouldn't have had products at lower price with the kind of heritage that we were able to get through the acquisition. So we really believe it has a long runway in front of us. Ramesh Subrahmanian, our Group President for International is going to do a deep dive on China at the Analyst Day Meeting and really our biggest opportunity, certainly in the next couple of years beyond China is taking Trauson to other countries which we are starting to do this year and which we will share more in the future, but there is markets like India that have big trauma markets where we don't even play in today. We are planning to launch into Trauson in 2015 in India and many other emerging markets where we have trauma markets where Stryker has not historically played. To us, that's a very, very significant growth potential for the long-term.

Operator

The next question comes from Mike Matson from Needham & Company. Please go ahead.

Mike Matson - Needham & Company

Thanks. I was wondering if you could maybe comment on the commission rate changes that you made in the recon business? I guess I am wondering, number one, was that limited to just recon or have you gone through similar moves in some of your other businesses? And then number two, how big of an impact has that had in the SG&A levers that we have seen this year? And is this something that you can continue to ratchet down in future years?

Katherine Owen

Yes, I would say, we did the commission rate cut for our recon sales forces in the U.S. at the start of the first quarter. We intend to do rate adjustment every few years. So it would have been three, four years since the last time. We recognize that we were above markets. So we moved in more line with the market and structured it to have a greater focus on growth. And that was one of the factors that we talked about the first quarter call that led to some of the softness on the recon business. It's clearly part of what's helping to drive the SG&A leverage. It's not all of it, but it's clearly a component of it. The rest of our businesses, MedSurg's does commission rate adjustments as well. They tend to do it more on an incremental basis, more frequently. Each of the businesses have their own approach to it. And there has been really no change that in fact was felt in some of the disruption around. It really was a first quarter effect.

Mike Matson - Needham & Company

Okay, and then just on the hedging program. Will that be fully in place by 2015? In other words, when we get into 2015, will these be pretty significant or potentially significant currency impacts on your gross margin be over effectively?

Kevin Lobo

Well, they are obviously never over because the exchange rates are always moving, right. So the hedging program is really just meant to mitigate that risk. It just buffers the impact with between quarters and try to smooth those increases, all right. It doesn't avoid the increases. So as those increases change over time, obviously that's an impact that occurs over time. Should you at least eliminate the peaks and the valleys associated with those movements, absolutely. The full program will probably be in place by probably mid-year, next year where we have got full six layer hedges consistently in place moving forward from that point.

Operator

The last question comes from Richard Newitter from Leerink Partners. Please go ahead.

Richard Newitter - Leerink Partners

Hi. Thanks for squeezing me in. Kevin, can you talk maybe just about how you envision MAKO potentially creating advantages for Stryker's recon sales organization through efficiency or enhanced flexibility either in the OR or outside of the OR?

Kevin Lobo

Well, I will go back to all of the comments we have made around the rationale for doing the deal is you deliver a delightful experience for the surgeon. The surgeon is able to produce consistent placement of the implant intraoperative adjustments and once they have that experience and we believe again the total knee will be the most promising. Certainly a bicruciate sparing knees becomes a big part of the market. We believe robotics will play beautifully into that. But it will be one of those situations, just like what happened with in the Uni market, where MAKO was able to take almost 20% share within a four year period. Once a surgeon does it robotically and has a delightful experience, they are not going back. So we will be the only game in town. So for us, it's a very differentiated approach that provides a meaningful benefit. A lot of those benefits, we believe, over time we are going to have to prove it with certain clinical trials, which we will be doing, but a lot of it's intuitive and obvious. It makes this procedure easier to do. It makes it more consistent. It makes it more reproducible and certainly once we put the Stryker implants with the robot, we have done a lot of research before we did the acquisition and surgeons were very interest in robotics. If you look at our manufacturing plants, you walk through Stryker's manufacturing plants, you see robots everywhere. And why is that? Well, robots can produce cleaner, more consistent results. It's just undeniable. And therefore we really believe bringing this to surgery is a logical extension and MAKO proved it already once with the Uni and we are going to now have to prove it in other procedures. And we feel very optimistic about being able to do so.

Richard Newitter - Leerink Partners

So maybe just my second question to follow-up on the first one. I was talking a little bit more just about the selling model, so to speak, or does it provide you with increased flexibility to drive efficiency through your sales organization itself, the way they itself interact with the physician, et cetera?

Kevin Lobo

Yes, sure. So, the way it works for robotic procedures, is you have a technician that helps operate the robot and that technician is not a regular commissioned sales person. So they are paid at a much different price point than our typical commissioned salesperson. And once the surgeon is converted and actually does their procedures robotically, you don't really need that commissioned sales force person to be there all the time. They can go off and cover additional surgeons and go cover additional hospitals. So over time, with the adoption of robotics, if it grows in the trend line that we expect, you would assume that the average cost of people that are in the field will go down over time. It doesn't mean we are paying our reps less. Our reps will still be paid as high powered reps that are gaining business, but the actual people who are technically there to help manage the case are paid at a much lower rate. And today there is one price model. The rep, whether it's a rep servicing an accounts or whether they are selling, they are paid the same today. With robotics, we are going to enable a bit of a bifurcation of the model to case coverage people who are technicians, who are paid at a lower rate and sales force who are paid for selling at a higher rate.

Richard Newitter - Leerink Partners

And does that lead to a bifurcation of the implant from the service cost eventually in your view?

Kevin Lobo

Well, as I said before, you are going to have two different kinds of people. You are going to have this commission sales force for selling and paid at a high price and the technicians who are a lower price, but there be less need if we gain tremendous volume, there will be less need for high-priced commission reps to just service accounts. They will be out selling. So I really believe that will give us better productivity with our commercial resources.

Operator

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

Kevin Lobo

So thank you all for joining our call. As you know it took a little longer this call and really part of the reason for that was to provide extra color on the acquisitions. We have been very busy on the acquisition front and we plan to provide additional perspectives on acquisitions every quarter. So thank you all for joining the call. Our conference call for the third quarter of 2014 results will be held on October 16. Thank you

Operator

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

Copyright policy: All transcripts on this site are the copyright of Seeking Alpha. However, we view them as an important resource for bloggers and journalists, and are excited to contribute to the democratization of financial information on the Internet. (Until now investors have had to pay thousands of dollars in subscription fees for transcripts.) So our reproduction policy is as follows: You may quote up to 400 words of any transcript on the condition that you attribute the transcript to Seeking Alpha and either link to the original transcript or to www.SeekingAlpha.com. All other use is prohibited.

THE INFORMATION CONTAINED HERE IS A TEXTUAL REPRESENTATION OF THE APPLICABLE COMPANY'S CONFERENCE CALL, CONFERENCE PRESENTATION OR OTHER AUDIO PRESENTATION, AND WHILE EFFORTS ARE MADE TO PROVIDE AN ACCURATE TRANSCRIPTION, THERE MAY BE MATERIAL ERRORS, OMISSIONS, OR INACCURACIES IN THE REPORTING OF THE SUBSTANCE OF THE AUDIO PRESENTATIONS. IN NO WAY DOES SEEKING ALPHA ASSUME ANY RESPONSIBILITY FOR ANY INVESTMENT OR OTHER DECISIONS MADE BASED UPON THE INFORMATION PROVIDED ON THIS WEB SITE OR IN ANY TRANSCRIPT. USERS ARE ADVISED TO REVIEW THE APPLICABLE COMPANY'S AUDIO PRESENTATION ITSELF AND THE APPLICABLE COMPANY'S SEC FILINGS BEFORE MAKING ANY INVESTMENT OR OTHER DECISIONS.

If you have any additional questions about our online transcripts, please contact us at: transcripts@seekingalpha.com. Thank you!