Stryker Corporation (SYK) Earnings Call Transcript & Summary

Thank you, everyone, for joining us today at the Morgan Stanley Healthcare Conference, I'm Drew Ranieri, one of the medical device analysts here. From Stryker, I'm really excited to have Kevin Lobo, Chairman and CEO; and Glenn Boehnlein, VP and CFO. Also, Preston Wells is here, Head of IR. They are joining us this morning for a fireside chat. But before we jump into it, just a housekeeping item. For important disclosures, please see the Morgan Stanley Research disclosure website at morganstanley.com/researchdisclosures. If you have any questions, please reach out to your Morgan Stanley sales rep. With that, Kevin and Glenn, thank you so much for your time today. Looking forward to the discussion. And so there's clearly a lot to cover today, and I don't think you'll be too surprised with kind of our first topic, considering that's on many folks' mind here.

But just -- I hope, in 2022, we won't have to really discuss anything about COVID, but can you give any qualitative color or update us on your thoughts for the Delta variant? Several procedure-related companies and even capital have already kind of been discussing elevated variant pressures, or the pace of recovery just haven't panned out as expected. But would love to hear what you're seeing, what you're hearing, and any talk about any trends?

Okay. Thanks, Drew. Let me start by saying that we typically don't comment, as you know, inter-quarter around our business activities, but we are in unusual times. So what I can say is we are experiencing negative effects from the Delta variant on elective procedures, most specifically for us in our joint replacement, being hip and knee, as well as spine businesses. And I would say the effects have been more negative than we imagined back at the end of the second quarter. We are also seeing some capital being pushed out. So there's actually issues of construction being delayed a little bit. Staffing challenges is the third kind of negative thing that we're seeing. All these 3 things are a little bit more negative than we had thought before. On the other hand, we are seeing Delta starting to peak in many geographies, which is positive. Obviously, not so positive for the third quarter, given that there's not much time left in the third quarter, but certainly positive as it relates to the full year outlook as well as going into next year. The other positive, I would say, is our capital order book is extremely healthy, I mean, very, very healthy. So some of the delays in the capital are not concerning to us over the midterm, but certainly has been acute in the short term. So at this point, we're not making any changes to our overall guidance. We've guided for the full year for organic sales as well as EPS, not making any changes. Let's see how the rest of this quarter unfolds. As you know, it's very fluid. The marketplace is fluid. Some of the bounce-backs are fast, some take longer. But we are experiencing what you're hearing from other companies.

So it's not solely related to joint replacement, it sounds like it might be spine, but other capital-related categories as well?

Yes. It's most acute in the joint replacement and spine areas, but there is some spillover to some of our other businesses. And as I said, in the case of capital, it really isn't a concern about demand. It's really just about the timing of when that capital just gets installed in the hospitals.

Got it. And for -- on the capital side for a moment. If we do get through kind of peak COVID, do your customers have like a set like level of what they would need to see from COVID impact, where you can proceed kind of with capital or some of the construction projects?

No. It's just this uncertainty is causing them to just pause. And we've seen this in the past, by the way. So throughout all of last year, we had some of these stops/starts, and the demand continued to be pretty strong throughout. But you had these quarter-to-quarter variations, which we experienced, and it's nothing alarming. It's just -- this is an uncertain time, and there's some stop-starting that's going on. But certainly, they're liquid. It's not a problem of liquidity. It's really just a problem of execution and scheduling and having staff available and feeling like the volumes are coming. And there's -- that uncertainty is just causing, I'll probably call it, very temporary delay.

Got it. Okay. So maybe let's move on to some other topics, mainly in orthopedics to start. But just you commented on the joint replacement side and COVID impacts. I think on the second quarter call, you might have mentioned where you thought market growth was for joint replacements. I mean can you give any flavor for what you're seeing there? Obviously, it's kind of being impacted near term. But any thought on where you would be kind of sequentially from a joint replacement perspective?

Yes. No, I'm not going to get into that. And we didn't -- we were one of the earlier companies to report, so we wouldn't have commented on the market growth in the second quarter. And what I'd just say is, look, it's choppy right now because of COVID. That's all I would really want to comment on. And there are pockets of really good performance and good volume growth, and there are pockets that are being disrupted right now. And so it's a fluid environment, and there's really not more I'm going to say on that.

Got it. And just kind of coming out of AAOS, just kind of one topic, one debate that I think I've been hearing more is just -- is the orthopedics robotic market getting a bit more crowded nowadays? So just with competitive entrants kind of coming in, you talked before about it validating the technology overall. But I mean is there more concern now that Stryker may not be able to continue to kind of outpace market growth or accelerate share recapture? I mean how are you feeling about Mako's positioning today? And is it more about stabilizing share or maintaining share? Are you able to still kind of go and be offensive and drive share gains?

I'm feeling great about our business. Our Mako order book is -- continues to be very strong. We know we have a fabulous solution. Robotics is here to stay. If you walked the floor, which I did, at AAOS, robotics was everywhere. 5 years ago, that was not the case when you walked the floor. And that, to me, is a tailwind. It's -- robotics, overall, it's still very underpenetrated. So that will grow the actual adoption. And as the leader and someone who clearly has a fabulous solution, we know we're going to gain more than our fair share of this market. So I feel very good about it. Certainly, the knee business has been kind of a killer application, feeling great about that. But increasingly feeling good about the hip business as well, which has been growing very, very well. That's going to, of course, be aided by the launch of our new stem in the fourth quarter this year. It won't have a big impact this year, but it will certainly have a big impact next year because you'll be able to do direct interior with that stem with Mako. And that is really exciting, combining the 4.0 software with Mako and this stem for direct interior. So we believe we're in a very good position, both for hips and knees, to be able to grow above the market rate.

And on the hip and -- the hip and the combination of the stem product launch that you're doing in the fourth quarter, you mentioned 2022 will be kind of a more important year, obviously, just given the launch timing. But how kind of long term or how long tailed as an opportunity is that kind of for you to drive hip growth between the new application and the new stem?

Well, I think it's multi years. I mean, I think this is one of those situations. If you look back to when we launched Accolade stem, we had many, many quarters of above-market growth in the hip business. So it's not a 1 quarter, 2 quarter, 3 quarters, and so this tailwind should last a long time. And I think the combination with Mako is very compelling. We've seen in the knee business, when you start to move the market, it tends not to happen just in 1 quarter or 2 quarters. It tends to be a sustained above-market situation. Of course, competitive entrants will come in, and we're going to have to make sure that we stay ahead, which we have historically. But we welcome the competition, and we think it validates robotics. And we needed this new stem. So we've held our own in the hip business in the absence of having a really, really good stem that meets a certain portion of the market's need related to direct interior. And so in spite of that, we're still growing kind of at the market rate. I believe with this, we'll be able to grow above the market rate.

Got it. And just to maybe focus on new robotics for a moment. There's just kind of one of the ongoing debates has just been robotics in knees is still very underutilized today. But the real question, I guess, is kind of what's going to drive utilization higher? Is it long-term data? Do we need to see 10-year data? Is it just market expansion for more competitors kind of coming in and getting the message out? But just do you envision a day where we're sitting at AAOS and robotics is becoming the standard of care in knees?

Yes, I do believe that will happen. I can't be precise on the timing of when it will become standard of care. But if you look at our own business, almost 1 out of every 2 knees in the United States is going in robotically, as we commented on the fourth quarter last year. So that tells you we're well past early adoption, at least, for our business, and something that I think will just continue. And the more competitive entrants there are, the more that validates this is going to happen. I think what gets us to the next level is people who were naysayers trying it. And once you try it and you realize you get more information, you have more -- you're able to do things you couldn't do before without robotics. It upskills the surgeon. And the hospitals that are buying their second and third and fourth robots are doing this because they're getting better outcomes, and they're feeling better about doing the procedure this way. And so it's not one of those things you're going to go backwards on. Once you start doing it and you see the benefits of it, what we were seeing in our business, and then I'm sure the market will see this more broadly, is once you start having a better way to do something, why would you start -- why would you go back? It's -- you're just going to continue to advance. And obviously, we're going to work on refinements and better software, and it will continue to get better over time. But I think we're past the point of no return here, where robotics will just continue, and they'll be here to stay.

Got it. And just for -- you mentioned more information from robotics. You also have the potential for wearables, for smart implants. So I mean what are your thoughts on wearables versus smart implants today? You've made the Orthosensor acquisition. A competitor seems to be going, or not seems to be, is going the smart implant route. I mean is it realistic that these implants could get a premium price in a knee category, which tends to see pricing pressure? And sorry to layer this on there, too, but just maybe take a moment just to maybe talk about kind of your digital solution or potential for digital solutions really broadly in your orthopedics category. What does that look like down the road?

Yes. Let me start -- let me step back first and say that I think digital and smart products are going to be launched across all of Stryker's portfolio. You heard about our recent acquisition of Gauss Surgical recently. And that is a digital product that's going to quantify blood loss. And so everything we do is going to have some smart components, some smart feature to it. That will include smart implants or wearables. And I think the value that it demonstrates is going to determine what kind of pricing you get. And so could there be a premium? Sure. How dramatic it is depends on what kind of value you're getting from it. And I think we're just in early stages. And so while I do believe smart implants and wearables is a big part of the future, which is why we did the Orthosensor acquisition, and we'll continue to pursue this. I think it's going to take time for this to really demonstrate the value because what data are you collecting? What are the end points? How can it help improve an outcome? Those are things to be proved. We have to prove it. Our competitors have to prove the value. And there are a lot of question marks today. I think the data is going to be useful, but we have to be able to turn that data into something that actually validates the need for it. And we're not at that stage yet. So I think this will be something that will grow over time, but it's not something that's going to transform the market in a very, very fast period of time.

Okay. And maybe just on Mako, specifically. I kind of like to better appreciate or better understand the OUS rollout and the opportunity ahead for Mako. I mean it sounds like it's still early days, but you're really approved in some major markets. But how should we think about rollouts? And I mean what would you kind of think about for utilization compared to some of your U.S. systems?

Yes. As you've seen with other robotic offerings, it takes longer in the markets outside of the United States, generally. And that's not true for every country, if you look at Australia or you look at the U.K., but many of the markets does take a little longer. They are more deliberate. They want to gather data. They want to see the improvements in their local markets. For us, the 2 biggest markets that are really exciting are China and Japan. We do have approvals in Russia and Brazil and other markets. But those are 2 big markets where technology is embraced and where we have a lead in both of those markets. Those are also big hip markets. If you look at the U.S., there's many more knees being done than hips. But these -- because of the anatomy, there's a lot of hip procedures that are done, a lot of dysplasia. And what we know with Mako is the more severe the deformity, the more the robot really helps the surgeon out. And they do tend to have more severe deformities in that market. So I'm actually very bullish on the hip market in both Japan and China, as well as the knee, where we know it's a great application. But I think we'll see a little bit more upside in hips in those 2 markets than we've seen in the United States, just based on anatomy, number of procedures and the types of deformities. But those will be the 2 markets of prime focus outside the U.S. We are in the very, very early stages in both of those markets, but so far, the reaction has been extremely positive. And obviously, COVID has kind of put a bit of a damper on things but -- just in terms on the amount of procedures, but it's starting to pick up. The rates are very low, but they're -- they've been in a very sort of modest environment in terms of doing procedures, and we'll start to see that grow over time.

And you mentioned China so maybe this is a good segue into that topic. But understandingly, China is still a small part of the Stryker business today. But could you maybe share your updated thoughts on the volume-based procurements that's -- tenders that are happening in China? But I think, more importantly, you've hinted at the potential to really kind of take this moment and go on the offensive in China. So kind of what does that strategy entail and look like? Is that just orthopedics? Or are we talking kind of the broader half of the Stryker portfolio?

Yes, it's not just orthopedics. So when I think about China, we're underpenetrated across most of our businesses. I think we have a very strong neurovascular business in China. But outside of that, I would say, most of the other businesses, we have a lot of upside in China. It's historic. It's an historic issue with Stryker. Just like you saw with Europe many years ago, we had historic underpenetration. We've been addressing that with very good growth in Europe the last 5 years and expect that to continue going forward. In China, we have to make up for some lost time across our portfolio. Of course, the VBP causes major issues in hip and knee, but we're a very small player in hip and knees. So we have less to lose than our competitors. And we have Mako, which the surgeons really want. And we believe that this is a time for us to lean in a little bit in China, more broadly, knowing full well that there's going to be some pain as we get through the VBP process with hips and knees. But given that we have Mako, given that they want Mako, we believe there's going to be a way for us to have an economic solution that works in China. And it's just too big a market for us to ignore, long term. And it's not going to move the needle in a major way in joint replacement, certainly, for the next couple of years. But 5 years from now and beyond, it's going to be very important for us. But the rest of our portfolio, we also want to strengthen in China.

And with the portfolio, some of it has been approved, but is it more just putting commercial feet on the street or working with partnerships -- or working on partnerships?

We don't have enough time on this call for me to kind of explain all of it, Drew. I would tell you, part of it is our people, our talent, our structure, our connection with our manufacturing divisions. Approval is natural, right? That's always caused us some of the delays. But I would say, it's really, let's call it, a reengineered commercial offense, which includes government -- government and market access. Having the Trauson and the Stryker teams -- so we sort of have 2 separate teams, and sometimes there are synergies that we can be gaining from the 2 teams. So we have a pretty robust commercial plan that we're going to be launching, not enough time to go through all of that. But it's kind of, call it, a little bit of a reboot of our commercial offense, not unlike what we did in Europe, but it's a little bit more adapted to the market because it's quite different in China.

And sorry if I missed this, but is this happening today currently? Or is this more of a kind of a 2022 initiative?

Yes, let's call it 2022. It's not -- the work has been underway this year in the planning phases and, let's call it, the implementation will start to go live in '22.

Got it. Okay. Maybe to change topics for a moment, just on M&A. I mean Stryker has clearly done a lot of M&A since you've been CEO. And I think I've heard you mention before that, even when you started, MedSurg was even a smaller business than orthopedics at the time.

Right.

So you've been able to layer in companies and products to really accelerate your organic growth over time. But really kind of what's next? Kind of in a post-pandemic world, how are you thinking about M&A? And maybe what are the challenges today that might not have been apparent several years ago when you were -- or even when you were first becoming CEO of Stryker? Should investors be concerned that maybe the M&A engine kind of will stall out in the next 12 to 18 months?

Well, I don't see it stalling out just because of the pipeline of deals in our businesses. We have a very robust pipeline. We have our decentralized business development people sitting in each division, constantly looking at targets. We have some new challenges, right? So one challenge is the IPO market is now open for business. We weren't really competing against IPOs in the first 4 years of my tenure as CEO. Now that's an option that some companies have. They can go IPO instead of being acquired by us. Valuation has always been a challenge, by the way. It's not a new challenge, but of course, the multiples have gotten a little higher. And you know that we're a very disciplined acquirer. And even if we like an asset, we're not going to reach and have financial metrics that we don't feel comfortable delivering and creating value for our shareholders. So we won't continue to reach. And then the third area would be sort of, let's say, filling major gaps. We've kind of addressed all of our major gaps. Spine was a major gap Upper extremities was a major gap. Sports was a major gap, foot and ankle. So both extremities, upper and lower, we were not leaders when I first took over at Stryker, and we're now in a very strong position across all of those areas. So we filled all of our major gaps, but that doesn't mean we don't have more opportunity. And certainly -- and you mentioned MedSurg, tremendous number of adjacencies that, where Stryker doesn't play today, that would fit very well inside of our company. And so I'm not worried in the short term, let's say, even in the next 3 years. I don't worry at all about not being able to deploy capital on value-creating deals. Many of them are going to be small, like the one we announced recently, but others will be a little bit larger. But there is -- there are plenty of companies out there that we think will be value-creating, and -- but it's really making sure we're smart about picking the right adjacencies. And picking -- the tuck-ins are easy. Those -- we were good at that, and we'll keep doing those tuck-ins. But when we're talking about multibillion-dollar deals, then making sure we pick the right companies. And our track record has been pretty good so far, and I think we'll continue to be a disciplined acquirer. But I'm very pleased, frankly, with the cash flow we've been generating. We're well ahead of our schedule in terms of the debt paydown. And so we'll be able to get back into, let's call them, more than small deals in the not-too-distant future.

Got it. Got it. Very interesting. And do you think -- we've had several large-cap med tech companies announce spin-offs or divestitures. I mean do you think that's an avenue for Stryker? I mean is there anything in the portfolio that you would label as structurally low growth? Or are you 100% satisfied with every part of the portfolio today?

Yes. Right now, I'm satisfied with our portfolio. And as you've seen, our growth has accelerated organically each of the years from '13 all the way to 2019 prior to the pandemic. And we grow above our markets, across all of our businesses, pretty much year in, year out. So I'm feeling good about our portfolio. You shouldn't anticipate any kind of spin happening here. Frankly, strategically, our companies make -- our divisions make a lot of sense. They actually work very well together. A good example of that is our ASC offense, where you see our divisions fitting very well and meeting the customer needs as they set up their orthopedic ambulatory surgery centers.

Got it. And just on the ASC. I mean you've talked before about the pandemic has accelerated that trend towards the ASC setting. And it sounds like -- and just being at AAOS, I mean, you essentially have the full portfolio in place. But is there anything that you could offer in terms of sizing the opportunity? Or could you help frame kind of the typical ASC opportunity from a contracting perspective?

One of the expressions our member of the ASC team uses is, if you've seen 1 ASC, you've seen 1 ASC. So some are 2 ORs, some are 4 ORs. Some have large physician ownership, some have smaller physician ownership. So -- but the reality is, these are all customized deals. Every single deal we do is a customized deal. And every single hospital system I talk to has plans to expand in the ASC. So the capacity -- it's just a capacity challenge. How fast can they build ASCs? How fast can they move the procedures? And so today, it's still a smaller portion of our overall, certainly, our joint replacement business, growing at a robust rate. But it's hard for me to predict exactly how big this will be. There are, as you know, you've read the research reports saying that, in 5 years, we could have up to 50% of the hip and knee procedures can be done in ASCs. I don't know if it will be that fast, but it's heading in that direction, without a doubt.

Got it. And I know we're coming up to our time here, but I just wanted to hit on a few other topics. Just in MedSurg, specifically within medical, the ProCuity bed launch. It sounds like you have some other models coming out later this year, early next year. But can you just let us get a better sense of how the launch is going, what you're seeing in terms of capital equipment health and the hospital bed market in general?

Yes. We're delighted with the reaction so far with that. So the low-height feature, the totally wireless feature is being received very well by customers. Our order book is strong right now. We have 4 models in total that we'll be launching which include fully featured beds that could be used in the ICU. That's not -- that one is not launched yet. But we started with the MedSurg beds, and they have basically different features in terms of mobility and other high-acuity features. So that's the 4, let's call it, 4 SKU design of the bed. We're making as many as we can. And right now, we're selling as many as we can make. So we have a high-class problem of having more demand than we can supply. But we're very excited. It's going to be a multiyear tailwind for us in the acute care business unit that sits inside of Medical.

Is it -- are you thinking this is more share gains? Or could this be a potential market expansion like for international bed capacity?

Well, certainly, international. As you know, we've been very weak overall in terms of our bed business and only started selling in Europe just about 4 or 5 years ago. And so it will be both. It will be sort of share gains here in the United States and expansion around the world.

Got it. All right. And wanted to maybe throw a question to Glenn for a moment.

Sure. Sure, feel free.

We're hearing some companies talk more and more about inflationary pressures, input costs. A robotics company last week noted that it's essentially hand-to-hand combat when it comes to supplies. So are you seeing these issues manifest more in the last couple of weeks? Or has it still been kind of manageable?

Yes. I would say, first of all, as a reminder, I mean, we typically see some kind of inflation on raw material purchases on an annual basis. I think where we're seeing inflation is in areas where we're seeing sort of shortages of the critical supply items like electronics, like resins. I would say, to date, it's been manageable. We're not really feeling like that's a limiter for us. We also have really spent a lot of time professionalizing our purchasing team. And so I would say that we're getting gains that more than offset any of our inflationary pressures that we're feeling. So I really don't expect that, that would be a significant impact for us this year.

Got it. And then just on tax for a moment. Just with the Biden tax proposals and some things coming out of Washington, is there anything or -- that we should be considering for the recent proposals, or things that we should start to kind of throw into our model for 2022 or beyond?

Yes, I don't know. It's a roulette wheel. It will have to get through the House and the Senate to become effective. Everybody is proposing a different number so far. Biden's on the high side. I think the Democrats have proposed like a 26% number. So I think, for right now, we're more in a wait-and-see mode than necessarily reacting to what we're hearing on the street.

Got it. And I'm sure you'll want to talk about 2022 operating margins, but I'm just going to ask the question anyway. I know you're not going to give guidance until January, but it sounds like Wright is growing much better than expected. You're very pleased with it. There's potentially other cost savings program. I think consensus has 2022 operating margins expanding about 70 basis points. I mean that's kind of over the 30 to 50 commitment that I think you've given historically. So is that, in any way, shape or form, kind of crazy directionally to think about? Is this something that we could potentially hear more about at the upcoming Analyst Day?

Yes. We're on track this year to deliver 30 to 50 basis points. As it relates to next year, we'll talk about longer-range financial guidance, which certainly would be applied to 2022. And then as you know, full guidance for 2022 will be released when we release our fourth quarter earnings in January. So that's all I can say.

Okay. And Kevin, I just wanted to ask you a moment for the -- ask you on the Analyst Day. I think the last Analyst Day was 2018 time frame, and that, I think, focused really on neurovascular, trauma, extremities and endoscopy. So should we kind of be thinking a similar showcase of certain product categories? Or because we're getting past COVID, hopefully, you might take the opportunity to really kind of showcase the full Stryker portfolio?

Yes. We're going to definitely showcase a broad set of products across our portfolio. It's not going to be one business or another business. We even have that safety component, which is very interesting. A thread that runs through many of our businesses that we'll be able to showcase with you, which is one of the deals -- the deal we announced this week is, again, related to safety, whether it's patient safety, whether it's caregiver safety. We have a pretty robust portfolio, which, frankly, has played well during these COVID times. And we built this prior to COVID because it's just, frankly, it adds value to the health care system. So you'll see a broad section of businesses at the Analyst Day. And you'll be able to interact with our management, which we always like to have our division heads, our business heads there, and you'll be able to have free access to them.

With that, sadly, we're out of time, Kevin. But I really appreciate your time, and Glenn also. Thanks for attending the conference today.

Well, thank you for having us.

Thanks.