Stryker Corporation (SYK) Earnings Call Transcript & Summary

[Audio Gap] executives from Stryker. We're excited to have you both here. Katherine Owen, I'm going to not get your title fully right, but Strategies and Investor Relations Vice President. President? [ All right, but...

Retiring.

And -- that's right. That's right. And Preston Wells. So Katherine, congratulations on the decision. We saw the press release earlier this week, and I just want to thank you for all your help over the years and helping us get our arms around the Stryker story and all the access you provided. Really appreciate and appreciate both of you coming today. And Preston, congratulations on the new position at Stryker.

Thank you. Thank you.

We'll be kicking off most of these fireside chats, unfortunately, just asking about the coronavirus and potential impact to specific companies. And I'll just maybe leave it open ended for any updates you want to provide or any messaging for investors.

Yes. So first of all, thank you, and thank you for everybody for coming here today. It's obviously still a very fluid situation, and it's going to remain so. I don't think there's anything magical about the end of the quarter that will suddenly make this disappear. We have about 2% of our revenue comes from China. We have 3 manufacturing facilities there. They are all open and up and running, but they're not at full capacity. And clearly, a lot of -- or essentially all elective surgeries in China have stopped. And so there will be a revenue impact, certainly, in Q1. We would imagine there'll be still an impact in Q2 as well as an earnings impact. And I think we have to wait and see how it plays out in some of the other countries like Japan, for example, as well as in the U.S., but we will call that out in terms of this is what we believe the coronavirus revenue and earnings impact is. And you can see an adjusted, adjusted number similar to what we've done in the past when we've had these extraordinary events, whether it's natural disasters or something like this. So we'll be able to call it out and give people a sense of the impact. At Stryker, we are starting to limit some of the nonessential travel. I imagine other companies are doing that as well. That just makes good sense and -- but again, it's still very fluid, and we'll give more details as we move through the time frame.

Understood. I guess one of the pushbacks that we've gotten on our Stryker thesis has been post the announcement of the Wright acquisition and just some concerns there, I think, primarily about historic orthopedic mergers and some of the trials and tribulations other companies have gone through. Stryker is integrating K2M. I mean it hasn't been a perfect, smooth path, but you guys have -- obviously, you have the integration playbook down, and K2's is making some nice progress, as I understand. Maybe you could first talk about the K2M integration and the Stryker integration playbook, and then maybe we'll have some follow-up questions on Wright.

Yes, sure. So we're about, I guess, close to 1.5 years since we closed K2M. And you're right. It was a big acquisition. It was a big integration. We are fortunate that in the last 12, 13 years, we have done numerous deals ranging in size from small to mid-sized tuck-in deals to ones that are cross-divisional, cross-geographical and as well as larger deals. And so we have built up a lot of competency around BD. As many of you know, we have determined that business development M&A is our primary use of cash from a capital allocation standpoint. And regardless of the deal, regardless of the division that is doing it, the one truism is it has to have a story around accelerating organic sales growth. It either has to be one that grows faster than our underlying growth or we see a path to accelerating its growth, and neurovascular is probably the best example. And we have dedicated BD teams that live in all of the divisions. We do have some centralized BD, but it is a very small core team at corporate, and the rest works across the line into the divisions. That gives us the closeness to the customer. And in most of the deals, that gives us a long time and time over target of building those relationships and being able to make sure it's the right asset. Is it something we should do ourselves? Do we want to continue to track this target? And so that is a competency and a playbook that we've built up over the years, whether it's how we go about due diligence, about the financial metrics that we use as well as the integration process. And we really put a heightened effort on integration, going back a few years, to have much greater speed to decision-making. And so we're moving quickly on deals, whether it's decisions around employees or physical locations, trying to move faster on those. And now we knew K2M was going to be a challenging integration. It strategically made a lot of sense for us. We had the benefit of having watched numerous spine deals over the years with not the best track record and understanding why that happened, what didn't work well because it would be just hubris for us to say, well, we're Stryker, we'll just do it better. We spent a lot of years examining the market, examining the targets out there and understanding what worked well and, more importantly, what didn't work well and took a lot of those learnings into the due diligence process as well as in the integration process. So we knew with K2M we were getting a target that from a culture standpoint, and this can't be overstated, from a culture standpoint, really meshed well with how Stryker operates. It's a very much a sales force-driven culture. And that was going to play well as we put the teams together. The portfolio was a perfect match for us because it gave us an immediate refresh of some of our core spine legacy products that had gotten longer in their life cycle while also giving us a much stronger presence in the deformity market where you have a lot of the key opinion leaders that really influence decision-making. Now like any acquisition, did we do everything perfectly? No. It took us a while to get the agencies figured out who was staying, who we were buying out, who we weren't. And during that time period, you're not hiring as many new reps because you don't have the territories determined. We didn't have a perfect match between what demand would be for some of the Stryker legacy versus K2M products. And there are weeks of lead time, like as much as 12 weeks of lead time, to make those products. So that delayed some of the revenue. But overall, we were ahead of plan on the cost side. And we targeted in the first year of doing a spine deal to grow underlying comparable apples-to-apples adjusted growth mid-single digits, and we grew it low single digits. So I'm still extremely proud of the team and what they were accomplished in a challenging spine market that's still in the first year, grow the business. And so while it was off modestly, it certainly wasn't like the business fell apart. And now we're back to hiring reps. We're rolling out new products. So I'm confident, as the year unfolds, you're going to see continued acceleration in that business. [ It's a long ] question...

No, no. That was -- no, that was perfect. And then just to follow up, I mean just historically, if we think about orthopedic mergers or spine mergers that haven't worked, I mean our being on this side of the fence as an research analyst, I think sales force distribution, kind of these hybrid sales forces and also maybe product overlap have been 2 big hurdles. And I don't know if that's the case in terms of how you guys evaluate acquisitions. But just in terms of driving some of the issues that Biomet Zimmer had, which is a huge one, or Synthes DePuy. And I -- it just doesn't seem like that's really in play if Wright comes and that deal closes underneath Stryker's roof. Is that a fair assessment? Or is that just too different -- for Wright specifically, yes.

For Wright specifically? Yes, every deal is different and the complexities are different, but there's always learnings that you apply, whether it's deals that we've done or others in the industry have done. Strategically, and I am -- in fairness, I'm really limited to what we said at the time of the announcement. We do not own Wright. They are a competitor, and our expectation is the deal will close in around the third quarter. I can reiterate that the rationale was it was strategically a strong fit for us. We have a goal across our divisions of having category leadership, being one of the top players. We weren't there, particularly in upper extremities. And this really was an opportunity for us strategically to drive our goal of having a stronger product offering in those markets. It's the target we've looked at for a long time and really was aligned with our strategic objectives.

Understood. And just in terms of the rationale, I mean it's Wright has got its double-digit revenue growth trajectory. You've talked about bringing in assets that are either accretive to top line growth or you guys can get it there. And maybe just to refresh on or just dig deeper into that strategy, I mean Stryker and other med tech companies have been rewarded on a valuation basis based on top line performance. I mean the margin expansion stories are definitely giving credit, but the real big metric is top line growth. And Stryker has been just driving that top line growth and delivering 8% the last 2 years. It's been quite a run, but maybe just to dig deeper into that prioritization of top line growth from the executive team.

So our goal for a number of years now has really been to deliver organic revenue growth at the high end of med tech. And we've done that year after year, going on 6, 7 years now of accelerating organic sales growth and, certainly, at the high end of med tech. I would say, from a how we deliver that, it really starts with the sales force. Stryker is very much a sales force-driven organization. Everybody in the company, regardless of what geography, what division, what function you're in, gets up and thinks about, "How am I going to be contributing to accelerating our sales growth?" We do a great job of hiring people who really excel in this. It's a very competitive, very high expectations of what we expect from our salespeople. In the U.S., it's 100% commission-based. We just came off of something like 30 national sales meetings where we celebrate who achieved quota. There's no rounding at Stryker. If you come in 99.99% to quota, you missed. I tell people the only rounding is in IR because I always round it up in terms of growth rates, but there is no rounding in the sales force. And that's part of the culture, and it really attracts a certain type of people who know we are going to invest in the sales force. I think part of the excitement when people become, through acquisitions, part of Stryker is they know that this is an organization that's going to invest in the sales force. Maybe an acquisition is a catalyst to split a sales force. Or maybe, as you saw with Instruments last year, a division gets big enough and we want to drive stronger growth, and we decided to split a sales force. That is how we operate, and it really allows great closeness to the customer. So whether it's sales, marketing, R&D and BD, all of those are decentralized and live in the division. We don't try and run any of those functions from a corporate entity because the goals and the markets and the customers in each of those divisions are going to be different. So we invest in the sales force. We very much believe in having dedicated sales forces specific to that organization. And I'll give you an example. You would on paper say, well, why don't you just have one selling organization that sells your recon implants, your Mako robot and your power tools because most of your instruments, power tools get used in orthopedic procedures? And on paper, that would make perfect sense. But what would get lost completely is it's a very different skill set selling a robot, which has a much longer time frame, than it is from selling an implant, than it is from selling a power tool. And you would probably end up discounting or giving away the capital in order to keep the implant. And so we have totally separate sales forces, which is why, you look in power tools, we have in the U.S. over 80% market share in power tools. And it speaks to the technology and the investments we make in generating and introducing next-generation products. So I think it really does start with the selling organization. It's our commitment to investing in R&D as well as acquisitions to bolster the product offering and drop these products into a global sales and marketing infrastructure. That's really the biggest part of what allowed our organic growth to accelerate.

Got you. Thinking about 2020 guidance, [ it's almost an instant replay ] from 2019 in terms of a really strong fourth quarter, 8% organic revenue growth for the year and guiding to modest deceleration. But I think all the commentary from your team and Kevin has been the momentum is continuing, and the Stryker engine is still running on all cylinders. Any -- just framing that up, you guys outperformed guidance last year. You guys have said you guys aren't kitchen sinking. I mean clearly, there's always unpredictable events. But maybe just help us understand the strategic rationale behind your expectation setting, particularly on the top line.

I would say, if we were sitting here a year ago, it feels very much a rinse, repeat of the last few years. And there's nothing magical about January 1 in terms of suddenly we think, well, this is a new market suddenly for us. Most of our product launches tend to be singles and doubles, and they come out with fairly consistent predictability across the divisions, and there's a steady cadence given how many segments of med tech we compete in. So as we think about product launches, there were a number last year, and there's a number this year and some remain in effect for a few years. And so it does give incredible visibility and conviction around our ability to continue to grow the top line. Now we're a bigger company, and so the comps get harder. I think we set the year an appropriate number where 6.5% to 7.5% organic is clearly going to be at the high end of med tech. And then we'll see how the year unfolds. If momentum is better than expected, if we have greater momentum than we anticipated, we'll adjust our expectations accordingly. And again, this is all said outside of coronavirus since, I think, we have to bifurcate how we think about the year. And -- but we feel very good about the guidance we've set out there and think it will represent, again, another year of high -- of delivering at the high end of med tech.

Makes sense. We talked [ a little bit earlier ] about companies getting awarded for top line growth, but there is the margin expansion piece, and that is another kind of good in the Stryker story. Excluding dilution from K2, you guys have, I guess, called out that the core business, the margin expansion in some quarters have been north of 50. I think the Cost Transformation for Growth initiative has been in play for a couple years now. That 30 to 50 is going to get blurry again, assuming Wright closes later this year. But maybe just, I guess, the long-term trajectory. I mean is that -- once you integrate Wright, should we still be thinking about the -- getting to the upper end of that range and maybe through it at some point? Or I know there's a lot of investment and, as you talked earlier about, the sales force investment and how that's crucial to a sales force-driven organization, but maybe just help us understand kind of the longer margin story -- or the margin story within the, I guess, longer-range plan.

Yes. So I think we've been really pleased, especially over the last couple years, of the magnitude of operating margin expansion we've been able to deliver even while absorbing some fairly meaningful dilution tied to a number of acquisitions. And acquisitions are going to continue to be a part of our playbook as we move forward. And that really is the organization galvanizing around a number of the CTG, the Cost Transformation for Growth, initiatives and getting far enough into them that you're starting to see the benefit, particularly around things like indirect spend, some of the product life cycle management. Now we've had to make investments, too, particularly around ERP, going from 42 ERP systems to a lot less, and that takes investment. So there's been a bit of a push/pull, but it's also gotten very much indoctrinated into the culture of Stryker. Operating margin expansion, not just op income expansion, is now part of our bonuses. This is year 3 of it...

Year 3.

So people are focused, drives performance. And so that was part of what really gave another leg of focus to our CTG efforts and our operating margin expansion. We haven't changed our long-term goal. Excluding any impact from the Wright deal, which we've talked about, would limit the ability to hit the 30 to 50, but underlying, we believe 30 to 50 of op margin expansion is appropriate. I'm not going to get too far out in terms of the outer-years. We're going to continue to invest as needed in our sales force. It's a strategy that has worked well for us. But we also believe that CTG efforts have years of benefits, and there will be legs that unlock a lot more value, like as we start to get further along in the ERP journey. And so there's a lot of opportunity for us to continue to realize what I think will be meaningful operating margin expansion.

Great. The Mako system, particularly the total knee application, has been a focus for investors. And if you break out, I guess, the revenue contribution, it's not the biggest driver, but it definitely is a driver within Orthopaedics. And having your knee business grow high single digits is -- I mean is accretive to top line growth corporate-wide, clearly. But I guess there has been some concerns just about more competition coming into play from one of your larger competitors. Clearly, you weren't feeling it in the fourth quarter. You have 80-plus Mako systems placed, a record number. And it seemed like there's just -- the market is kind of maybe not hitting an inflection point, but it's starting to ramp. You have another competitor in, I think, Smith & Nephew. I don't know how many they called out, but their kind of other revenue line grew nicely as well. So maybe talk about the market and then competitive landscape and whether you see any impact in 2020 to your ability to continue to place Mako systems at the clip that you exited '19.

Yes, I think I will just speak to our performance. We're years, 6 years, into the launch. We've captured 600 basis points of knee market share, which we said from the beginning when we did the deal that the best barometer of our success with what we believe is very differentiated robotic technology is going to be evident in our ability to take meaningful market share. And so 600 basis points later, we feel really good about that. We had a record year last year with 89 robots placed in the U.S. compared to 54 in the comparable quarter a year ago. We've got 850-ish globally now. We've got approvals in Japan. We now have 9 Mako robots, as of the end of the year, in Japan; a pending approval in China for the total knee application. We also benefit from having applications in not just total knee but hip and, of course, where it all started with uni. And we believe our differentiated technology and the unique capabilities to allow that intraoperative flexibility, particularly on the knee side, to optimally balance the knee is generating better outcomes, particularly in the short term where the data is showing these patients ambulate quicker. They get out of the hospital quicker. They return to work quicker. They are less likely to go into rehab. They have -- less likely to need opioids post the surgical procedure. So there's an enormous amount of benefits that again we think are unique to our technology. I think that the whole everybody being supportive of robots now certainly helps as you go into accounts and talk about this is why we think you should buy a robot. You don't have competitors counter-detailing like they were a few years ago before they switched to liking robots, saying that they're not needed. That has really changed. I do think there's been a bit of a false narrative out there that one robot's success means somebody else's technology, whether it's navigation or otherwise, won't succeed. This is still a very low-penetrated market for us and to the market in general. So I think there's a lot of runway. As we get further into the launches from competitors and you start seeing more head-to-head trialing, I think that's when our differentiated technology set is really going to be an advantage for us. But right now, I think there's a lot of competitors probably primarily focused on their own customers as the first wave of adoption, which candidly probably weren't candidates for Mako given it would require switching from what is their primary vendor for the implant given it's a closed system.

Understood. And just thinking about the market in general, I think we have some similar, at least, [ research ] recognizing capital sales within the knee revenue line. But trying to back that out and making some assumptions, it does seem like the knee market in the U.S. has accelerated a touch in the back half of '19. I think there were concerns around total knee reimbursement coming off the inpatient-only list, moving, getting reimbursement for ASCs but at a low level, so not getting much movement there is our understanding. And there's risk that maybe more pricing pressure in the market would actually maybe decelerate. But maybe just talk about some of the market drivers. I know it's only a couple of quarters. It's been relatively stable the last number of years, but anything to call out just from market trends on the volume side or pricing side in knee specifically?

Yes. I think it's true last year was incrementally better. And for us, pricing was incrementally better, still negative but incrementally better. And there's no doubt that having the Mako robot with a closed system helps on that fact. I do think it does somewhat obfuscate the underlying market growth with the way some are accounting for robots. Our other -- our robot is in our other ortho number. So our knee number is a clean number in terms of the revenue, whether it's traditional manual or a robotic procedure. But I think the market was incrementally stronger in the fourth quarter. I don't know that I'd read a whole lot into it. I think this year will play out probably fairly similar to last year in terms of just it's a healthy recon market. There's no doubt we're benefiting, and we fully expect to continue to benefit and grow well above the market in knees and increasingly in hips because of Mako as that base gets bigger and utilization rates continue to climb.

Great. And just the halo effect robotic hip procedures. I mean you guys have made some comments. I think, in the last couple of quarters, your hip business is making some strides, too. I think it's the Accolade 3D -- sorry, the Trident 3D cup has been a nice tailwind as well. But maybe just talk about your view on how robotic total hip procedures trend over the coming years. I mean is there truly kind of some momentum there?

I think we are seeing some momentum. I think it's partly from our new hip cup that is 3D printed, and it's been really, really well received. I think it's also that halo effect you mentioned as surgeons use Mako maybe for the first time but primarily for knees. There's a natural inclination to see "Well, maybe this will provide some benefits to me on the hip side." So we have seen very strong double-digit growth on Mako for hips. We are introducing new Mako hip software. You'll see that at academy later this month. That helps with the registration process, which has been some of the pushbacks. It can -- it typically takes longer upfront to do these procedures. So we've invested in next-gen software to help with the registration. That software also helps in terms of doing simulated range of motion movement for the hip. It also helps adjust or take into account for the surgeon pelvic tilt. This all helps in terms of optimizing the placement of that hip in the patients, and that will obviously improve income -- or maybe that, too, but outcomes. The software also has improved performance mechanisms built in, and it also allows for a surgeon to do a direct superior approach. So it further broadens the applications the surgeon has in terms of preference around how they do the surgery. So I think we're excited about the momentum we're seeing across the board. Knees, again, we think will be the biggest driver of growth not just in the U.S. but as we continue to broaden globally. And increasingly excited about what we're seeing on the hip side.

Got it. Thinking about just Mako and other indications outside of knee and hip and uni, I think you guys have talked about spine, potentially extremities, potentially maybe bicruciate-retaining procedure, revision procedures. Anything you can share just in terms of pipeline indications that are either feasible or any updates in terms of timing?

Yes. So clearly, there's still a lot of runway with the existing indications, particularly when you look at it on a global basis. We have prioritized and have dedicated teams working in conjunction with the Mako robotics team on extremities as well as spine. So those are the 2 top priority areas. It's too early to get into timing around launches or the specific indications. And clearly, when we invest in robots -- and it's a lot of money and a lot of time and you're more likely to see delays around timing than the opposite, but we want to make sure we have a truly differentiated indication when we come to market. And so those will be the 2 top priorities internally in terms of where we're investing, but it'd be too soon right now to talk about timing for a launch.

Got you. And the Cartiva acquisition, I mean how does that play into the spine acquisitions...

It absolutely feeds into the intellectual property and some of the technologies we want to incorporate into the ultimate robotic application.

I guess, just seeing the impact that Mako has had in knees and just starting to get some momentum in hips as well, but I guess, just thinking about the timing of getting your sort of spine application through the development path and out and commercialized, I guess, why has it been more of a priority? And I mean how much of a disadvantage is Stryker in the market today without a robot in spine specifically?

So clearly, we're not going to be first to market. I don't think you're in a market environment in spine right now where you're truly disadvantaged because there isn't that true killer app in spine. When we look at what we've done with knees, 1 out of every 3 knees in the U.S. for Stryker is done on the robot. And we've had tremendous success and market share gains that you just haven't seen in other applications, and I think it does ultimately speak to the indication. That doesn't mean that killer app isn't out there, but I think that's one of the benefits. I think the immediate priority for us in spine was we needed a portfolio refresh. And we needed to have a bigger presence in the spine market overall to be closer to category leadership. So when we did bring a robot to market, it was from a much bigger springboard, if you will. And so we've phase-gated it and now spending the time and money to make sure we have that right indication. So I don't think it's going to prevent us from doing well in spine over the near midterm. But longer term, I think you're going to only see more and more robotic applications because of its ability to improve the outcomes, the surgeon experience and the patient experience.

So should we take anything away from those comments just in terms of the development thrust? And are you guys going to come out with something that potentially leapfrog what's currently on the market? Is that the goal? I mean right now, it's primarily pedicle screw placements. There's been some advances for interbody spacer robotic placement as well. But am I reading too much into the -- into your answer?

So I'm going to do a super not long not answer. But we're very focused on having a meaningfully differentiated technology and indication when we come to market. We're not looking to come to market, whether it's spine or extremities or any of the areas, with a me-too that doesn't provide the type of benefit that we've seen particularly on the knee side. So I'll just leave it at that. More to come, but it really would be premature to have folks starting to focus too much on when that launch is coming because, again, robots, it takes time. It takes money. You need to have all the capabilities. What we're fortunate with at Stryker is we have a strong experience, whether it's R&D or selling, around capital. We have strong experience around how to build software. And then obviously, we have experience around the implants and understand the market. So I think that really does bring the best of the best internally and then augmenting it with some acquisitions, like you referenced, to make sure that we are as well positioned as we can be when we bring this product to market.

Great. And maybe I'll just get one last question in I realize I forgot to ask you a bit earlier, but just on the extremities business, can you help us understand just the sales force structure? Is that a pure direct sales force in Stryker's group? Is it a hybrid sales -- direct sales rep and distributor...

For Stryker, ourselves, we have a dedicated selling organization in lower extremities, and we've had that in place for a number of years going back to -- I can't remember what year now but years ago when we did the Memometal acquisition. That was a catalyst to establish a dedicated lower extremities. We have some dedicated upper, but it's not as large or as well established as what we have in lower.

Thank you. Fantastic. Thank you, guys, so much for joining us. We're looking forward to seeing you later this evening as well. And congratulations again, Katherine, on moving to a next chapter in a couple of months; and to you, Preston, as well for your new seat. Thanks.

Thank you. Thanks, everyone.

Thanks a lot.

Thank you.