Stryker Corporation (SYK) Earnings Call Transcript & Summary

Good morning. I'm Josh Jennings from the Cowen Medical Devices team, and we are thrilled to have 2 executives from Stryker join us at the 42nd Annual Cowen Healthcare Conference. Glenn Boehnlein, VP and CFO; and Preston Wells, VP of Investor Relations. Glenn, I'm going to hand it over to you for a couple of introductory slides that may include some minor updates and then we'll dive right into a fireside chat mode and -- but Glenn, take it away.

Okay. Great, Josh. Thanks for having us here. Today, I just wanted to take an opportunity to present a few slides and talk about Q1 specifically, and I'm sure you'll end up having more questions that will supplement this even. I'd like to kick things off with our mission and values. I'm happy to be here and update everybody on the Stryker business and our strategies. But this mission and value is really core to everything we do at Stryker. These are important characteristics that kind of underpin our strategies across all of our 22 distinct business units and our global functions. Our mission and values are visible worldwide at all of our Stryker locations. And I would tell you that now more than ever, this has been a really unifying important part of our culture. So moving on to first quarter revenues, there's some really positive things that I'd like to talk about here and then there are some things that are still variable that I want to make sure everybody understands. First off, we are seeing a positive trend on elective procedures returning, especially in the U.S. This trend really began to pick up in February, and we expect that to continue through the remainder of the quarter. Keep in mind, too, that the trend really impacts our deferrable businesses, which are primarily hips, knees, extremities and spine. So we're starting to see those pick back up as we closed out February. If you think about outside of the U.S., we're seeing pretty good progress and similar progress in Europe. There is still a lot of variability in Asia is what I would say. Japan went down -- back down on locked down pretty recently. And so we're actually seeing a fair amount of variability as it relates to procedures in Asia. During the quarter, as you turn to the other sort of big piece of our business is our capital businesses, I would tell you that customer activity and customers' willingness to place orders remains very, very strong. I mean we're seeing a level of robustness in our order book that we just really haven't seen before. The flip side of that is if you think about sort of the global supply chain issues that are going on and really as it relates to electronic and computer and other components, this is really having an impact and it's really delaying our ability to ship some of these capital products. I would say this impact is hitting all of our capital businesses, but it's most pronounced in our medical business. So despite all that and despite those challenges, we are going to have some pacing variability in the quarter. We still expect sales growth to improve. We still expect that sales growth will be in line with the guidance that we set forth at the end of January, and that would be -- that organic sales will be in the range of 6% to 8%. So as you think about moving down the P&L and we think about sort of earnings, there are some key things that I want to make sure everyone understands. As we outlined in our January earnings call, we fully expect and we are experiencing that the first half of 2021, our gross margin will be impacted by these inflationary items and supply chain issues. Specifically, these relate to the cost of spot buys for materials like electronic computers, electronic chips, and components. We expect that this is going to drive a negative impact. And in January, we said between 50 and 100 basis points within gross margin as you compare it to prior year. I think if you think about the full year, it's going to lean more towards 100 basis points in the first half of the year, and then it will moderate down as some of these supply chain issues improve in the back half of the year. The second thing that I want to point out is if you think about our operating expenses, first of all, we haven't cut any funding to R&D. We believe that R&D and the innovations that we are working on in R&D are core to our growth strategy. And so we have not pulled back on our R&D spending. I would also point out that if you think about our spending in our selling organizations, we have not pulled back there, too. We're committed to fund those programs because we think they're core to our strategy. During Q1, we hired sales reps. We expanded customer territories, and that isn't part of our sort of normal pacing of how we execute our business. The thing that I think that is important to point out though is if you think about this Q1 over Q1 2021, Q1 2021 had extremely low spend levels compared to sort of how we exited 2021 in Q4, which obviously rolled into the first quarter of 2022. So we fully expect that our EPS in this first quarter will be deleveraged from an operating expense standpoint. And when you combine that with our gross margin pressures, overall EPS will be negatively impact -- impacted during the quarter. So keep in mind, though, that this impact and this pacing of earnings throughout the 4 quarters of this year was fully baked into our EPS guidance, which remains intact. And as a reminder, that guidance was delivering full year EPS of $9.60 to $10 a share. We fully expect that -- while there will be some uphill issues that we're going to tackle in the first half of this year, we expect that some of those things will ease in the back half of the year. And you should keep that in mind as you think about pacing consensus quarter-to-quarter. So with that, I'd like to end here on a couple of high notes. We still have a lot of activity going on at Stryker. We are still heavily launching products. We are executing on our M&A strategies. And 2 of the really big things for this quarter are, first of all, the launch of our Insignia Hip Stem. The Stem marks kind of an exciting launch for our Orthopedics team as we kind of complete our hip portfolio, within the important and growing direct interior approach segment. Keep in mind, too, this Hip Stem will be Mako capable by the end of this quarter, which is a really big achievement for the team, and we're excited. We think there's a really great upside with the launch of the Stem. On the other spectrum, and I think everybody is aware that we previously announced and completed the acquisition of Vocera. We're excited to enter into this fast-growing segment of digital care coordination and communication. It will provide significant opportunities to advance innovation and accelerate our digital aspirations within health care. Vocera will bring a highly complementary and innovative portfolio to Stryker's Medical division, and it will enhance the company's advanced digital health care offerings and further advance our focus on preventing adverse events throughout the continuum of care. As a reminder, we had said the acquisition will be neutral to our adjusted EPS in 2022 and accretive thereafter. We're really excited about these growth engines for 2022. We remain confident in our ability to grow at the high end of med tech. And with that, I will turn it back to you, Josh, for Q&A.

Thanks, Glenn, and I appreciate you delivering those updates today. And a couple of follow-ups. It's encouraging to hear that the top line growth is intact and particularly in the Q1 because there have been some lingering headwinds. And -- but maybe just to ask about Asia, which seems to be the region that's most impacted in Q1. And what's changed? You mentioned Japan is locked down, and you're seeing a fair amount of variability in that region. Maybe just review your revenue exposure to the Asia Pac region? And just any further details you can give on Japan and maybe China, you can add a little bit of color there.

Yes. I think if we look at sort of the environment and focus on sort of what we felt in the U.S., we saw procedures that were coming back. We saw better and better scheduling, less procedure canceled. I would tell you that Australia and Japan, which are sort of our 2 biggest regions in Asia Pac, have experienced variability through the course of the last few months. I think Australia is clearly in the bucket of coming out of things, and we're starting to see more robust procedures there. On the Japan front I think that what we're feeling is just a little bit of pullback is what I would say, during the quarter. I would say in January, we were starting to feel pretty good about procedures coming back in Japan. Japan went back down on the lockdown and things slowed down again. I'd love to tell you that things are as predictable as I wish they are, but they're not. I do think that a lot of this variability that we're seeing in Asia Pac, we've built that into our estimates in terms of how we formulated our growth estimates. And so we don't necessarily believe that what we're feeling in Japan will be something that will be -- put us at risk relative to our top line growth.

Understood. And just -- maybe just a good opportunity to just reiterate or revisit just China. Like one of your major competitors has talked about VBP impacting their trauma and spine businesses. But maybe just what is Stryker's exposure to China? Our understanding is it's less than 2% of the revenue base, just want to confirm that. And then also, what are your -- what's baked into 2022 guidance in terms of VBP impacting your trauma and spine franchises?

Sure. And -- yes, you have it right. China is less than 2% of Stryker's total revenue. So we are generally under-indexed in that market. And even in spite of VBP, we do feel that there are still great growth opportunities in China. That being said, the biggest impacts that we're going to feel related to VBP will be reductions in pricing in our joint replacement businesses, hips, and knees. As it relates to the 12-province tender related to trauma and spine, we'll feel that most pronounced within our Trauson business is where we'll see that. We actually are starting to already feel the impact of some of that. I think that the impacts there, again, have been built in sort of to our overall estimates of where we'll perform as a company. We do think that there are still excellent opportunities in the Chinese market. We think, first off, our MedSurg products performed very, very well there. Our Neurovascular products performed very, very well there, and we expect to see growth out of those. We also expect that the Mako opportunity in the Chinese market will be very high. It is not impacted by VBP. The demand for that kind of technology in China is very good. And so we actually do feel like -- that gives us a leg up in spite of VBP to have opportunities in China to grow.

Understood. And just -- I know you just provided a download on the capital side and just some of the computer componentry delays and just the global supply issues impacting. But I think there have been an issue with capital deliveries at hospitals. So maybe to tie in staffing shortages or labor shortages at hospitals. I mean, from your comments around the U.S. and Europe and improving volumes, it sounds like some of those, I guess, COVID absenteeism has reduced, and there's been some modest relief at least in those metrics for your capital business but also your implant business over the last month, 1.5 months or so.

Yes. I think what we're seeing in our customers and especially maybe our larger customers is that they're navigating these challenges related to staffing. Keep in mind, their staff challenges were all over the place. They were in the OR. They were on the loading dock on the back, janitorial staff, frontline nurses, especially. And so I think what we're seeing is that as COVID is abating, that is providing some relief relative to the workloads of their staff and they're starting to sort of moderate and adjust to -- what's required to kind of continue and pick up their day-to-day activities. So I do think as we think about our capital businesses, while staffing has provided maybe some scheduling challenges and shorter-term scheduling challenges to deliver significant capital, the far greater impact on our capital businesses have really been the supply chain challenges and component challenges. And if you think about -- it's not just maybe a Stryker manufacturing issue, it can be an issue for our vendors that provide components that go into the capital products. And so it really is up and down the whole supply chain.

Understood. And moving down to in terms of the commentary around gross margins and the cadence and the update where some incrementally stronger gross margin headwinds in Q1 and then hopefully dissipating throughout the year. Maybe just to better understand, I guess, I mean, no one has a crystal ball, but to better understand your optimism around some of these gross margin pressures waning as we get into the back half. Anything of note outside of -- I think you have a consistency with most other management teams that we've spoken with, and that is our view as well. But and possibly 100% certain. But are there other specific maybe FX drivers or other elements to gross margin trajectory over the course of the year outside of just some of the supply chain pressures just improving inherently?

Yes. I think there's a couple just finer points as you think about our gross margin. First of all, as the year progresses and our Orthopedic Implant businesses become a bigger percentage of gross margin, those are not as impacted by supply chain issues. They generally have a higher gross margin than our MedSurg businesses. So as that becomes a bigger share, our gross margin should improve naturally. The other thing I would say is that we are out in the spot market and acquiring components, not only for us but also for our second-tier manufacturing suppliers. And as we acquire those components, we're securing longer-term supplies, so in other words, we're seeking to buy 6 to 9 months of supplies of some of these components. So as we are successful in those efforts, it gives me confidence that the supply will be there for manufacturing as we think about the second half of the year. But as we think about sort of this first half of the year and this first quarter, we are -- first of all, we are feeling the impact of the cost of those components more severely in our P&L, especially as it relates to sort of our MedSurg gross margin. And then secondly, just general price increases up and down the supply chain, transportation is more, labor is more. So all of those things, the disruptions in shipping and say, overseas, over water shipping by containers is not as reliable. So we're having to airfreight much, much more than we used to. And so all those costs are compounding to put a lot of pressure on gross margin.

Josh, if I could also add, when we talked about at our Analyst Day, our CTG 2.0, there were also some other aspects of that, that were beyond just direct procurement. So if we think about manufacturing excellence or distribution excellence, looking at a plant network, so all of those other activities are still in motion and understanding that they were a little bit longer term than maybe what some of the more direct spending initiative were. So those are obviously continuing. We would expect those to have some impact as well towards the back half of the year.

Understood. No, I appreciate those incremental details. I know you haven't given operating margin guidance for the year, but just any directional help, I mean, it seems as if there's incremental gross margin pressure, maybe hard to see margin expansion, considering all the headwinds you're facing. But is there still potential to get to a flat year-over-year operating margin performance in 2022?

Yes. Early on in my career, I learned about providing guidance in very uncertain and variable times. So I'm not going to provide guidance, but what I would say is that the first quarter specifically will be very pressured as it relates to operating margin performance. And that, that will progressively get better as we think about the pacing in the full year. And so you'll see Q4 margin delivery sort of more in line with what you're traditionally used to for Stryker. And I do think, as I think about your consensus estimates, you're probably a little flip flopped in terms of a little overly optimistic in Q1 and maybe kind of under-clubbing Q4 is what I would say as I think about the pacing of that throughout the year.

Excellent. And I just want to be clear, that's on both operating margin and the EPS line. I think the -- $2.06 for Q1. Understood. You mentioned about hiring sales reps in Q1 continuing to be committed to funding the selling organization. If that's just normal course of business in terms of the plan, are you seeing opportunities with this, I guess, just the wage increase, the environment of where you're seeing wage increases? Is that a part of the sales force, too? Are you guys plugging off also reps in different businesses? Or is this just normal course of Stryker's sales force expansion?

Yes. I think the reason I kind of wanted to make the point is if you go back and look at 2020 or even 2021, we hired sales reps, but not at what I would say is our normal course of business and pace of business. I would say in Q1 for 2022, we hired reps back at the pace that we normally hire with an eye to expanding our market shares here in the U.S. and elsewhere in the world. And so that kind of happened and restarted back sort of like our regular offense in terms of expanding those sales forces, expanding territories. We are the best sales force in med device. And so we do attract the best reps, and we absolutely make an effort to make sure that we're attracting those people. And keep in mind, too, though, the majority of compensation for our sales reps is commission based. So as you think about -- yes, there are hiring costs that will hit us in Q1 for sure. The bulk of their compensation really relates to how they perform relative to sales. And so that flows through the P&L at a commission basis.

Understood. Sorry if I missed this, and I can't believe I'm asking this question because I -- maybe just fell out of my memory -- short-term memory gap. But just in terms of the full year EPS guidance range, Glenn, you just -- did you make comments or reiterate that range or talk about the lower end of the range? I just want to make sure everyone's clear on the full year EPS update.

Yes, Josh. No, we reiterated the range.

Perfect.

And I have no comment as to where we might fall within that range. We'll update that at the end of our Q1 and that earnings call related to that. We'll likely narrow the range down based on performance in Q1. But right now, we reiterate that range.

Excellent. I wanted to maybe move on to some of the -- now we take advantage of having you, Glenn, getting being in front of you and asking about, I guess, more normalized terms that you talked about post-COVID at your Investor Day about the margin expansion trajectory. You set a new floor without a top end of the range of about 30 basis points of operating margin expansion. I know we've got to get through 2022 and see some normalization of the environment, both from a pandemic standpoint on volumes but also on the supply chain and inflation issues that everyone is facing. But maybe just, from a high level, just to -- I know you've talked about -- I think it was as an example of how bullish your team is in terms of the margin expansion potential that you set this 30-basis point for inclusive of acquisitions. And maybe just from a high level, any maybe mention the top 3 or 4 drivers of operating margin expansion as we get back into normalized times. And one, obviously, I would start off with is the volume recovery and that market-leading med tech revenue growth profile that you guys are aspiring to return to, I think, the right medical acquisition is accretive. But any other highlights you'd share just in terms of your increased optimism on the operating margin trajectory in normalized periods?

Yes. I would love to talk about operating margin expansion in a more normalized environment. First of all, I guess, I would say, through the pandemic, we kind of never let off on some of the initiatives that we had in place that we knew would sort of secure, have a more efficient operating environment. Starting in the gross margin line, when Preston highlighted our CTG strategy, which we sort of relaunched and reinvigorated at that Analyst Day, all of those things manufacturing excellence and network strategy, they're key. We have 46 manufacturing facilities. We truly believe that those can be scaled down and narrowed down to provide focus and that, that will drive future benefits and future leverage to Stryker. We also have continued our indirect purchasing sort of centralization, I would say, in driving better results from that. And that is the one thing that actually was very successful. In our first CTG, we've kicked it off and professionalized the staffing through the pandemic in that area. And so I fully expect that, that will be a driver. And frankly, not only this year, but for sure in future years. We continued with our rollout of our global SAP program. That will actually reduce the number of ERPs we have, and it will put the United States businesses all on 1 commercial ERP, which is a big deal at Stryker. It hasn't happened in 40 years. And in some instances, we're replacing systems that are over 25 years old. So there's a really big opportunity there to streamline. In connection with that, we have rolled out kind of our global business services in shared services. So we have over 400 people now in Costa Rica that are focused on finance, focused on IT, focused on sales operations, and that is really driving good efficiencies across our businesses. We've launched and announced the launch of our Warsaw Shared Services, which will do the same thing as Costa Rica. We are moving our teams that are in Amsterdam and relocating or rehiring in the Warsaw location, which will continue to drive really incredible efficiencies. And then we've continued to expand. We have shared services outside of Hong Kong. And we partner with Capgemini there, and we continue to expand that, too. And so all of these efforts really give me a lot of confidence that post pandemic will -- we'll keep our heads down and keep going like we are. But post pandemic, we should be able to emerge with a lot of good things in place that give me confidence that we will drive operating margin improvement.

Excellent. And one of the elements of just the gross margin, actually pre-COVID and once we get back to normalized areas it's just been Stryker's ability to navigate the secular pricing headwind in the med tech space. I think you called out less than 1% pricing headwind for 2021. I mean that's think back 5 years ago, if we were able to forecast that, we would have been even more bullish on the Stryker story. I mean how do you see pricing going forward? I mean hospitals don't seem to have significant budgetary issues currently, but there has been this lingering COVID, and they haven't gotten the funding in back half of '21 than they did in '20. But just the pricing environment and how you're thinking about that evolving in the longer-term margin trajectory for Stryker?

Yes. I think it's -- in med device, we have faced pricing cuts every single year across various pieces of our portfolio. So we -- all of our divisions have pricing teams. We look very hard at what are the opportunities to increase prices. And frankly, some of our divisions like medical do gain price increases year-over-year-over-year. And our other capital businesses to the extent we introduced new technologies or new innovations, we are able to grab price. On the procedural side of things, we enter into longer-term contracts that provide for more fixed pricing or more pricing that is indexed to sort of Medicare reimbursements. That being said, as we say, if you -- for instance, if you look at our Mako business and as we continue to place more and more Makos and those Makos are often tied to volume purchasing plans related to the underlying implants, that typically has -- is a mechanism where we can fix price over a 3- to 5-year period for those implants. So we -- trust me, Josh, as we think about the environment of inflation that is going on, we are very focused on figuring out how to manage pricing, looking for opportunities to increase pricing where we are providing value and innovation and then also looking for ways that we can seek to at least lock in other pricing. And so it gets a lot of focus. And I think it will be something we'll continue to talk about.

Understood. Maybe one last question, run up to end the half hour here. But actually, assuming there's no material exposure to Russia and Ukraine for Stryker. You didn't call it out, but so I just wanted to check that? And then are there any details you can -- incremental details you can share about just -- or quantify the sequential improvement you've seen in February versus January and then to early March on the U.S. ortho business and just elective procedures in general?

Yes. We don't really have a material commercial presence in Ukraine at all. So while we think the attacks are a little bit senseless and tragic, and we certainly feel for those people. In terms of our Russia business, it's a very, very small percentage of the overall Stryker revenue portfolio less than 0.5% is what I would say. We don't manufacture products there. We have a pretty limited presence in the country. We do feel that we provide technologies that save and improve lives, and our responsibility is to support our employees and customers and patients wherever they reside. So we're monitoring the global impact of this, and we constantly look at it, but that's where we are relative to those 2 locations. And then to your other question, just in terms of sequentially how things -- what I would tell you is that, as we look at December, January, and February, as it specifically relates to implant businesses, we are seeing pretty meaningful sequential improvement every single month. Are we back to pre-COVID levels? I'd say we're not quite there yet, but we have confidence in the trajectory. We're seeing procedures are being canceled. Do I think we're going to see one of those things where we saw that bolus, you remember back in Q3 as things abated? I don't think it's going to happen that way at this time. I just think what we'll see is we'll see a steady ramp up and maybe a period of time that kind of runs what I'll say is above normal. But we're excited about that aspect of our business, and we're ready to get back to being in those procedures and helping solve those issues for patients. So that will be a great thing for us.

Appreciate it. Glenn, Preston, thanks so much for participating once again, I mean, Stryker team participate once again, the Cowen Healthcare Conference, and I appreciate the updates and looking forward to keeping in touch.

All right. Thanks, Josh.