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Stryker (NYSE:SYK)

Q3 2012 Earnings Call

October 17, 2012 4:30 pm ET

Executives

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

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

Dean H. Bergy - Interim Chief Financial Officer, Vice President and Secretary

Tony M. McKinney - Chief Accounting Officer and Vice President

Analysts

Michael N. Weinstein - JP Morgan Chase & Co, Research Division

Robert A. Hopkins - BofA Merrill Lynch, Research Division

Kristen M. Stewart - Deutsche Bank AG, Research Division

Richard Newitter - Leerink Swann LLC, Research Division

Matthew S. Miksic - Piper Jaffray Companies, Research Division

Matthew Taylor - Barclays Capital, Research Division

David L. Turkaly - JMP Securities LLC, Research Division

Jason Wittes - Brean Murray, Carret & Co., LLC, Research Division

David R. Lewis - Morgan Stanley, Research Division

Raj Denhoy - Jefferies & Company, Inc., Research Division

Bruce M. Nudell - Crédit Suisse AG, Research Division

Rajeev Jashnani - UBS Investment Bank, Research Division

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

Michael Matson - Mizuho Securities USA Inc., Research Division

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

Lawrence Biegelsen - Wells Fargo Securities, LLC, Research Division

Jeffrey D. Johnson - Robert W. Baird & Co. Incorporated, Research Division

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

William J. Plovanic - Canaccord Genuity, Research Division

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

Operator

Good day, ladies and gentlemen, and welcome to the Third Quarter 2012 Stryker Earnings Conference Call. My name is Derek, and I'll be your operator for today. [Operator Instructions] And as a reminder, this conference is being recorded for replay purposes.

And before we begin, I would like to remind you that the discussions during this conference call will include forward-looking statements. Factors that could cause actual results to differ materially are discussed in the company's most recent filings with the SEC. Also, the discussions will include certain non-GAAP financial measures. Reconciliations 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 like to turn the conference over to Mr. Kevin Lobo, President and Chief Executive Officer. Please proceed.

Kevin A. Lobo

Thank you. Good afternoon, everyone, and welcome to Stryker's third quarter 2012 earnings report. Joining me on the call is Dean Bergy, who many of you may recall served for many years as Stryker's CFO and has assumed the position of Interim CFO over the next few months. Also joining me is Katherine Owen, Vice President of Strategy and Investor Relations.

In terms of the format for today's call, I'll provide opening comments and then turn the call over to Katherine for details regarding our recently announced planned acquisition of Surpass Medical. And then Dean will cover the financials. We will then open the call to your questions, where we will be joined by Tony McKinney, Stryker's Chief Accounting Officer.

Before we go into the specifics as it relates to our third quarter results, I first wanted to make some comments following my move into the role of President and CEO. Having joined Stryker roughly 18 months ago, I have had the privilege of connecting with many of our 20,000-plus employees around the globe. Those experiences have underscored the pride and dedication we all have in doing the very best for our customers through innovative and value-added products and services. This has been, and will remain, at the very core of Stryker's culture as we go forward. Our focus will continue to center on quality, innovation and cost.

We have a broad and diverse footprint of products and services that span many of the fastest-growing segments of medical technology. We have a strong balance sheet that allows us to augment our internal investments through selective M&A, in addition to buybacks and dividends, all 3 of which will continue to be a key part of our capital allocation strategy.

As we look ahead to the completion of 2012 and prepare for 2013, we remain focused on delivering solid revenue growth and leveraged earning gains.

Turning to the third quarter results. Although our underlying core growth after adjusting for currency, acquisitions and one less selling day of 3.9% was solid, it was nonetheless below our targeted expectations, particularly as it relates to our international and capital equipment sales. The resulting earnings shortfall is disappointing, and masks positive performances in many of our U.S. businesses, which posted sales gains of 4.7% on a reported basis and 5.7% on an average daily sales basis.

And with the exception of Medical, all of our U.S. franchises posted year-over-year revenue gains. Additionally, we realized solid cash flow generation during Q3. However, in the month of September, we did not see the expected acceleration in growth in sales outside the U.S., as well as with our capital businesses, resulting in a misalignment between our top line and spending.

As it relates to our International segments, our top priority is turning around our business in Europe. New leadership is focused on accelerating actions aligned with the structural changes we see in the marketplace. Additional areas of focus include strengthening our distribution, especially in Southern Europe, and optimizing the breadth of our product portfolio. You will also note that we did benefit from a lower tax rate in the quarter, which helped to offset some of the impact of the earnings shortfall. Combined with a roughly 1.5% decline in the share count versus a year ago, adjusted per share earnings came in at $0.97, or up 7% year-over-year.

With respect to guidance for 2012, we are narrowing our sales range from 2% to 5%, to 2.5% to 4% underlying revenue growth, excluding the impact of foreign currency and acquisitions. And we are now projecting full year adjusted per share earnings in a range of $4.04 to $4.07, up approximately 9% versus our prior target of double-digit year-over-year earnings growth. The revised outlook takes into account the weaker-than-expected Q3 results and lower Q4 revenue versus our prior expectations due to the continued challenges in international markets and greater pressure on hospital capital budgets. Based on the combined impact, we are taking a more conservative stance, which reflects the current uncertainties and mitigates the risk of a shortfall relative to expectations.

Looking ahead to 2013, we are no longer assuming we can fully offset the impact from the medical device excise tax and still deliver double-digit EPS growth and now target adjusted per share EPS in a range of $4.25 to $4.40, up approximately 5% to 8% which includes an estimated $100 million impact from the medical device excise tax. Excluding the tax, we are targeting 9% to 12% EPS growth. This guidance does not assume any significant increase in share buybacks.

The one question you may have is, how do we reconcile the downward revision to 2013 guidance in light of our recent Analyst Meeting, where we provided additional details around the drivers of our EPS target. The deciding factor behind our new target was not a function of whether or not we could deliver 10-plus percent EPS growth in 2013, but rather in light of the current environment, particularly as it relates to Europe and capital globally, what impact would such a degree of leverage have on our future growth prospects. Against that backdrop, a decision was made to revise downward with a range which we believe allows for meaningful earnings leverage, particularly after factoring in the excise tax, but still enables us to make the necessary investments to drive our performance long term.

In closing, Q3 presented challenges, while also underscoring the potential we have to deliver solid underlying revenue growth. Although the issues impacting our International businesses will not be resolved in a single quarter, I'm confident that we will be taking the necessary measures to ensure we first get back to market growth, while also ensuring we are realizing the leverage in the P&L. We have a number of important product launches underway throughout the company, coupled with a focus on driving greater operating efficiencies through our global quality and operations teams, which will drive $500 million of cost savings over the next 5 years.

In summary, with our revised guidance, we are well positioned to deliver on our expectations and build upon our leadership position. With that, I'll turn the call over to Katherine.

Katherine A. Owen

Thanks, Kevin. My comments on today's call will focus on our planned acquisition of Surpass Medical, which further broadens our presence in the neurovascular market and reflects our commitment to delivering complete stroke care. Specifically, yesterday we announced the definitive agreement to acquire privately held Surpass in an all-cash transaction for $100 million and up to an additional $35 million of milestone payments.

By way of background, Surpass was founded in 2005 with a focus on developing and commercializing next-generation flow diversion stent technology to treat brain aneurysms. Surpass' key product, the NeuroEndoGraft family of flow diverters, is designed to redirect blood flow away from an aneurysm using a unique mesh design and delivery system, allowing a stable clot to be formed within the aneurysm pouch.

With this acquisition, we are continuing with our M&A strategy, which is focused on our core and key adjacent markets. Recall that in early 2011, we acquired Boston Scientific's market-leading Neurovascular business, which significantly broadened our limited presence on the neurosurgery market, with a focus on the hemorrhagic stroke segment. In October of last year, we entered the ischemic stroke segment with the acquisition of Concentric Medical, which in August received 510(NYSE:K) clearance of its latest generation Trevo stent retriever system with commercial launch now well underway.

Surpass should enable us to further build on our global product offering and leverage our considerable sales and distribution infrastructure. We believe gaining access to the fast-growing and highly innovative flow-diverting stent market is an important component in our strategy to offer our customers complete stroke care. With the NeuroEndoGraft, we will be able to treat large and giant unruptured intracranial aneurysms, and provide physicians with another option to complement our market-leading portfolio of coils. The NeuroEndoGraft is CE Marked with a limited launch underway outside U.S. In addition, Surpass will begin enrolling patients in an IDE clinical trial in the fourth quarter of this year. Overall, we are excited about the opportunity to use the strength of our balance sheet to continue to make targeted acquisitions that we believe will help drive accelerating core revenue growth.

And with that, I'll turn the call over to Dean.

Dean H. Bergy

Thanks, Katherine. As noted, solid sales growth in the U.S. anchored our 3.9% core average daily sales growth in the quarter, which compares to 2.7% in quarter 2. With one less comparable selling day in the current quarter, the company posted sales growth of 1% on a reported basis and 2.9% in constant currency. With regard to earnings, we delivered adjusted diluted net earnings per share of 97% -- or $0.97, excuse me, representing growth of 6.6% over Q3 2011. On a GAAP basis, diluted net earnings per share were $0.92, an increase of 9.5% versus Q3 2011. A reconciliation of non-GAAP to GAAP EPS was provided in the tables accompanying today's press release.

In reviewing the quarter, I will start with a discussion of the components of our revenue growth. In the third quarter, volume and mix contributed 3.4% to our top line growth, acquisitions added 0.4%, and currency decreased top line sales by approximately $38 million and decreased our overall reported sales growth by 1.9%. Pricing pressure remained stable with companywide selling prices down 0.9% globally.

Looking at our reporting segments, I will start with the Reconstructive products, which represented 43% of our sales in the quarter. Reconstructive products include our hip, knee, trauma and other reconstructive lines. Our Reconstructive segment saw sales decrease by 1.1% as reported, and increased by 1.1% on a constant currency basis. U.S. sales led constant currency growth with Knees up in the mid-single-digits, reflecting the early impact from our GetAroundKnee direct-to-consumer campaign. And our U.S. Trauma sales posted an impressive increase of roughly 11% in the quarter.

Turning to Hips, the approximate 2% increase reflects tougher year-over-year comparisons and a modest impact from the Rejuvenate recall. These gains were partly offset by weakness in our International Reconstructive business where sales declined 4.1% in constant currency, with Europe experiencing continued softness, and Japan negatively impacted by the April 2012 reimbursement of price reduction on implants.

Next, I will turn to the MedSurg product segment, which represented 38% of sales in the quarter. For reporting purposes, MedSurg is comprised of Instruments, Endoscopy, Medical and the Sustainability Solutions business. In total, MedSurg sales increased 1.7% as reported and 3.1% on a constant currency basis. These results were led by growth from our Instruments and Sustainability Solutions businesses. Instrument sales growth was hindered by the Neptune Waste Management System recall, which adversely impacted sales by approximately $8 million in the quarter. We expect the recall to negatively impact sales by about $16 million in the fourth quarter. As we work with FDA to address the requirements for the Neptune 510(K), we anticipate regulatory clearance is unlikely prior to sometime in 2013.

Medical sales were strong on a small base overseas, while the U.S. was down modestly, due in part to challenges with hospital capital budgets. Endoscopy posted a small sales gain in the quarter as the full benefit of the new 1488 camera launch is not yet been realized, given the late second quarter launch coupled with some minor product issues that are being addressed in the field.

Our final segment, Neurotechnology and Spine, which represented 19% of company sales, had a very solid quarter. Sales increased 4.7% as reported, and 6.9% on a constant currency basis. Acquisitions added 2.1% to the constant currency gain, reflecting the performance of the Concentric acquisition. Our Neurovascular, NSE and Interventional Spine platforms all generated double-digit constant currency growth. As it relates to Neurovascular, we would highlight that Q3 saw a continued strong uptake for the Target Coil, while the early launch of the Trevo stent retriever is off to a solid start. Core spinal implant sales were down slightly on a constant currency basis.

I will now turn to the income statement beginning with our gross margin performance. On a reported basis, gross margins finished at 68.1%, while adjusted gross margin finished at 68.2%. The adjusted gross margin represents a 20 basis point improvement on a year-over-year basis, almost flat sequentially. Research and Development finished at 5.6% of sales, consistent with the prior quarter and our overall expectations.

Selling, general and administrative costs represented 38.5% of sales. Adjusting for restructuring- and acquisition-related charges, SG&A finished at 38.2% of sales. The unfavorable year-over-year comparison results primarily from a favorable resolution of a value-added tax issue in 2011.

Reported operating income increased 1.4% over the prior year and was 21.9% of sales. Adjusted operating income decreased 2.6% and the adjusted operating margin finished at 22.9%, primarily as a result of the relative increase in selling, general and administrative expenses as a percent of sales.

Other income and expense reduced pretax income by $6 million in the quarter, down from $10 million in the second quarter. Components of this included investment in interest income of $12 million, offset by interest expense of $16 million, and a foreign exchange transaction loss of $2 million.

The company's effective income tax rate was 20.5% for the third quarter of 2012 compared to 24.1% in the prior year. The lower effective tax rate in the current year results primarily from favorable tax adjustments, as well as the finalization of our 2011 U.S. income tax return. We expect the effects of the tax rate for the fourth quarter to return closer to the rate experienced in the first 2 quarters of the year, but with a downward bias.

Turning to the balance sheet, we ended the quarter with $3.9 billion of cash and marketable securities, an increase of approximately $450 million from year-end 2011. As a reminder, we have $1.75 billion of long-term debt on the balance sheet.

On the asset management side, accounts receivable days ended the quarter at 59, which represented an increase of 1 day compared to both the prior year and last quarter. Days in inventory finished the quarter at 183, which was up 9 days sequentially versus the second quarter, and up 7 days when measured against the prior year. Inventory days traditionally spike up a bit in the third quarter due to slightly lower seasonal sales. In addition, we are building inventory in preparation for the upcoming manufacturing plant transfers associated with the neurovascular acquisition integration.

Turning to cash flow. In the quarter, we generated cash flow from operations of $569 million, up significantly versus last year. Year-to-date, we have passed $1 billion in operating cash flow, an increase of 31% versus 2011.

And finally, in the third quarter, we repurchased approximately 350,000 shares of stock at a cost of $19 million. Year-to-date, we have repurchased 2.1 million shares and have spent $108 million to do so. We currently have open share repurchase authorizations totaling $595 million.

And with that, we will now open the call up to your questions.

Question-and-Answer Session

Operator

[Operator Instructions] Our first question comes from the line of Mike Weinstein, JPMorgan.

Michael N. Weinstein - JP Morgan Chase & Co, Research Division

Unfortunately, it's not the quarter you probably wanted to start off on. Let me ask you, first, just on the capital equipment side, and really, I think if we're -- if we're saying we're surprised by one side of the business, it's going to be more the U.S. Instruments and Endoscopy, even obviously, backing out the Neptune impact. So can you separate your view of what's going on in the U.S. versus what's going on in Europe? I think we've heard a number of reports this week, and I think we'll hear more about Europe, but it seems like both markets are weak, not just Europe.

Katherine A. Owen

Mike, I'm going to assume it's good to hear my voice too, but I’ll just -- maybe I'll just start with a couple of specifics and then I'll hand it over -- Kevin can take the European component. The Instruments piece, I would highlight we're continuing to see really nice growth for our System 7 heavy-duty power tool. The capital component there was a trend similar to the second quarter, it was up over 25%, but we were impacted by Neptune in the quarter, which reduced revenues associated with that recall by about $8 million in the third quarter, and we'll see another impact again here in the fourth quarter. And then on the endo piece, which also has about 40% of their revenue tied to capital, there wasn't -- we did launch the 1488 Camera late in the third quarter. That launch is underway. We did have some, I would call it relatively minor technical issues that we typically see manifest as volumes start to ramp. Those have been resolved. And given some of the improvements associated with that camera relative to the prior generation, we would expect to see accelerating growth there. But those were 2 of the out-of-the-norm of factors that did impact instruments in endo, specifically in the U.S.

Kevin A. Lobo

Yes, Mike, and certainly you're right, this is a -- certainly a challenging quarter in some respects, certainly a lot of other businesses were very healthy. As we mentioned, the U.S. businesses were very healthy. Last quarter, we talked about challenges in Europe and Japan. Those challenges continued in the third quarter. And we're seeing capital slowdowns occurring really, all over the world. So we really have a challenge in Europe that we have to address. We normally see September as a month where the sales will pick up. Even in Medical here in the U.S., we didn't see the kind of pickup we were anticipating. And certainly, in Europe, the normal pickup that we would have, that we had factored into our projections did not materialize. And so we're now assuming that this is a new normal, at least for the next little while. And that's the reason for our adjustment to the guidance for both 2012 and 2013.

Michael N. Weinstein - JP Morgan Chase & Co, Research Division

Okay. If I can step back, just one follow up here, just on the big picture with your taking over as CEO of the company, can you just spend a minute talking about where you would like to see the company focus its resources and its capital and how the strategy would evolve? What are your thoughts behind that? Surely you have some thoughts, and maybe just some preliminary ideas on how the direction that Stryker may shift a little bit now that you're at the helm?

Kevin A. Lobo

Well, thanks. Well first of all, I feel honored to be leading this great company. And let me start by saying that Stryker has a bright future, which we were able to share with many of you at the Analyst Meeting, the recent Analyst Meeting. Regarding our strategy, you should not expect significant changes to our overall strategy, which focuses on quality, innovation and cost, as well as a balanced approach to capital allocation. However, as mentioned in the Q3 results, we need to be much more aggressive in certain areas such as the European turnaround. And you can rest assured that focus on International is something that we will continue to drive, particularly in the emerging markets which we shared with you back in September. So I would say that the strategy's going to continue to evolve, but I would not be expecting any major shifts in our strategy.

Operator

Your next question is coming from the line of Bob Hopkins, Bank of America.

Robert A. Hopkins - BofA Merrill Lynch, Research Division

First question for me is I'd like to focus on International and specifically, Europe. Can you give us a sense as to the growth rate in Europe and how much that might have deteriorated this quarter versus last? And also comment, how much of Europe do you think is your own company-specific struggles versus a market slowdown in things like Hips, Knees or Trauma?

Kevin A. Lobo

Okay, thanks, Bob. What I would say is we pass in the second quarter, we experienced mid-single-digit declines in our sales in Europe. And I would say that it's a combination of the market being difficult, as well as our own problems, particularly in Southern Europe and also in Germany. So we have new management that's underway with a very clear plan going forward as we mentioned recently in September. This is something that's going to take multiple quarters before it gets fixed. It won't be resolved in one quarter. But I would say it's probably split evenly between market challenges and we are clearly losing some market share in Europe and as I had mentioned before, it's job one, is to get the European turnaround going.

Robert A. Hopkins - BofA Merrill Lynch, Research Division

Did it get worse in Q3?

Kevin A. Lobo

No, it stayed the same. It did not improve. We were anticipating some level of improvement; it did not improve. It was at same level as Q2.

Robert A. Hopkins - BofA Merrill Lynch, Research Division

Okay. And then, just one other quick follow-up is, one, can you give us a sense as to what kind of organic top line growth you might be assuming for 2013 in your guidance? And then, Dean, did I hear you correctly that on a same-day sales basis, organically you think you grew about 3.9% in the quarter versus 2.7%? And if that's right, what got better sequentially?

Dean H. Bergy

That is right, Bob. And I would say our -- in our U.S. franchises, and particularly our Reconstructive business, continued to have a very nice quarter. Knees, as you saw, did well. Trauma had a very nice quarter. So that's primarily where you're seeing that improvement.

Kevin A. Lobo

Just to address your first question, we are not giving specific guidance right now related to 2013 sales. We'll be doing that in January, as we customarily do. But you could assume that there won't be a significant change in our sales growth versus what we're experiencing right now.

Operator

The next question is coming from the line from Kristen Stewart from Deutsche Bank.

Kristen M. Stewart - Deutsche Bank AG, Research Division

Just a follow-up, I guess, to Bob's last question on the top line and I appreciate you don't want to give specifics, but I guess in light of capital equipment kind of flowing down here, I guess can you help us get comfortable as to why there wouldn't be a significant change? You're saying that Europe is going to take several quarters to kind of get back on track, and I guess it seems a risk, at least from how you're posing it, seems more on the downside for MedSurg. So should we read into this as greater confidence in Reconstruction next year? Or perhaps with some of the new products coming from the neuro side?

Katherine A. Owen

Yes, Kristen, I -- just to make sure we're clear on, for next year, although we're not giving top line guidance, what we're indicating around the bottom line and how it would be affected by the top line is, don't anticipate any real change relative. Right now we're at 2.5% to 4% full year targets for 2012. And I don't think anybody should anticipate anything meaningfully different from that when we do set our top line guidance next year. And that does assume that Europe, as Kevin mentioned, is going to take a little bit of time for us to turn that around and get back at, to the very least, market growth. While other segments of the business have been performing well, as we mentioned with exception of Medical, we saw positive growth for every one of our U.S. franchises. We got nice product launches underway for Neurovascular and some ones pending there as well. And then we also would assume that the 1488 Camera in the Endoscopy division starts to see better traction as we've worked through some of the initial glitches. But don't assume -- what we're trying to say is, the top line growth expectations we have, are going to be somewhat similar to what we're experiencing in 2012.

Kristen M. Stewart - Deutsche Bank AG, Research Division

Okay. The 2.5% to 4%, is that organic or is that just like a constant currency?

Katherine A. Owen

Yes. That is core underlying growth exclusive of impact from acquisitions and currency.

Operator

Your next question is coming from the line of Richard Newitter from Leerink Swann.

Richard Newitter - Leerink Swann LLC, Research Division

Just maybe, as you could talk a little bit about the range that you gave for 2013 on the EPS line. Can you maybe tell us where you see -- what factors you see getting you to the lower end? What has to happen? How much of it’s deterioration in the markets do we have to see in Europe? Is that a worst-case scenario in the U.S.? And what about the same thing on the upper end? And does the upper end factor in any potential share buybacks?

Kevin A. Lobo

I would say, right off the top that, that these ranges do not include any meaningful change in share buybacks. So the reason for the range really has to do with the uncertainty in the market conditions, both in Europe and with capital equipment, globally. So if we look at 9% to 12% before the excise tax, that's a pretty meaningful degree of earnings leverage if you consider Katherine's previous comment regarding what type of sales you should be expecting. With the mix of businesses that we have within Stryker, and the mix of geographies, the puts and takes between each one, I'm not really going to really speculate right now, but suffice to say that when we look at the overall landscape, we expect the growth rate in that, if you say, roughly around the 4% range, and you consider EPS growth in the 9% to 12% before the device tax, that's a significant degree of leverage, but it's not pushing us past the point where we'd start to compromise long-term investments. So I prefer to sort of keep at the macro level, because there always are moving parts in our businesses, and if we start narrowing it down, it'll kind of lose the picture.

Richard Newitter - Leerink Swann LLC, Research Division

Great. And then maybe just one follow-up on hip growth this quarter. I know you said that there was an impact from the product recall in your modular franchise, modular stem franchise. Can you quantify that for us in any particular way? And just maybe describe, what -- how you're having conversations with customers there? Is it just more difficult to get them to switch to other non-modular stem products?

Kevin A. Lobo

Yes. So what I'd say is, you have to remember that, especially the U.S., we've been the leading growth company in the hip business for probably 7 or 8 quarters. So if you look at our comps versus our competition, we had much more difficult comps this quarter for Hips. Certainly, it was a modest impact related to -- switching for a customer is always a little bit challenging. The majority of our customers had switched to one of our other stems, a nonmodular stem. We have had a couple of customers express concern. There certainly was a bit of disruption from their day-to-day activity of surgery as they had to contact patients and receive calls. So it was a quarter that had a modest impact, but I would say the bigger issue was really the comps. And certainly, our customers have continued to be pretty loyal, and we've been able to ship, for the most part, all of our customers to other stems within our portfolio.

Operator

Your next question is coming from the line of Matt Miksic from Piper Jaffray.

Matthew S. Miksic - Piper Jaffray Companies, Research Division

One follow-up, I guess for Kevin, your comments on the International growth, understanding that'll take more than a couple of quarters to resolve, but I don't know if you commented on timing or the duration of the kind of challenges you're seeing on the capital side, in general, for MedSurg or Medical. If you could maybe talk a little bit about what you're seeing there in the U.S., what specifically has gotten worse. And then maybe your confidence in turning the camera issues, the glitches that you mentioned, Katherine, around in the next -- is that a quarter, is that a couple of quarters, some color on that would be helpful. And I have one follow-up.

Katherine A. Owen

Yes, thanks, Matt. So as it relates to the 1488 Camera and the issues we saw, those have largely now been resolved. Now as I mentioned, we've got some great improvements with this camera. The image is 52% brighter, there's 33% more lines of visualization. So the image here is terrific, and we've normally seen, when we launch a brand-new camera, these early glitches that honestly, are just not readily apparent until you get them out in the field and the volumes ramp. So that issue has been resolved, and we would expect to see the normal pattern as it relates to the ramp-up for a new camera. Within Instruments, you're aware we have the Neptune recall, and that will take us some time as we work through with the FDA to resolve that issue, and that will impact a portion of their capital business, probably about $25 million revenue impact in the fourth quarter, and we would expect to have that 510(K) clearance sometime in 2013. So those are some very product-specific issues that we can put our arms roughly around a time frame for resolution. The other component, as it relates to Medical on both a U.S. and a global basis. And it's not that we're seeing a return to what happened in '09, where we saw significant percent of hospitals go into either a frost or a freeze mode, but we are seeing capital decisions take longer. They are being scrutinized more heavily and are requiring more approvals within a hospital. We're also seeing smaller hospital capital budgets, and also some anecdotal evidence of continued focus on IT spending, which we had highlighted earlier in the year. That segment is probably the one that's the most difficult to predict and is part of our more cautious stance as it relates to the top line. So whether or not that gets resolved in a quarter or 2 or lingers into 2013, I think it's just an uncertainty right now.

Robert A. Hopkins - BofA Merrill Lynch, Research Division

And the reason for that, just to -- anything bubbling up in the channel, the reasons for those cuts or lengthening purchasing cycles?

Katherine A. Owen

It's -- a lot of this has to do with the hospitals are finding themselves concerned about reimbursement cuts and their overall financial health as healthcare reform plays out. And that's still a black box for a lot of us. So until we see some of the impact of the Affordable Care Act, we are seeing some more cautious stance by our hospital customers.

Matthew S. Miksic - Piper Jaffray Companies, Research Division

And then one question on the actions you're taking overseas and the -- you understand that's going to take a little bit longer, weighing on your European business, say on the recon side. The one surprise I guess, you mentioned the modular hip on the U.S. Hip side having an impact. But it was a little bit of a bigger dip than we would've expected, given the size of that modular hip in your franchise. Is that -- was there anything else that happened here in the third quarter, anything in terms of seasonality or pricing or competition that you could call out as having an impact on Hips?

Kevin A. Lobo

Well yes, let me just go back and say of the 3 factors that really affect the growth rate that you're looking at, I would say that the -- if you look at the first impact, it's really just one less day. So it does make a difference if you look at the average daily sales rate, we had one less day in the quarter, that's probably the biggest, or at least one of the biggest impacts. The second impact, which we'd mentioned earlier in our statements was the comps, and I think that probably is the biggest item.

And then the last one is the modular impact. Because you're right, it's not a huge percent of our sales, but it did cause some disruption at the customer interface. But we had very, very strong comps in the prior quarter. We had one less day. So if you look at our Knee business, as well, with one less day, you can see that, that was very strong performance. But certainly we are not concerned about our hip business. Our Accolade II stem is launched and is gaining traction. So we really feel very good about our hip business and it's been a run that we've been in on quite some time. It is a little bit of a dip in the overall growth rate, but not something that we're concerned with.

Operator

Your next question is coming from the line of Matt Taylor from Barclays.

Matthew Taylor - Barclays Capital, Research Division

I wanted to see if you could go into a little bit more depth on Europe. I know we touched on this, but you mentioned the changes in leadership distribution. But can you maybe go into some of the specific changes and talk about what gives you confidence that you're going to be able to turn things around there? And sort of what the timing or the shape of the curve would be over the next couple of quarters?

Kevin A. Lobo

Well, Europe, we have 2 problems, right? So with the first problem we have is a top line problem, where we're not going as fast as the market. It's obviously a different market, but we're not growing as fast as the market. So we really need to address Southern Europe and as I mentioned in Germany, we're looking at different distribution approaches there. It's not something I'm really ready to comment on just yet. But the team has a very active action plan related to recovery on the top line. And the secondary we have to look at is our cost structure. So obviously, in the light of this changing marketplace, we're going to be taking more aggressive action related to back office and other areas in Europe. So those -- it's a two-pronged strategy as I mentioned, I think twice already. It’s the #1 focus is really getting Europe turned around. At this point, I'm not really ready to go into more specifics regarding that.

Matthew Taylor - Barclays Capital, Research Division

Okay. That sort of ties into your broader theme, where you talk about leverage and investments and lowering the earnings guidance, I wanted to understand, in terms of the leverage that you're talking about in the earnings versus top line, how much of that is in the P&L versus share buyback? And then have things changed in your mind over the last few months with regards to a weaker environment, changing how you think about investing or the cost structure, maybe you could talk a little bit about that?

Kevin A. Lobo

Well, if you look at the degree of leverage, clearly, the sales expectations are now below what we were initially planning on. And the degree of leverage that we talked before device tax of 9% to 12% earnings growth off of a lower sales base of, let's say, in that kind of 4% range, that's a healthy degree of leverage. If we push the leverage beyond that, then we're going to be looking at curtailing investments. And there are a very robust pipeline of R&D investments that I'm really not wanting to compromise. We're continuing to invest in some dedicated sales forces in fast-growing markets. I'll give you one example, our foot and ankle business unit in the United States grew 27% in the third quarter. It was part of that contributor to the great trauma and extremities results in the U.S. So we have very, very fast-growing business that we need to continue to feed. And even outside the U.S., if you look at emerging markets, we continue to have robust growth. And as we mentioned in the Analyst Call in September, we plan to increase those investments in 2013. So being able to make key investments while still delivering a leveraged P&L is really the plan going forward. It's a plan that will sustain us for the next few years. And if we push our leverage too far, which really is if you look at 10% before the device tax, it's closer to 15%. On the kind of sales growth we're achieving now, that's a very high degree of leverage and something that I think could compromise our long-term growth prospects.

Operator

Your next question is coming from the line of Dave Turkaly, JMP Securities.

David L. Turkaly - JMP Securities LLC, Research Division

Back over to the hips for a sec, could you comment on the mobile bearing side of your franchise. I know that's been growing well. Did that grow well in the quarter? And could you give us potentially a ballpark estimate of what that is of your mix today?

Kevin A. Lobo

Yes, mobile hip business represents -- the mobile hip -- the total cups is roughly 22%. It continues to grow well and it's -- those are used in both revision and primary procedures. So that percentage has been creeping up and it's continuing to be a very successful product. There's actually a lot of competitors that are now entering at the mobile bearing category, which is great news for us, which is an indicator that this is going to be a good market for the future. Our field really was more focused on Accolade in the last quarter, which is really gaining traction very quickly and is now, I believe, the #1 stem in the United States. So it grew extremely fast. So that's really where there's been a little bit more focused. We'll get the balance back right going forward in both the stem and the cup will be a great combination.

Operator

Your next question is coming from the line of Jason Wittes, Brean Capital.

Jason Wittes - Brean Murray, Carret & Co., LLC, Research Division

So just wanted to ask on the comps for Recon. I get what you're saying about MedSurg in terms of the visibility being challenged, also about Europe. But I also look at the recon comps and they definitely will be tougher next year, especially in the U.S. Should we be factoring that into our models? And what drivers are there left for next year to offset some of those tougher comps?

Katherine A. Owen

Yes. We're not going to get into specifics in terms of the components of top line growth for next year and we're not really giving a specific guidance, other than to say it's probably not that dissimilar for this year. We are seeing some good momentum in the U.S. on the knee side. A lot of that is tied to our GetAroundKnee campaign. And we indicated we'll continue to evaluate whether we'll maintain that program depending on the traction we're seeing. But right now, we're pretty pleased with the early uptake. And on the hip side, we also see some pretty good momentum, recognizing the difficult comps we saw this quarter and also adjusting for one less selling day. I think we are seeing more normalized growth rates as the market starts to get back to something that approximate underlying growth in that mid-single -- low to mid-single digits range and there's no real reason we would expect a big change next year, nor are we expecting a bolus of patient to represent. But beyond that, I'm not going to get into too many specifics about the key segments and what the assumptions are behind 2013 growth.

Jason Wittes - Brean Murray, Carret & Co., LLC, Research Division

Okay, then just a quick housekeeping follow-up question on Neptune. Did you say $16 million or $25 million? And I guess you're also saying that in terms of when that gets back on the market, and that would be the impact for the last quarter, and in terms of the impact -- in terms of when it gets back on the market, you don't have great visibility. But I assume -- it's fair to assume, sometime in 2013, that it would get back in the market?

Katherine A. Owen

Yes. We're working with the FDA right now regarding the 510(K) clearance requirements and I would assume, right now, it's difficult to predict with the FDA exact timing, but we would say sometime in 2013. I apologize; I did say $25 million for the fourth quarter, that's the full H2 effect. So you're looking around $8 million in the third quarter and something closer to $16 million or so revenue impact in the fourth quarter. And that would fall within the Instruments line.

Operator

Your next question is coming from the line of David Lewis, Morgan Stanley.

David R. Lewis - Morgan Stanley, Research Division

Kevin, I just want come back to, it sounds like based on your preamble remarks that the reason to cut 2013 guidance is more about the need to invest and maybe less about a material change in the environment. I guess the question we've gotten from a lot of investors this evenings is, did you have enough time to sort of evaluate all the various investments that you stated that you may need to make in a matter of weeks to sort of feel comfortable that, that guidance range for '13 sort of captures what you want to accomplish for investors long term?

Kevin A. Lobo

Yes. Well, first I would say is that, I'm not an outsider that wasn't part of Stryker. So clearly, my view changes as I move into the CEO chair, but I certainly was well aware of the environment that we are under. September was a big surprise. So the sales uptick that we were expecting September didn't materialize. And when we project that forward when we look at what these trends are, it really caused for rebalancing. But I certainly wasn't starting from standing start. I was, obviously, involved in the company, understood the strategy and we really need to maintain our investments. We really want long-term growth. And when I looked at the actual degree of leverage that would require -- you guys do this math all the time. If you look at that sort of 4% top line and you try to deliver something that's 15% on the bottom line, that's going to come at a cost and that cost will be investments. And so even though it's been only 2.5 weeks, it has been sufficient time and this has been, frankly, a key focus of my first beginning in this job, was really making sure we did our best to set a clear path for the future. And certainly, anticipating that this call was coming, it became the top priority. I have the luxury of having Dean here. So in terms of replacing some of the open positions, I can take some time. Curt's been a great help in my early days as well. So I do want to let you know this has been something that, as a team, we have worked on very thoroughly. It's been -- it was obviously, a great deal of thought was put into it, but it's something we feel very confident about for the years ahead.

David R. Lewis - Morgan Stanley, Research Division

And then just maybe Kevin, a [indiscernible] on your remarks about Surpass. It has been a view that competitive flow diverter products have resulted in sort of pull-through on the coiling side, you've been pretty adamant that you are growing at the market rate, I think the last quarter. So maybe help us understand, are we still growing at the market rate on the coiling side? And in this window before you can get a flow diverter on the market, do you still think you can continue to grow at market heading in next year?

Katherine A. Owen

Thanks, David. Actually, our coil business has been growing above market and that has been driven by the launch of our new Target coil, which we've seen some great uptake and then we followed it on with the nanocoils. So in terms of our market share gains, we've been above market. But at the same time, the coil market has been impacted by the launch of competitive flow diversion stents, which are probably around 15% of that total coil market. Some of that is new procedures, some of that does help coils, but there is also some cannibalization. So really pleased with the uptake for the coils, but this was an important part of component to fully round out our bag, and really allow us to demonstrate that commitment to having a full bag that addresses both hemorrhagic and ischemic.

Operator

Your next question is coming from the line of Raj Denhoy from Jefferies.

Raj Denhoy - Jefferies & Company, Inc., Research Division

Wonder if I could ask a bit about the spine business. I think you posted about 2% in the quarter, if I’m reading it correctly. There's been a lot of talk about pressures in the spine market, perhaps intensifying it again in terms of PODs and insurance push-back. Do you have any general comments on how the spine business is fairing?

Katherine A. Owen

Yes. We haven't seen any really meaningful change, and I've read some of the commentary about PODs. They're obviously still there and we still see some surgeons switching over, but there's been no meaningful change in either the push-back from payers who are looking for more clinical data or the impact we've seen from PODs. So from our perspective, the market's been relatively unchanged versus what we saw in the prior quarter and that includes negative pricing pressure. We are benefiting from the broadened bag that we realized with the 2011 acquisition of Orthovita and getting a biologic there and some of the pull-through we've been able to realize, but I wouldn't say we've seen a meaningful change in the backdrop in the spine market.

Raj Denhoy - Jefferies & Company, Inc., Research Division

Okay. And then maybe just on the U.S. Knee business. You mentioned a couple of times that you are seeing some nice results from your advertising campaign. I know it's still early days, but have you given any thoughts to what that means broadly, whether that's something you want to explore further as a company, perhaps a real change in the way that you sort of do business here with these product?

Kevin A. Lobo

Yes, this is certainly the first one where we've been broad scale in terms of direct-to-consumer. I think, the consumer will continue to be very important. And as I mentioned in the September Analyst Meeting, we are focused very much on power brands. Knee is certainly more elective than hip. The hip marketing team is thinking about whether the communication direct-to-patient would make sense. We have no plans as of yet. Certainly, it makes more sense with knee being a more elective procedure. But it's something for the future that we're certainly interested in and we're going to continue to explore.

Operator

Your next question is coming from the line of Bruce Nudell, Crédit Suisse.

Bruce M. Nudell - Crédit Suisse AG, Research Division

Kevin, in your discussions with the board, as this process progressed, could you share kind of the top line and bottom line expectations for company performance over the midterm?

Kevin A. Lobo

Well, I think we were pretty clear about the guidance, at least as it relates to the end of this year and into next year. My discussions with the board have been very good. We expect Stryker to continue to be a high performance company, with performance at the high-end of the medtech sector. Beyond that, I'm not really going to get into long-term numbers and what that means. But don't misread this change in guidance as us changing, in anyway, our focus on being a high-performance organization, focused on innovation, quality and cost.

Bruce M. Nudell - Crédit Suisse AG, Research Division

And I guess a follow-up to that, now that you've taken over the reins, could you share your view of given where you think the major joint market is going in the more kind of conventional segments of orthopedics, do you feel that the company needs to diversify more into kind of science-based endeavors such as neurovascular, where it's more the PMA process, but maybe higher risk but higher reward?

Kevin A. Lobo

Well, let me go back to the comment I made, I think, early on, which is our core strategy really is not going to change fundamentally. So, in fact, at the Analyst Meeting and Katherine laid out a very clear picture of our BD approach, where we're really looking at our core markets and adjacent markets as being priorities to fill out our portfolio. Long term, we love being in the ortho space. The demographics are clearly very favorable. It's a very competitive market, but we've been winning in this market. Clearly, there are some countries in the world where have work to do. But overall we've been winning and we're clearly a major player and intend to remain, and we're very happy to be in that market. But again, don't expect any major strategic shifts, at least not in the short term. And as our strategy continues to evolve, we will keep you posted.

Operator

Your next question is coming from the line of Rajeev Jashnani, UBS.

Rajeev Jashnani - UBS Investment Bank, Research Division

Some of the concerns we heard over the past few weeks just relate to ability to hold together the management team and defections. Kevin, I was wondering, maybe you could comment on what your plans are in that regard, whether it's bringing in additional folks you may have worked with in the past or how should we expect the senior leadership team to transition or stay relative to what we see today?

Kevin A. Lobo

Well, first of all, as you all know, we have an outstanding management team at Stryker. We have a deep bench at Stryker. Clearly, having somebody like Dean, as I mentioned earlier, helps really to stabilize. We have a very strong finance organization, but having Dean, as somebody who has the history, is -- the Secretary of the board, as well, on the team, is a very stabilizing force. The orthopedic business, obviously, I'll be looking to name a replacement there. Both the CFO and the group orthopedic role, we're going to be looking at both external and internal candidates. It's not something I feel a big rush to name a replacement. If I find somebody and the right person quickly, I'll move. But there's no big hurry. As you saw, our U.S. orthopedic business is performing very well and has been all year, and has a very strong management team. So, as it relates to defections, we have a very, very good management team. It's not something that I'm very concerned about, at least not in the short term.

Operator

Your next question is coming from the line of Joanne Wuensch, BMO Capital Markets.

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

Could you please comment on price and volumes as it relates to your hip and your knee franchise in the last quarter.

Katherine A. Owen

Yes, Joanne, we break out the pricing as it relates to the 3 main business segments: Reconstructive, MedSurg and Neurotech & Spine. And that detail is in the press release. We don't specifically break out hip and knee pricing, and it is still net-net negative, but we have been seeing a modestly improving trend with a nice mix component, particularly on the hip side. So net-net, still modestly negative, but consistent with some of the general area that we've been in.

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

Okay. You talked about September being a big surprise. How much of that is market related and how much of that is Stryker related?

Katherine A. Owen

Well, the big surprise really was specific or more highlighted towards some of our International businesses, as well as some of our more capital-intensive business, where we expected a stronger acceleration in growth than we realized. And I think we'd point back to some of that as the markets, clearly, as we've seen in the news, the European markets remain challenged, but also some of that is clearly Stryker-specific. So call it 50-50, half market, half us.

Kevin A. Lobo

Yes, at least for the International. As it relates to capital, it's really more of the market than it is us losing any kind of share.

Operator

Your next question is from the line of Michael Matson, Mizuho Securities U.S.A.

Michael Matson - Mizuho Securities USA Inc., Research Division

Yes, so I guess just with regard to your new focus on the International markets, Kevin, Stryker, as you talked about at the Analyst Day is a bit underexposed to some of the emerging markets relative to some of the other larger medtech companies. And I'm just wondering if that's going to be a big focus early on? Or if you're really more focused on trying to fix Europe and Japan and sort of triaging and not as focused on building out the emerging markets at this point?

Kevin A. Lobo

Well, obviously, Stryker's a vast company and we need to focus on multiple areas. I would say the more urgent or pressing problem is Europe. But emerging markets we represent, that would be roughly 6% of our sales in emerging markets, which is clearly lower than what we would like to be. So I wouldn't say it's one or the other, I think we're going to focus on both. But clearly, Europe's turnaround is more pressing in importance.

Michael Matson - Mizuho Securities USA Inc., Research Division

Okay. And then I just wanted to ask the inevitable question on your use of cash. I understand you've laid this out at the -- not you, but the prior CEO, laid this out at the Investor Day, but it seems like we're kind of hitting the reset button here. So, just wondering, would you be willing to increase your dividend in the future at a greater rate than you've done in the past, just to give -- given the really strong cash flow that we saw this quarter?

Katherine A. Owen

Yes. I would -- just some comments from here, and as you know, our capital allocation has really been focused on using our cash for M&A as evidenced by the most recent deal with Surpass, announced yesterday, buybacks and dividends. And really, if you look back, since 2009, we've announced 10 acquisitions and that includes Surpass. We've also have been investing significantly in our dividend. It's grown at a compound rate of roughly 40% since 2006. And since '08, we've repurchased roughly 2 billion of shares. So we like this balanced approach to capital allocation and we're really not trying to signal a reset here as it relates to that. There may be more or less of one in any given quarter, recognizing that we've been increasing the dividend rate at a fairly consistent clip above the level of earnings growth.

Kevin A. Lobo

The other thing I'd like to add is as you saw in our guidance, we're not talking about buybacks as part of our guidance, I really would like to decouple kind of EPS and underlying performance from whether we decide to do more or less share buybacks in the future.

Operator

Your next question is coming from the line of Matthew O'Brien, William Blair.

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

Kevin, I was just curious and, Katherine, back when you bought Boston Scientific's Neurovascular business, you mentioned or you told everybody, hey, we're going to be growing below market rates for a while, but we anticipate getting back to the market level in 18 to 24 months and now you've done that. And so, when we think about Europe and the investments that you have to make there, would you be disappointed, second half of next year, if you're not back to market rates? Or is that more of a 2014 event, more back to the market rates in Europe?

Katherine A. Owen

Yes, I'm not sure we can necessarily triangulate some of the objectives we've set out with Neurovascular to some of the action plans that we have underway. In Europe, Neurovascular was really tied to some product launches and some other initiatives. I think at this point as we alluded to in our commentary, this is a very big priority for us both in accelerating the top line and addressing the cost structure, that we're not going to resolve in a quarter or 2. I think right now, especially given the state of flux in some of those European market, it's probably a little bit premature to start pinpointing exactly when we would expect to be back to that level of market growth or exactly what level of growth would look like in 2014.

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

Okay. And then just a follow-up question and correct me if I heard this wrong, but it sounded like in spine your commentary about a growth in the quarter, while still under pressure, is a little bit better than we saw in Q2. I think you said down low-single digits versus kind of 5% to 6%, historically. First of all, is that right? And then secondly, if that's true, is it volume related or is it product [ph] specific related?

Katherine A. Owen

Our premise were really intended to indicate that we weren't seeing a really meaningful change as it's related to the overall market, either from the impact of PODs or some of the pushback that we were seeing from payers.

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

Okay. But your business, specifically, it sounds like it got a little bit better, so it's really more Stryker-specific than anything else?

Katherine A. Owen

Core Spine, modestly better, but honestly, it's not enough that we would signal a real change in the trend. We have been seeing some very good growth in some of our more interventional-based spine products in our Neuro, Spine, ENT. It's more that core Spine business that, on the margin, a little bit better, but not enough to talk about a reversal of trends or really being out there doing something dramatically ahead of market growth.

Operator

Your next question is from the line of Larry Biegelsen, Wells Fargo.

Lawrence Biegelsen - Wells Fargo Securities, LLC, Research Division

Kevin, 2 questions. First on pricing and recon, it looks like it did get significantly better from negative 2.4% to negative 1.4% this quarter. Why the improvement? Or where was it?

Tony M. McKinney

This is Tony McKinney. I've just chime in. Really, we saw relatively good improvement across all of our recon lines. We've had a nice stable trend and it's been modestly improving here quarter-over-quarter. So it's really across each of the lines.

Kevin A. Lobo

Yes, and I think at the marketplace, you'll be hearing from the rest of our competitors and there is a sign that pricing is moderating. It's a trend, frankly, we've seen for the last 2 quarters. That trend continued this quarter. It is a good sign for the overall recon markets, certainly in the United States.

Lawrence Biegelsen - Wells Fargo Securities, LLC, Research Division

And then lastly, for me, I'm trying to reconcile the acceleration in the growth per selling day in the third quarter, the 3.9%, versus I think you said 2.9% in the second quarter and what you saw in September, and what that means for the fourth quarter? In other words, sales per day accelerated the growth to 3.9%. Is that -- how do feel about that acceleration going into the fourth quarter?

Katherine A. Owen

Yes, when we gave the guidance range of 2.5% to 4%, which is underlying growth. In the fourth quarter, in terms of extra selling day, we have 1 extra selling day, so that will, obviously, impact the math as it relates to the core growth. And on an adjusted basis, on adjusted daily sales basis, we were very pleased with our U.S. performance. As we mentioned the exception of Medical, every franchise was in positive territory. The comments that related to not seeing as much of an acceleration in the month of September was more specific to certain International geographies and some of our more capital-intensive businesses. And I would just note, those capital businesses tend to have less of an impact as it relates to an adjusted average daily sales, just given the nature of those products.

Operator

Your next question from Jeff Johnson, Robert Baird.

Jeffrey D. Johnson - Robert W. Baird & Co. Incorporated, Research Division

Katherine, just following up on your International point around the MedSurg side of the business. That business was up 7.5% constant currency. A big part of that was, obviously, Medical. Just wondering was there something onetime in the Medical that we should be looking to back out or nonrecurring to think about that Medical business, or I'm sorry, the whole MedSurg business is really trending in international markets at this point?

Katherine A. Owen

No. I would just note that the medical base outside the U.S. is small, so you are seeing the impact from just a lot of small numbers. The comments we made about pressure on capital budget, that's really not just specific to the U.S. It's a global comment.

Jeffrey D. Johnson - Robert W. Baird & Co. Incorporated, Research Division

Okay. Dean, just one or no, I guess it's Kevin, for you, a question just on the foot and ankle business, you talk about that being up there nicely in the U.S. this quarter, adding some sales rep there, not wanting to cut back on the sales rep investments then, just wondering how you're thinking about product portfolio in foot and ankle, do you need to add products to that portfolio as you add sales rep as well?

Dean H. Bergy

We actually have a great product portfolio. We had existing products within our Trauma business and then we combine those with the Memometal acquisition, which we did the middle of last year, as a very, very complete. We don't have a total ankle. But to be honest, it's not holding us back whatsoever. Something that we're looking, but not something that we feel we absolutely need. So that would be the only product gap that I could point to. But if you look at 27% growth, roughly $20 million of sales in the quarter, so you can see that we're actually not that far from the market leader, Wright Medical, and something that I don't think people really fully appreciate. And we've just made this decision at the beginning of the year to focus on foot and ankle and it's really paying dividends. So we have a great product portfolio. The Memometal acquisition gives us a pipeline, as well as new products. So we don't really feel we need anything to take market leadership within a reasonably short period of time.

Operator

Your next question is from the line of Steven Lichtman, Oppenheimer.

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

First question, Kevin, as you talk about the investments for next year and those that you want to retain, how should we be thinking of them. Are they, primarily an R&D? Is it targeted sales force investment? Or is it really keeping that U.S. cash, the powder dry there in case of a potential M&A?

Kevin A. Lobo

No, I would say one of the -- it's not because we want to keep the U.S. cash powder dry. We have a capital structure that's pretty flexible and we can do things. So that would not be one of the reasons. What I would say and I'll go back to the examples I think I may have mentioned, it’s a combination. It's pipeline and R&D pipeline as a part of it. Selective investments in sales forces in fast-growing spaces. So that would be a second piece. So it's really just -- it's a combination of making sure we preserve those kind of investments going forward.

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

Okay. And then Katherine, I know there's a lot of noise in the Instruments line with Neptune, but can you talk about the powdered instrument rollout, the new line, is that fully out? How is that progressing? And is there any sort of cooling off in expectations based on some of your capital expense comments?

Katherine A. Owen

No. Within Instruments, they had a great performance again this quarter with the System 7 power tool that we've launched late last year. We had another quarter where the heavy-duty power tool capital component in the third quarter was up over 25%, that's consistent with the levels we saw in the second quarter. It really is indicative of the benefits of that new product offering. Remember, we have got 30 years of innovation history in power tools. This has a smaller battery, lighter weight, and some other terrific performance features that are -- we're really able to leverage to a considerably vast sales and distribution presence. So very pleased with that, but the issues with Neptune did mask some of that growth as it adversely impacted total Instruments, but we feel really good about the rollout and the traction Instruments are seeing with the power tools.

Operator

Your next question is from the line of Bill Plovanic, Cannacord.

William J. Plovanic - Canaccord Genuity, Research Division

Just I've had some people ask, as we look in Q4 and especially on the capital good side, with the medtech tax coming to play, do you see any buy in as we head through Q4 into Q1 potential in any of the businesses?

Katherine A. Owen

No, I wouldn't say that's what we're anticipating. Our fourth quarter sales tend to be heaviest for capital, that's just reflective of the nature of hospital capital budgets and that's a trend we see regardless of what's going on with the broader government actions and the tax, but we're not anticipating any real change associated with that.

William J. Plovanic - Canaccord Genuity, Research Division

And then secondly, just on SG&A, I think the spend was a little higher, you mentioned September caught you off guard. Is that something you adjust as you go into Q4 or is it something you wait to see how October and November go before any final adjustments are made?

Kevin A. Lobo

Yes. So first of all, it didn't really catch us off guard. The year-over-year increase, I think Dean mentioned, really had to do with that onetime event that occurred last year. So it was very similar level of spending as we had in the second quarter. So it wasn't that we are caught off guard. Where we missed was on the top line. So the spending was kind of to plan the top line miss. So as a result, clearly, we are and I'd mentioned, I think, a couple of times, in certain countries, we certainly are going to look at our spending and make some actions and start some action in the fourth quarter.

Operator

We have time for one final question. The final question is from the line of David Roman, Goldman Sachs.

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

Just I wanted to ask 2 questions: one strategic and one on the P&L. The first one is as you think about the M&A strategy and the company starts to get bigger and bigger, what point do you kind of worry that it becomes somewhat unwielding [ph] from a management perspective, particularly if you look at other examples across medical devices, bigger has not proven to always be better. So if you look at some of the operational missteps, obviously, in like Europe and things like that, to what extent can you -- does it get harder to control things like that as the company gets bigger?

Kevin A. Lobo

Well, I really don't think our missteps have anything to do with company size. So if you look at our business in Europe, we've been having some challenges. They're really more to do with what I'll call the basics: management, leadership and basics. Making sure we stay close to the customer and don't get distracted. So I really don't believe it has to do with size. If you look at our acquisition strategy, it's really core and adjacent markets, which allows us to really be masters of certain service lines. If you look at the orthopedic service line, we are deeper in that service line than even a broad company like Johnson & Johnson. If you look at neuro now, we're rounding out that portfolio, and we're going to be very, very deep in the neuro space. So it's not that we're acquiring companies that are far field from who we are and the formula that we have to win really applies very well across this. So it's not a size issue. I'm not making any excuses. We have to improve our performance, but this situation outside the U.S. has been, frankly, going on for a little longer than any of us would like and it's something that we are going to address as job one.

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

And then on the P&L, and if I look at the gross margin line, since 2010, you're obviously down, I think, kind of 80 basis points or so on an adjusted basis, if you just look at this quarter or even year-to-date. But it looks like some of the higher-margin businesses like knees, Neurovascular, Trauma tend to be doing better. Is there -- maybe what's going on the gross margin line that's dragged it down in the context of favorable mix? I mean, you said that pricing has been pretty stable and, in fact, getting better? And is that, therefore, an opportunity going forward that something you can improve upon?

Katherine A. Owen

Yes. I would point to some of our prior comments that are associated with some of the acquisitions that we've made and the investments in our GQ [ph] and our own quality overall. So those are 2 big buckets. Recall that we have done 10 deals, if you include Surpass, 9, obviously, excluding that since 2009. We've had to make investments as we look to transition those to our quality systems and some of that has impacted the gross margin line. And we've also talked about initiatives underway through Looney Carpenter and his broader organization in Global Quality and Ops that we anticipate will drive about $500 million of cost savings between '12 and 2017, but we've had to make investments there and that has impacted the quarter in some periods, gross margin, in some periods, we've opted to make those investments. So those are probably 2 of the big factors, along with the normal noise you hear with foreign-currency, et cetera.

Operator

At this time, I would like to turn the conference over to Mr. Kevin Lobo for any closing remarks.

Kevin A. Lobo

So thank you, all, for joining our call. I look forward to beginning to meet with you in the months ahead. Our conference call for the fourth quarter 2012 results will be held on January 23, 2013. Thank you.

Operator

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

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