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No. of Recommendations: 7
Stryker is probably my favorite of the ortho companies right now. They are slightly more diversified than ZMH but not as many segments as SNN.

Stryker has two reportable business segments: Orthopaedic Implants and MedSurg Equipment.

Orthopaedic Implants sells reconstructive (hip, knee, and shoulder), trauma, spinal and craniomaxillofacial implant systems; bone cement; and the bone growth factor OP-1.

MedSurg sells surgical equipment; surgical navigation systems; endoscopic, communications, and digital imaging systems; as well as patient handling and emergency medical equipment.

Implants are used in joint replacement, trauma, craniomaxillofacial and spinal surgeries; bone cement; and the bone growth factor OP-1.

Artificial joints are made of cobalt chromium, titanium alloys, ceramics or ultrahigh molecular weight polyethylene

OP-1 bone growth factor, which induces the formation of new bone when implanted into bone, is composed of recombinant human OP-1 and a bioresorbable collagen matrix.

Minimally Invasive Surgery

Some reconstructive implants are suited to minimally invasive surgery (MIS) procedures that are intended to reduce soft-tissue damage and pain while hastening return to function. Stryker supplies technology, procedural development and specialized instrumentation

The company also has developed instrumentation for MIS total joint procedures. Its surgical navigation systems are used in MIS procedures to improve the accuracy of measurements and to position the implant.

Orthobiologics

This is a fairly good portfolio of products and broader than competitors. The OP 1 is the subject of potential legal action as the company is being investigated for use outside its current approval. It is difficult to know what the fine/action will be if any. Should not be severe imo

In 2008 the Company and certain current and former employees received subpoenas from the U.S. Department of Justice Office, Criminal Division, of the United States Attorney in Massachusetts requesting documents related to (i) false Institutional Review Board approvals; (ii) the amount of sales of OP-1 under the Humanitarian Device Exemption; and (iii) the off-label promotion of Calstrux in combination with OP-1. The Company is in the process of responding to the U.S. Department of Justice regarding this matter

The product portfolio includes

OP-1, a proprietary, recombinant version of a signaling protein with multiple tissue regeneration properties

TissueMend, a single-layer acellular collagen matrix that handles and delivers both strength and documented remodeling capability

Hydroset, the product used in bone substitute technology, which is injectible, sculptable and fast setting

BoneSource BVF, an osteoconductive bone substitute with biocompatibility and mechanical stability

BoneSave, a granules-based alternative to conventional bone grafting.

Hip Implant Systems

Just a list to show how much product they have.

• ABG Hip System,
• Partnership Hip System,
• Secur-Fit Hip System,
• Omnifit Hip System,
• Accolade Hip System
• Restoration Hip System

Systems of hip for primary and revision procedures

The Exeter Total Hip System is based on a collarless, highly polished, double-tapered femoral design that reduces shear stresses and increases compression at the cement/bone interface.

Restoration Modular Revision Hip System offers surgeons performing revision surgeries flexibility in treating complex hip stem revisions and restoring patient biomechanics.

Cormet Hip Resurfacing System spares tissue and is for less severe joint destruction. Stryker has a marketing and distribution agreement with Corin Group for the product. A good strategy for them in an emerging therapy

And there are a few more

First Post-FDA Approved Stryker Cormet™ Hip Resurfacing Procedure Performed

http://www.ryortho.com/NEWSSHORTS/volume3/issue35/11-07-07-N...

By Walter Eisner November 7, 2007

Orville Todd is the first person in the U.S. to undergo Stryker's Cormet Hip Resurfacing procedure since the FDA approved the procedure last summer. __The procedure was performed by Richard A. Conn, M.D., an orthopedic surgeon with Southern Bone & Joint Specialists in Hattiesburg, Mississippi. __

Todd, 60, said, “I had hip pain for about five years, and it just kept getting worse. Finally it got to the point where I couldn't stand it anymore. It made my job difficult—the longer the day went, the more I'd hurt." Since the surgery, Todd says, "I can do most anything now. Knowing what I know now, I would have gone in for this three years ago. It seems like it's going to be a long-term solution for me." _

_Hip resurfacing gives the more than 43 million Americans suffering from arthritis an alternative to total hip replacement.__Since performing the first procedure with the Cormet Hip Resurfacing System, Dr. Conn has used the system on an additional 10 patients.

“Our patients’ results have been really strong, which makes for very satisfied patients and a very pleased physician,” said Conn.

Dr. Conn trained with the surgeons who designed the Cormet Hip Resurfacing System in England, and he is a member of the surgeon-training group for the Cormet Hip, having trained more than 40 physicians from across the country on how to select the appropriate patient for this procedure and how to perform the procedure. __

Stryker is the first company to give Smith & Nephew's Birmingham Hip™ Resurfacing System some competition in the U.S. marketplace.


Knee Implant Systems

Stryker five major knee implant systems with each line having several models that address specific needs and problems

• Duracon
• EIUS
• Global Modular Replacement System
• Scorpio
• Triathlon

Other Joint Replacement Products

Again Stryker has a good sized porfolio

Other products:

Principally shoulder and elbow implants and related instruments

Solar Total Shoulder System provides a design for the humeral head that allows surgeons to adjust tension of the supporting tissues while maximizing range of motion

The Solar BiPolar Shoulder provides surgeons with additional options for addressing rotator cuff arthropathy arthritis of the shoulder

The Solar Shoulder product line gives surgeons increased intraoperative flexibility to restore the patient's shoulder kinematics.

ReUnion Shoulder fracture system of implants and instrumentation. The ReUnion System utilizes a trial system to simplify the reconstruction of the shoulder during fracture surgery.

The Solar Total Elbow complements products offered for upper extremity procedures.

Bone Cement

Most of the companies have their own proprietary cement. It is an important product that is sold along with the implants

Stryker manufactures and provides several variations of Simplex bone cement to meet specific patient needs.

Trauma Implant Systems

As with the other ortho companies, Stryker has a catalog of nails screws and plates to repair fractures and other trauma to bones

These include nailing, plating, hip fracture, external fixation systems and bone substitutes, and are used primarily in deformity corrections and in the fixation of fractures resulting from sudden injury.

Spinal Implant Systems

Spinal implant products include cervical, thoracolumbar and interbody systems used in spine injury, deformity and degenerative therapies. Spinal implant products include plates, rods, screws, connectors, spacers and cages, along with proprietary implant instrumentation.

Craniomaxillofacial Implant Systems

This product line includes plating systems and related implants and products for craniomaxillofacial surgery. In 2006, the company introduced HydroSet, a self-setting calcium phosphate bone substitute that is indicated to fill certain bone voids or gaps of the skeletal system. Also in 2006, the company launched DuraMatrix, a second-generation dura substitute technology, which is a conformable and resorbable membrane matrix engineered from highly purified type I collagen.

MEDSURG EQUIPMENT

The Stryker Instruments and Stryker Endoscopy product portfolios include micro powered tools and instruments that are used in orthopaedics, functional endoscopic sinus surgery, neurosurgery, spinal surgery and plastic surgery.

Surgical Equipment

Again presented to show the range of products Stryker has

Stryker makes a line of surgical, neurologic, ENT and interventional spine equipment that is used in surgical specialties for drilling, burring, rasping or cutting bone in small-bone orthopaedics, neurosurgical, spine and ENT procedures; wiring or pinning bone fractures; and preparing hip or knee surfaces for the placement of artificial implants. Stryker Instruments also manufactures an array of different attachments and cutting accessories for use by orthopaedic, neurologic and small-bone specialists.

Stryker Instruments also produces products that are used with joint replacement surgery. These products include the Revolution Cement Mixing System, designed to provide one solution for mixing all surgical cements; the Interpulse, a disposable, self-contained pulsed lavage system used by physicians to cleanse the surgical site during total joint arthroplasty; and the ConstaVac CBC II Blood Conservation System, a postoperative wound drainage and blood reinfusion device that enables joint replacement patients to receive their own blood rather than donor blood.

The PainPump2 is a disposable system that offers electronically controlled flow rates of pain medication directly to the surgical site to help manage a patient's postoperative discomfort.

The Neptune Waste Management System represents Stryker's product for waste management in the operating room. The self-contained device collects and disposes of fluid and smoke waste from surgical procedures, minimizing the need for operator intervention and therefore the risk of exposure to these waste products.

Surgical Navigation Systems

--a line of surgical navigation systems gives surgeons the ability to use electronic imaging. In 2006, the company released two navigation applications for the joint replacement and craniomaxillofacial implant markets.

Endoscopic, Communications and Digital Imaging Systems

video-imaging and communications equipment and instruments for arthroscopy [joint surgery], general surgery and urology. Products include medical video cameras, digital documentation equipment, digital image and viewing software, arthroscopes, laparoscopes, powered surgical instruments, sports medicine instrumentation, radio frequency ablation systems, irrigation fluid management systems, i-Suite operating room solutions and state-of-the-art equipment for telemedicine and enterprise-wide connectivity.

in 2007, launched the Stryker Digital Capture (SDC) Ultra, an all-in-one medical imaging information management system allowing for patient scheduling, video capture and storage, DVD burning. This system also allows for the recording of all surgical footage in high-definition video.

Finally:

Patient Handling and Emergency Medical Equipment

a variety of stretchers customized to fit the needs of acute care and specialty surgical care facilities.

beds and accessories that are designed to meet the needs of specialty departments with in the acute care environment.

MX-PRO BT ambulance cot with a weight capacity of 850 pounds for use in the emergency medical services transport market.

The DOJ settlement

This affected all the ortho companies and involved the payment to docs essentially for using their product bottom line

In 2007 the Company announced that it reached a resolution with the U.S. Attorney's office for the District of New Jersey in connection with a previously announced investigation relating to "any and all consulting contracts, professional service agreements, or remuneration agreements between Stryker Corporation and any orthopedic surgeon, orthopedic surgeon in training, or medical school graduate using or considering the surgical use of hip or knee joint replacement/reconstruction products manufactured or sold by Stryker Corporation."

The resolution is in the form of a non-prosecution agreement for an 18-month period. During the term of the agreement, the Company's Orthopaedics subsidiary is subject to oversight by a federal monitor, as appointed by the U.S. Attorney, regarding compliance with certain standards and procedures in connection with the retention and payment of orthopaedic surgeon consultants related to reconstructive products and the provision of certain benefits to such surgeons.

Subsequent to entering into the non-prosecution agreement, the U.S. Department of Health and Human Services, Office of Inspector General ("HHS") issued a civil subpoena to the Company in seeking to determine whether the Company violated various laws by paying consulting fees and providing other things of value to orthopedic surgeons and healthcare and educational institutions as inducements to use Stryker's orthopedic medical devices in procedures paid for in whole or in part by Medicare.

The Company produced numerous documents and other materials to HHS in response to the subpoena and had been working with HHS to attempt to narrow the scope of the requested production. In 2008 the Company was informed that the U.S. Department of Justice and the HHS would seek judicial enforcement of the subpoena. Subsequently, the Company filed a complaint in the U.S. District Court for the District of New Jersey to quash the subpoena and seek other appropriate relief on the grounds that the subpoena is overbroad and oppressive.


This is a lot of text but it is interesting. Zimmer and SNN have already paid fines for the charges essentially admitting they did it. Stryker is saying the charges are too broad and demanding specifics. So far the DOJ isn’t going for it. Looks like SYK does not want to pay the fine.

All of the companies have to have these overseers for 18 months, This is running in to tens of millions of dollars for the fees for the oversight. Will margins increase for all concerned when it’s over? Some are of the opinion the AG has taken some liberties with the fee schedule and is using this as an enrichment opportunity at the expensive of these very profitable companies. Perhaps the overseers need overseeing

Q3 and 9 month results

Net sales were $1,653.0 million-- a 14% increase year over year. Growth was 12% as a result of increased unit volume and changes in product mix and by 2% due to favorable changes in foreign currency exchange rates.

Net sales in the first nine months grew by 11% as a result of increased unit volume and changes in product mix and by 4% due to favorable changes in forex

Domestic sales were $3,153.5 million for the first nine months of 2008 and $1,067.8 million for the third quarter of 2008—a 13% increase for both from higher shipments of Orthopaedic Implants and MedSurg Equipment.

International sales were $1,846.5 million for the first nine months of 2008 and $585.2 million for the third quarter of 2008, representing increases of 19% and 15%, respectively.

Global sales of implants were $2,950.6 million for the first nine months of 2008 and $963.3 million for the third quarter of 2008, representing increases of 13% and 12%, respectively. On a constant currency basis, sales increased 9% and 10% for the first nine months of 2008 and third quarter of 2008, respectively

Hips increased 6% in both the first nine months and in the Q3 (2% and 4%, respectively, on a constant currency basis). In the US sales growth was driven by sales of Cormet Hip Resurfacing and sales growth in some product but slowing in one or two lines offset the growth. Hip resurfacing is an important product. Zimmer is having difficulty competing and its hip business is somewhat disappointing and in need of revitalization.

Knees increased 16% in both the first nine months of 2008 and the third quarter of 2008 (12% and 14%, respectively, on a constant currency basis) due to strong worldwide sales growth of the Triathlon knee system as well as strong sales growth of the Scorpio knee system in Japan.

Trauma increased 22% in the first nine months of 2008 and 20% in the third quarter of 2008 (15% and 16%, respectively, on a constant currency basis) as a result of strong worldwide sales growth in the Gamma 3 Hip Fracture System, the SPS Calcaneal foot plating system

Spinal increased 21% in both the first nine months of 2008 and third quarter of 2008 (18% and 19%, respectively, on a constant currency basis) primarily due to strong worldwide sales growth of thoracolumbar implant systems, interbody devices and cervical implants.

Craniomaxillofacial increased 19% in the first nine months of 2008 and 10% in the third quarter of 2008 (16% and 9%, respectively, on a constant currency basis) bone substitute product.

Global sales of MedSurg were $2,049.4 million for the first nine months of 2008 and $689.7 million for the third quarter of 2008, representing increases of 18% and 16%, respectively. On a constant currency basis, sales of MedSurg Equipment increased 16% and 15% for the first nine months of 2008 and third quarter of 2008, respectively

Sales of surgical equipment and surgical navigation systems increased 19% in the first nine months of 2008 and 13% in the third quarter of 2008 (16% and 12%, respectively, on a constant currency basis) due to strong worldwide sales growth in powered surgical and operating room equipment and interventional pain products.

Sales of endoscopic, communications and digital imaging systems increased 14% in the first nine months of 2008 and 11% in the third quarter of 2008 (12% and 10%, respectively, on a constant currency basis)

Patient handling and emergency medical equipment increased 23% in the first nine months of 2008 and 31% in the third quarter of 2008 (21% and 30%, respectively, on a constant currency basis)

Research, development and engineering expenses R&D was 5.4% of sales in the first nine months of 2008 compared to 6.3% in the same period of 2007 and decreased 2% to $268.0 million.

Costs decreased 4% in the third quarter and were 5.6% of sales in Q3 and 6.7% in 2007.
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Normally I get nervous when companies start cutting R&D. SYK has cut back to “normal” levels after several years of high spending. There are no blockbusters in the pipeline right now and spending is mainly on fine-tuning and improving existing lines—costs less.

From the CC:

Now, on the R&D piece, I would tell you we've not cut back people. It's been more some of the external stuff. I'd also tell you some of the clinical work. We were quietly continuing to spend on OP-1 to get it there. And we've beefed up some of the other projects over the last few years that are coming through on project basis. But our people and projects, we still feel very good about. And as a remainder, we kind of back to historical norms on the R&D line after a few years being well above that.


R&D has been at 6% since 2005 after staying constant at 5% for six years previously
-------------------------------------------------------------

SG&A increased 14% in the first nine months at 39.6% of sales compared to 39.9% in 2007.

In Q3, these expenses increased 11% and were 39.0% of sales compared to 40.1% in 2007. The decrease is good considering the costs of monitoring for compliance to DoJ guidelines.

Earnings for the first nine months of 2008 were $870.1 million, an increase of 22%

Net earnings per share increased 22% in the first nine months of 2008 to $2.12 from $1.74 in 2007

Diluted net earnings increased 23% in the first nine months of 2008 to $2.09 from $1.70 in 2007.

Stryker is trading around $38 per share—a price not seen for any period of time since 2003 when the company was earning around $1.10 Something truly terrible must be going on to cause such a huge drop in price.
Obviously it isn’t the Q3 results that were good. Maybe it’s guidance?

Outlook

The outlook for 2008 continues to be optimistic regarding underlying growth rates in orthopaedic procedures and sales growth in Stryker products. Management [as with the other ortho companies] is not predicting an outsized negative impact from the current recession.

Guidance is for diluted earnings per at approximately $2.88-- 22% increase over $2.37 in 2007 [excluding the impact of a charge to for intangible asset impairment in 2007 the increase is 20%]

Included is a constant currency sales increase in the range of 11% to 12% as a result of growth in shipments of implants and MedSurg. If foreign currency exchange rates hold near October 31, 2008 levels, unfavorable forex will be 4.5% to 5.5% in the fourth quarter of 2008 and a favorable impact on net sales of approximately 1.0% to 1.5% for the full year of 2008.

Guidance is OK and even if management is few percentage points optimistic, 2008 will still be good. Gross margins will be down possibly more than half a percent—very worrying to analysts who regard this as a trend they do not like

Gross has been affected by commodities, fuel costs and the expense of initiating company-wide compliance to a single manufacturing standard. Management says in a roundabout way 2008 will see a large decline of more than 0.4% in gross and that could carry into 2009. Beyond that it’s not clear what may happen. At the very least I expect the increased costs to decline in 2010 and the fuel and commodities costs are already declining. By 2010 assuming demand increases at least at current market share levels, margins should improve.

For 2009 they expect at least Medsurg to maintain decent sales levels even if recession influenced hospital based capex-spending declines. The equipment they provide is not big ticket like the DaVinci robot but smaller things like beds that do wear out and need replacing

Unidentified Analyst

Great, thanks a lot; good afternoon. Could you discuss just the visibility that you have in the MedSurg business? I'm not really sure in terms of the timing when you know you're going to get certain orders, but especially in the digital OR business. How many month ahead you can see revenue coming in?

Stephen P. MacMillan - President and Chief Executive Officer

Sure, Gerard. I don't know if you heard it, we have a crack going on the line with your questions. So, I apologize that we didn't hear it exactly correct. But I think your question was regarding capital spending. As many of you know, about 60% of our MedSurg sales are capital as a result there is significant interest in the potential of sales slow down tied to the current economic environment.

Couple of things we'd like to point out there; first: although we have a hefty capital exposure, the vast majority of our sales are relatively low-ticket items. And we simply don't have any single product within ASP 100s of 1000s not alone millions.

As a result, probably insulate to somewhat from the higher level of scrutiny from hospital capital committees. Second, quarter-to-quarter the impact of swings that occur whether the MedSurg divisions are generally a function of capital spending budgets.

So against that all those facts and circumstances, we're cautiously optimistic regarding potential for our MedSurg franchises particularly when you layer in overall relatively low market shares across the world and considerably U.S. opportunity that we are now leveraging. We are also cognizant of how much economic uncertainty there is and the potential impact it might have on capital budgets and hospital's financial flexibility going forward probably can't be overstated. All of which will be considerations as we prepare our budgets for 2009.


What Stryker is not doing is offering any glimpse in to 2009 and is also telling analysts they will be spending approximately $50 million in 2009 to institute company wide quality control and compliance to manufacturing standards to be directed from one central set of guideline/rules. Analysts really hated the idea and suspected Stryker was hiding an iceberg-like hidden pile of upcoming recalls and potential FDA actions. Stryker denied this and said they were formerly decentralized and were becoming too big to be able to get that model to work reliably. They do have 3 outstanding letters from the FDA and this no doubt underlies part of the company-wide remedial [voluntary] action. The company has also refused to speculate on how the FDA inspections will come out and when the issues will be solved

From the CC:

Turning to the regulatory update; as most of you are aware, we currently have three FDA warning letters in place; two within our orthopedics division, and one of biotech. When we received the warning letters, we made the strategic decision to implement a quality initiative company wide rather than focus our efforts strictly on the three facilities that have received FDA actions. This decision is much broader in scope given our global footprints as evidenced by the roughly 20 manufacturing facilities we have worldwide.

However, we believe implementing a common set of quality standards throughout the company will allow us not only to address the issues raised in the warning letters, but elevate the entire organization to the standard required by the FDA.

And it's also true that our comprehensive approach requires significantly greater investment and will take several years to fully implement. As such, as we have indicated previously, we will spend at least $50 million annually for the next three years on our quality initiative.

The FDA clearly expects in today's day and age, they want big companies to have one system across everything. They don't like to decentralize the operations that had different ways of doing things. It's all about harmonizing, standardizing, and getting them all to the same place.

And I think as we dug deeper in from very early in the year, we realized, you know what? There is probably more work to be done than we fully imagined. And we've taken it now with the full vigor. And that's why we are trying to particularly emphasis the at least, because we didn't want people to assume that this was the peak year. Deep down, I would say '09, I think some people were assuming, okay. And we might have bought very early in the year: okay, we spend a lot this year and it starts to taper back down. I'd say '09 is probably going to be higher than '08.

It is possible management knows more than they are saying and perhaps the news is not good. However, the current 5-year low may allow some margin of safety from fines and/or temporary shutdowns that could ensue. Again, nothing like that is even in the wind but it surely is going through analysts and investors minds

The other pall over these companies is the democratic presidency and congress coming to power—traditionally thought to be unfriendly to health care. It might impact the pricing but that could take time to come in to play. Medicare change happens glacially and it could re-price procedures and implants within a year or so. I find when I try to work Medicare in to stock analysis I usually end up losing by being overly pessimistic.

Investment in SYK is not a slam-dunk to hundreds of percentage points of gain. Maybe the spending to implement standards will escalate and not provide any synergy or benefit; will SYK get hit with fines and plant closures? Will commodities again rocket up and reduce margins further/ Will the democrats put a lid on reconstruction? Will hospitals stop buying beds?

All these things can conspire to make SYK a bad investment but even with declining margins and slowing growth its dominant well-diversified position in the industry makes it interesting at current prices.

http://finance.yahoo.com/echarts?s=SYK#chart2:symbol=syk;ran...


In summary—

• Lower gross margins and possibly operating margins
• DoJ monitoring ongoing and possible fines
• Three letters of warning from the FDA
• Democratic presidency
• Price cuts
• Slowing demand
• Recession

I must have missed a few points but these explain a lot of the disenchantment with orthopedics.

There is still a lot to like in ortho

• Inflexible demand
• Increasing demand
• Wide moat
• Low debt
• High cash flow


A few numbers because we like numbers so much


LTM 2007 2006 2005 2004 2003
--------------------------------------------------------------------
Return on Assets 13.09% 12.54% 12.84% 13.06% 13.85% 14.18%
Return on Capital 17.26% 17.28% 18.03% 18.83% 20.29% 20.27%
Return on Equity 21.02% 20.62% 20.59% 20.90% 17.93% 24.83%

Margins

Gross Margin 68.46% 68.92% 68.59% 67.69% 64.48% 63.80%
EBIT Margin 22.70% 22.12% 21.69% 20.57% 18.82% 18.70%
Net Margin 17.22% 16.96% 15.11% 13.96% 10.32% 12.51%


In millions

Cash from Ops. 1,124.1 1,028.3 867.3 833.4 559.5 648.5
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capex 174.1 187.7 209.4 261.8 187.8 144.5
Acquisitions 19.3 54.8 93.9 56.7 144.7 10.8



Total Debt/Equity 0.37%
Total Debt/Capital 0.37%

Lots of cash flow easily covering capex and acquisitions
Very little debt

$2.2 billion in cash at the end of the quarter. Management is looking for acquisitions.
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