Stryker Corporation (SYK) Earnings Call Transcript & Summary

Well, good morning, everyone, and welcome to Day 2 of the Morgan Stanley Healthcare Conference 2020, and thanks for joining us here as we progress through our medical device presentations here in the morning. It's my pleasure to have this year our first large-cap presentation of day 2, which is Stryker, and I've got multiple members of the management team with me, including Kevin Lobo, CEO; Glenn Boehnlein, CFO; and Preston Wells, VP of IR. Kevin is going to do a couple of quick slides here with his traditional preamble, those should be loaded in your screen. You should have those slides. You can see both the disclaimer and the slides on your screen. He's going to run through those, and then we're going to jump into Q&A. With that Kevin, the floor is yours.

Okay. Great. Thank you, David, and I am going to go quite briskly through these slides and then obviously have Q&A with David. Let's start with Slide 3, which is the mission and values. And we launched this about 6 years ago. It's been a unifying force in our company. And nor has it been more important than during a pandemic where we're on the front lines, supporting all of our customers, but really a rallying force for all of Stryker, and it's really helped shrink the company and collaborate more than ever. If you go to the next slide, Slide #4, this is the recovery curve. So you've heard every type of letter imaginable for prognosticators on what this recovery curve would look like. I think if you look at this curve, it's pretty clear that it's a V, a very strong V-shaped recovery. We're really pleased to see that progression consecutively following the month of April May, June, July, and August also was an improvement over July. And so obviously, the pace of that V will start to moderate as the recovery really accentuates. But a really terrific recovery curve and, frankly, much faster than we were expecting ourselves a couple of months ago. If you go to Slide 5, I think it's really important to highlight that we haven't stopped our innovation engine at Stryker. So I just have a few examples here. On the left, you see the Surpass Evolve, which is our flow diverting stent, the next-gen flow diverting stent for Neurovascular. We're very excited about this. Here are a couple of pictures from the first cases in the United States. This was approved in Europe a couple of years ago and has had great success, is a very, very streamlined delivery system. And as you can see, it's the first one with 64 versus the 48 normally with other flow diverting stents. So we're really excited to be on the market in the U.S. Great initial feedback from the surgeon community. In the middle, you see the new bed. So I'm really pleased to announce, effective today, we are launching the new bed called ProCuity. It's been a long time coming, and we're very, very excited about this launch. It has a number of very exciting features, including fall prevention. So it has a low height feature to go very, very, very low to the floor. So patients can put their feet on the floor. It is completely wireless and has a whole range of other features. And so we're in the sort of the early launch phase right now, and full launch will be by the end of the year, but very exciting new launch for our Medical division. And then on the right hand side, you see the ambulatory surgery center. And here, Stryker is extremely well-positioned. We've been winning a lot of deals this year. We created a dedicated team to act as a quarterback for all surgery center deals. You can see there's a large number of procedures done in surgery centers. The shift to surgery center has started prior to the pandemic, and it will only accelerate with this pandemic. And we believe we're very, very well-positioned, with strength across all of these product categories as well as having capital equipment, disposable and implants. If you go to the next slide, we -- just this quarter celebrated our 1,000th Mako installation. And that's a picture of me, I was able to go down and attend that. You can see it just arrived and it was going through its testing. So it's -- that's not in the actual operating room just yet. But very excited about the progress of Mako. As you heard, we had a terrific second quarter with Mako. That's continued into the third quarter with a very, very strong order book. So the lead that we have in robotics is clear, and it's continuing. And it's really a global thing. We have over 28 countries now that have a Mako robot, and that growth will continue long into the future. And then turning now to the last slide that I have. Just as the long-term commitments that we outlined a number of years ago, we are still affirming that these are the ongoing commitments that we imagine for our company. Now obviously, this year is a bit of an anomaly year. We have also called out Wright Medical as being a little bit higher than normal dilution. But this 30 to 50 basis points, we expect to be able to get back on that train, and that would assume, let's say, the smaller amount of dilution from normal acquisitions, Wright's a bit of an outlier. But we do feel with this recovery, that V shape that you saw on Slide #4, that we're going to be sort of back to doing the Stryker offense that we had prior to the pandemic. And so with that, I'll close my prepared remarks and open the floor back to you, David.

Great. Kevin, thanks. That was pretty quick. I appreciate it. And also appreciate you announcing your new technology launches at the Morgan Stanley Healthcare Conference. We wish more companies to do the same. It's exciting news on the bed launch, thank you. So look, I appreciate your comments on recovery. So I'm not going to sort of bemoan that point too much. One of the dynamics, though different from Stryker, is because you're capital-oriented businesses, you've said we were seeing recovery. I understand, we've seen that recoveries extend through the summer. That's great news. Some investors are concerned that because you have these capital businesses that your recovery by -- has been V-shaped to start, we'll look particularly like that in the third quarter and the fourth quarter because the MedSurg business sort of moving around. So what would you say to those investors who are concerned about your pace of recovery into the back half? And do you think Stryker can get back to some semblance of normalcy by the fourth quarter?

Yes. So what I would say is we have pretty good visibility on capital equipment through the end of this year. So our order book, we track orders. And obviously, on large capital, the order timing is a little longer than smaller capital, but we have actually pretty good visibility through the end of this year. And right now, our order books are very healthy across large capital as well as small capital. And so what we saw in the financial meltdown, if you think back to then, we saw the order book completely fall off. And the fact that the order book is healthy gives us confidence that this recovery will be sustained at least through the end of the year. And I can't predict next year, right? Obviously, as the year unfolds, we'll have greater visibility into 2021. But certainly, through the end of this year, we feel very good about it. And I do believe in the United States, which obviously is our biggest market, the stimulus funding has been a big source of strength for the hospitals, which have enabled them to continue to acquire capital at a good rate.

Okay. I want to come back a little bit to MedSurg bit, Kevin. But I know Glenn is on mute, and I want to ask Glenn a quick question here, because you went there, Kevin. If I think about '21, Glenn, and I know we don't have guidance this year, we're not going to get it for next year, but Kevin just made a comment about getting back to that sort of 30 to 50 bps of margin. I know we have Wright to contend within '21. In my model has '21 margins, I think similar kind of right around 2019 margins. Is that a crazy way to think about it, can '21 margins be higher than 2019 margins?

Yes. I think to Kevin's comment, I think what we're assessing now in our business, as we look at 2021, is we have a number of programs that have been ongoing to really deliver margin expansion. And I would say that all of those programs, with the exception of our ERP program, have continued through sort of this pandemic. And if anything, it's allowed some good focus in areas of shared services, in areas of direct spend. So I do expect that those will continue to drive savings. As I think about 2021, obviously, Wright Medical will be a call out relative to that op margin dilution. But I do think that we would look at maybe 2019 as the sort of the benchmark to expand off of. And we would look to drive the underlying business somewhere between that 30 and 50, based on benchmarking with the 2019 number.

Okay. Very helpful. And then, Kevin, similar question for you as relates to growth. Obviously, hard to do this in '21 yet. But I have my '21 revenue numbers kind of 9%-ish above 2019, which obviously I can argue that's a conservative number, not conservative number. Any ways of thinking -- help us think about qualitatively what '21 could look like over 2019 from a growth perspective?

Yes. I know it's a bit early, David, to really -- in January, we'll give you our guidance for '21. But most of your models are never really crazy, honestly, when I looked at what you've modeled. I would say it's based on your assumptions that you do, and I've never felt that you're sort of an outlier, frankly, on the conservative side or the aggressive side. So we're -- based on the recovery curve, if things continue as they are, we're expecting to have a pretty good '21, but that's a big provisor, right? The pandemic is new. Let's see what happens in the future, but we're feeling pretty good about '21.

Okay. I thought you're calling me a little boring there, Kevin, but I'll move on.

No, you can take it however you like. I mean, it's -- I just think you do your homework and your models tend to be fairly accurate.

Okay. So let's think about Stryker, stating the obvious, was the premium growing large-cap medical device company for several years, and in fact, accelerated every single year under your tutelage here as CEO of the business. So people kind of ask you very simple question, can Stryker get back to the top-tier grower that it always has been? And I want to focus on 3 core tenets that I've identified is what I think is most important. So #1 is you and Boston Scientific acquires a lot of M&A, you've said multiple times that the M&A muscle is something that's been developed and located under Stryker, you've done 100 deals. So the question now is you're going to exit COVID, you went from the most flexible balance sheet in med tech to the -- to a less flexible balance sheet at kind of 3x net debt to EBITDA, a little lower. I think some are concerned that you cannot continue to do this kind of cadence. So in a world where, for 18 to 24 months, you can't do the same kind of deals, and I think that M&A has driven kind of 50 to 100 bps of incremental growth, should investors be concerned that M&A engine or relying on that M&A engine in the next 18 months is going to be more challenging?

Yes. Well, obviously, Wright Medical is a very big deal that we'll be doing and we expect to close in early October. So that deal brings tremendous growth with it, by the way. So the Wright Medical is growing quite a bit faster than Stryker's overall growth rate. And so we're in a high-growth space, but it does tie up capital. We'll still do tuck-in deals, but they won't be, let's say, have the same size as the more recent years of our acquisitions. But we've gone through many years with a small number of tuck-in deals, and that continue to fuel growth. But we also have existing growth engines that are very strong. I just mentioned Neurovascular, with the flow diverting stent in the U.S., just really being able to go after that market. We also have the large bore catheters that were recently launched, including our Vecta 074 catheter, which is really receiving very favorable feedback. So we have a good product flow there. We have the new bed. And Mako continues to be a tremendous engine for growth. And then, of course, international has still been an area of great growth potential for Stryker. You saw the last 2 years, we had terrific growth in international. So we have the foundation for tremendous growth in our existing business with new products, with geographical expansion. And so I don't see any reason why we won't continue to be at the high end of med tech. That's one of our commitments, and we had that going into the pandemic, and nothing has really changed. Our strategy is still solid. Our decentralized business unit focus is still solid. We've maintained high employee engagement throughout this pandemic with the recovery curve coming back. The fact that we won't necessarily be doing as large deals as a NOVADAQ or K2M while we digest Wright, that's just very temporary. And with our focus on cash flow, if we generate better cash flow, we'll be able to do even more deals. So we've not turned the funnel off. And don't forget, we are picking up a pretty growthy asset with Wright.

Okay. And on that point, Kevin, the last $7.5 billion that was deployed, K2, Mobius and then Wright, some would have preferred that, that $7.5 billion went somewhere else where there's 2 ways you can grow a med tech. You can take share in your core markets or just get into better markets. Why would you sit back, a benefit of hindsight, that $7.5 billion deployed, you make your case on why that was the right $7.5 billion to spend?

Well, if you go back to our strategy, David, which we articulated 7 years ago, was category leadership and really being strong in every single market. We had a number of areas where we were far from category leadership. We were far from category leadership in Spine. We are far from category leadership in Sports Medicine, in foot and ankle. And the last remaining big gap was upper extremities, specifically shoulder. And moving into category leadership has been tremendous for us. It really makes us more relevant with our hospital customers. If you think about a surgery center, that slide I showed you, those roughly 20 specialties, we're going to be strong in every single one of those, including shoulder, with the addition of Wright Medical. So Wright medical, yes, orthopedics is not as faster-growing market as some of the other spaces in med tech. But upper extremities sure is, right? Upper extremities and even lower extremities, extremities is the fastest-growing segment within orthopedics, and we're going to be the #1 player in the upper extremities and the #1 player in lower extremities. They also bring a nice Biologics portfolio with them. So the fact that we're deploying -- when we did Spine, there were people, I think, like you, who weren't as crazy about us deploying capital within Spine. But that shoring up Spine is -- makes us a stronger overall company. It's the largest market within orthopedics. Innovation is rewarded. And so we feel that this is -- this category leadership philosophy and strategy has been consistent and has been a winning formula. And our Spine business is certainly in a much healthier position than it was prior to the acquisition of K2M. And it really does help in the surgery center. We provide everything they need across all those 20 specialties, including Mako, including stretchers, Neptune waste management, power tools, we give them the capital, we give them. So we're very deep in the service lines, and that's -- it's not a new strategy. So we've just continued to fulfill our strategy. Just look at Wright as a large tuck-in. I mean, it's a very large one, but it is a tuck-in to really strengthen our category leadership philosophy. And honestly, we are a high-growth company. You sort of look at a market and then you look at Stryker's growth. And if we -- with our winning formula, we can grow well above market rates and do it very sustainably. I think you've seen that. It's not a 1-year thing or a 2-year thing. And so even if a market may not be as attractive as another market, if it leverages our core strengths and fits within our categories, then we know we can win.

Okay. That's very clear. Second key component, and I'm going to focus on the business that is the most misunderstood business inside Stryker, which is MedSurg, right? It's a big capital business. It can't grow. You and I both know that business has grown above the corporate rate really for the last 5 to 6 years. Here with [indiscernible] COVID, you just talked about your order book in your preamble, which sounded pretty healthy, frankly. There's still that persistent fear that this is a capital business, we're going through a challenging cycle. Why -- if I say to investor Stryker grew 6.5% MedSurg the last few years, take the over or the under on that 6.5%, 99% of investors are taking the over -- sorry, taking the under. Why are they wrong? And why are you so confident that this portfolio can continue to grow in a challenging environment?

Yes. So I think there's a few reasons why it's misunderstood. I think the first reason is there's sort of memory of what MedSurg used to be, right? If you go back to the financial meltdown, the MedSurg business dropped like a rock, right? There's a liquidity crisis, which there isn't this time. And it was much more tilted towards capital and large capital. And now if you look at the MedSurg portfolio, it's been very diversified over the past 7 or 8 years. We've added businesses like Sage, like Physio-Control, like Invuity. All these instruments, little, little deals. They are much more disposables, much more consumables in our portfolio. So the mix of business of MedSurg has changed very profoundly. That's the first thing. Second thing is we've accelerated our innovation cycles. So the time between a camera launch, the time between a power tool launch, the time between launches has shortened, and we've gotten faster at continuing to innovate. If you keep innovating on a faster cycle, you can drive higher growth. And so this is then -- and we've also specialized. So more and more specialization drives growth. And that's been a formula for Stryker. You saw just a year ago we split our Instruments sales force and created 2 different parts of that sales force just within the surgical portion of Instruments, and it drove terrific growth. And part of that split, though, was doing the Invuity acquisition, doing the TSO3 acquisition, doing these little, little deals that create this engine of growth. And it really, both sides have grown. So when you split a sales force, sometimes you worry that focus on the product that was more neglected, but the product that was the flagship would start to sag, and that hasn't been the case at Stryker. So we have this winning formula in MedSurg, and we have very high market shares. So when we have this replacement cycle, we were able to renew this fairly, fairly easily. And so we love our position in MedSurg. It's kind of the -- it's been the reliable, the most reliable portion of our business. And if -- when I joined Stryker, Orthopaedics was the largest segment. At Stryker, MedSurg is now our largest segment, reporting segment. That's not an accident. We see great opportunity within MedSurg, and we have really great strong businesses. Our challenge has, frankly, been to grow MedSurg more outside the United States, where we have very high -- we're over-indexed in the U.S. And that's been part of the engine of growth in Europe, has been getting MedSurg to really fly high in Europe. So we still have a tremendous amount of growth outside the United States. But inside the United States, this formula that we have of constant new cycle innovation and specialized sales forces and dedicated tuck-ins, that's been a winning formula, and that will continue.

So it's not crazy to believe that MedSurg can continue to grow somewhere around the corporate growth rate in the next couple of years?

Absolutely not crazy at all. And think about something like Sports Medicine, that's been a tremendous grower for us, and that sits inside of endoscopy. So we have some of these like hidden businesses that, because they're small, they don't get as noticed. But that's -- those are all engines of growth.