Stryker Corporation (SYK) Earnings Call Transcript & Summary

Travis Steed, medical device analyst at Bank of America, and glad to have Stryker here this morning. I have Andy Pierce, Group President of MedSurg and NeuroTech. We also have Preston Wells, VP of IR, for about another month. And so Preston, maybe you want to introduce the new IR in transition.

Absolutely. So Jason Beach, who's down here in the front left, will be assuming the IR responsibilities for Stryker as I transition back into the business.

Great. And look forward to working with you, Jason.

So I guess, Preston, we could start out on -- we'll start the top line recovery. Strong March, sounds like things were also strong in April as well. Like how are you seeing the top line recovery throughout 2022 and especially the -- given some of the staffing issues and that easing over the course of the year?

Yes. I mean we talked about it in our first quarter call. We saw a really good return of procedural growth, really starting in February, accelerating through March, and we've seen that continue into April. So we're feeling really good about the top line. We look at the guidance that we gave in terms of our overall 6% to 8%, really skewing towards the top end of that. And so we're feeling good about it both from a procedural return standpoint, but also from a capital standpoint, we're seeing strong double-digit growth across many of our capital businesses. Our order book from a capital standpoint remains really strong. So we're feeling really, really good about the top line and how that's continuing to progress. I think the one caveat I would put out there is as we think about growth rates, though, second quarter of 2021 was the strongest quarter -- non-COVID impacted quarter that we had last year. So from a growth rate standpoint, it will look a little different than the other quarters for this year. But overall, in terms of that return of procedural growth, it's really, really, really strong.

Was April pretty similar to March? Or is it similar?

Similar. Yes, similar from an overall procedural standpoint? Similar.

And when do you expect to kind of get back to more normalized levels? In the summer? I think that's what...

Yes. I mean I think in many places, we are starting to see it back to more normal levels. If we go back and look at what we did last year and we compared our growth rates versus 2019, if we assume 2019 is kind of that normal baseline, I mean we are seeing growth even off of last year's numbers, which grew off of 2019. So I think we're getting back to more of those normal levels. I think we're going to have sporadic challenges with staffing and things like that will persist throughout the year. But overall, I would say that we are certainly getting back to more normal levels.

Right. Okay. And you called out 50 to 100 basis points of margin pressures on the full year. It sounds like more probably closer to 100 basis points now given some of the incremental changes. If you break that down in different pieces, shipping, raw materials, spot buying, like how do you think about the different buckets there? And what could potentially ease?

Yes. I mean, listen, it's a dynamic time from a supply chain standpoint. I think you're not going to hear anything different from us than you're hearing from many others from that standpoint. If we think about that 50 to 100, I think the last thing we said is we're probably skewing more closely to the 100 side of that, that impact from all those different areas. And it really is a few different things. So inflation on a commodity basis is kind of that normal -- or that new normal of like 7-ish percent that you're hearing across the board. But the bigger component of that comes from the spot buy. So if we think about electronic components where we have to go out into the open market because our current supply base can't supply enough, we're paying pretty significant premiums on that. So that's a big driver. So that material piece is a big driver of that gap. The other area is around freight. If you think about transportation from an oil perspective, I mean we all can see that when we go to the gas pump. So I think that's another area that's playing heavy on that number. And then there's just our own internal inefficiencies that are also driving a piece of that. So if we think about not having good material availability for certain products, we have times where we have downtime in our plants. We have overtime in our plants. We're expediting and seeing air shipments that are playing into that as well. That's the part we expect to ease in the second half of the year. The inflationary pricing is going to be with us, right? It's going to be with us because we're buying now, we're getting better line of sight into our materials. And so that piece and that component of increase is going to stay with us throughout the year. But what we should see improve because of that line of sight is actually improvements in our own inefficiencies. We should be able to eliminate some of those downtimes and overtimes and expediting shipments and things like that. And that's the part we'll see ease a bit in the second half of the year.

If you break it into pieces, like parts are going to ease and parts that aren't going to ease, would it be roughly half and half? Is that a good way to think about it?

No, I think it's not. It's not going to be half and half. I think it will be less than that in terms of what eases. Because again, those material components that are real, probably the largest impacts, are going to stay with us.

Okay. That's fair. And I did look at Q2 of this quarter and where The Street's at. I do want to make sure we're clear The Street's at least thinking about Q2 correctly. And The Street's at 24.3% op margins versus the 21.8% you did in Q1. And you did say sequential improvement. I want to make sure that's where we should be thinking about sequential improvement. And also in earnings as well, Street's at $2.30 versus the $1.97 in Q1.

Yes. And I think The Street's modeled it pretty appropriately based on our comments coming out of Q1 for sure. I mean we should see some improvement because we're going to get some leverage on a higher sales number in second quarter than what we saw in first quarter. But yes, I would say The Street has modeled it pretty appropriately.

Okay. All right. Great. And then if you think about the pressures that you're seeing, not all of them is going to ease and we just talked about. Just given Stryker's ability to still do kind of 30 basis points plus of margin expansion over the duration. And then is 2023 a transition year where there's less than that? Or is it potentially a lot more because The Street's modeling like 100 basis points of op margin expansion in '23? I just want to make sure we're not well ahead of ourself at this point.

Yes. We're still committed from a long-term perspective that after we get out of this COVID environment that we will generate those improvements in terms of our operating margin on a long-term basis. Look, I'm not going to give guidance on '23. And certainly, I think, if anything, pandemic taught us that it's hard to see out into the future in terms of what's going to be happening. But certainly, as we see some of these impacts easing and at least the inflationary rates starting to maybe moderate a little bit, it does give us the opportunity to see some expansion in '23.

Okay. And then maybe to bring Andy in, the hospital CapEx environment, a lot of that's in your business. Maybe just kind of break down what part of that's capital versus not and what you're seeing in the CapEx environment given some of the pressures of the hospitals.

Yes. Sure. Thanks, Travis, and thank you for having us, first off.

Sure thing.

And wonderful to be back in person. The CapEx environment in terms of our capital in the company and what we're seeing and what we're hearing from our customers remains robust. Our customers are continuing to invest in products like ours. They need to run their business. Most of what they buy from us helps them to generate revenue and profit as an entity. So they are investing in our equipment. We have not heard, and we do spot checks with our own businesses in the capital world, our sales forces, our sales leaders. What are you hearing? What are you feeling out there? And it continues to be a healthy capital environment.

The hospitals are dealing with some of these pressures themselves, like are they offsetting that with other things than capital? Or just how does that come up in conversation because it sounds like even your backlog is incredibly strong right now from our conversation last night at dinner?

Yes. The hospital is going to have to figure out how to deal with their own inflationary pressures. That's for sure. We hear that. We see that. I believe there was an article in The Wall Street Journal this weekend about that on the labor side. And certainly, that would be affecting their operating budgets. But as far as their capital budgets are concerned, again, I'd go back to -- they need to get the train rolling again in surgery, and the vast majority of our equipment helps them do that, helps them do that well successfully, predictably, safely for their customers. And yes, as you noted, our order book or backlog, if you will, is as strong by bit of a factor as it's ever been. And that's really about getting the machine moving again with our hospital customers and in our ASCs as well.

Right. How much of the backlog is demand versus the shortages that you can't meet at this point?

Yes. It's a wonderful question, Travis. And I think the way that I would think about it is if you look at what our projections are in orders, particularly in our capital businesses, specifically to our capital businesses, sort of through the back half of last year and the first 4 months of this year, we've significantly exceeded our expectations from a demand perspective on the capital side. So yes, that is the majority of what our backlog is related to. Is there supply chain issues as well that adds to the backlog? Yes. But I would say the majority is over demand, if you will, from what our expectations were.

Is this usually a 6-month backlog or a year? Any way to sense how long it takes to get through a backlog?

So Travis, it depends on the business. So if you're selling power tools, you may have a 3- or 4-week turnaround from order to shipment on average. If you're installing or building a brand-new hospital room and you're putting in booms, lights and tables, that might be 10 to 12 months. So it varies. I would say, on average, our capital backlog usually turns every 3 to 4 months.

Yes. Okay. That's helpful. And you said the backlog was a factor of normal or where it's been historically. It sounds like a big number but...

I'll tell you what that factor is. It's more than 1.

More than 1. Okay. Is that across the business? Is there anything that stands out as being particularly strong right now within the capital piece? Or is it just everything?

It really is across the business. So if you look at our -- in our MedSurg world, our traditional capital businesses, we have our Endoscopy business, our Instruments business, in our Stryker Medical, bed stretchers, et cetera, business. And we have backlog built off of demand in each of those 3 big businesses. However, I would say the proportion of our backlog is stronger in our Medical division. Our ProCuity beds that we launched last year, our defibrillators, our AEDs have been particularly strong. So the backlog is disproportionately favored in that business.

Now the macro environment obviously could get worse from here. So when you think about looking at your business and more of a slower CapEx environment or a recessionary environment, how do you think your business would hold up? Is there -- what parts of the business and capital do you think are going to do well or not do well just when you look across the portfolio and look at historical recessions?

Yes. If we think about our history, and this is year 26 for me, I've been through a few recessions, and '08, '09 was particularly challenging, of course. Our business, by and large, when you think about our small capital, our power tools, our cameras, primarily being our small capital portfolio, some others in there as well, held up quite well even in the most dire financial circumstances. What did get impacted, just purely from an access to capital for our customers, was our big capital business. So think about our bed business, our booms and lights business, that larger capital that we have. That was impacted then. Now hopefully, we don't enter a phase that resembles '08-'09. But by and large, I would say -- and remember, that's only a small portion -- if you think about our 25% Stryker Corporation business makeup being capital, about 10% of that is large capital. So the small capital holds up fine. And again, it's prioritized in the investment profile of our customers because they need to generate that revenue and profit.

And then when you think about pricing in your business, where has it historically been? When you're having these conversations now, like if you look at the backlog, has pricing actually improved in your backlog now, some of the new conversations that you're having today, are you able to get a little bit more flexibility from your customers?

Sure. Yes. We reset price at the beginning of every year. So we raised prices internally. Of course, everybody knows in med tech that, that's not always fully passed on to the customer. But we generally hold serve in our MedSurg and Neurotechnology businesses if you think about our pricing year-over-year in any given time frame. Today, our customers certainly are much more aware of what's happening in general. It's happening to them and their -- particularly on their labor from an inflationary pressure perspective. So those conversations around taking price up more than we traditionally have are certainly much more amenable on the part of our customers. We're having those conversations today. We do expect that we're going to be able to move price to offset some of those inflationary pressures that Preston talked about. And we're right in the mix of doing that right now.

Is pricing offsetting like a small part of your inflationary pressures on your business or most of them? Any sense for how much you're able to offset?

It's a portion. Now typically, in any given year, we have various inflationary pressures. And we usually find operating efficiencies in our business, like any other good company would do to offset that. This year, it's obviously just too big. A portion -- remember, we believe that a fair degree of what we're talking about here is spot buy-related, which Preston talked about. So the durability of that from an inflationary perspective we expect to wane. So we are looking to cover what is more real inflationary pressure is what we see as longer-term sustainable inflationary that we love it with our pricing increases.

And Preston, while we're on pricing, maybe talk about pricing dynamics and the other part of Stryker.

Yes. Absolutely. So I mean, I think we're all aware that traditionally on the ortho and spine side, we do see price decrease is typically happening on a year-over-year basis. But as we've mentioned on our quarterly call, all of our business is under evaluation from a pricing action standpoint. It will play out a lot differently on the ortho and spine side because most of that business is under contract. So you have generally 3-year contracts. And so as each of those contracts is coming up, just like Andy said, on the MedSurg and NeuroTech side, we'll be having those same discussions on the ortho, spine side and you'll start to see that flow through. And I wouldn't expect to see major price increases happening across ortho and spine, but certainly to curtail some of the decreases that are happening on an annual basis will be the focus.

Do you think overall pricing for Stryker could go flattish?

I should say, we'll see improvement. I don't think we're going to guide on where price is going to go, but we would expect to see some pretty significant improvement.

And if you look at like contracting and stuff like that, how long does it actually take for us to see that in results? Are we going to wait till next year or by the end of this year?

I think you'll -- and I'll certainly defer to Andy to talk about the MedSurg business. But I think for the businesses that are under contract, it will be kind of a slow build in because it will happen as each contract comes up for negotiation. So it will be over time. So you'll see that really start to kind of build up over time. And so it's not something you're going to see happen right away in second quarter, even third quarter. I would say, by the end of the year, you should start to see some improvements happening there. But it will be really over time, you'll see the improvements on the contracted business.

Okay. That's helpful. Do you want to talk about the MedSurg...

Yes. I wouldn't really add or improve upon what Preston said. I mean the reality is if you look at where our contracts lie, it is the vast majority of our portfolio has some contract tied to it, whether that's at the GPO level, the IDN level or the local hospital level. When you're talking about local hospital contracts, that might be 2 or 3 years in nature. There are thousands of them. And as Preston said, they will sequence in. As they come up, we will renegotiate those with a little more vigor on the price increase side. So you'll see that layering in over time to offset the inflationary pressures that we're feeling.

Okay. Great. And switching gears to the ASC strategy at Stryker. Like how much of your business has been pulled through from new builds versus remodels? And what's the outlook for some of those newer builds?

Sure. Our sweet spot as a company is when our customer is going through some disruptive change in the ASC. What is disruptive change? That would be a new build or that would be a remodel. And the reason why it's our sweet spot is if you look at our breadth and depth, our ability to essentially manage all of the capital requirements in an orthopedic surgery center, we have that. Whether it's booms, lights, tables, all the power tools, Mako robots, et cetera, we have them covered, cameras. And that becomes a very powerful offense when you look at our breadth and depth in those scenarios with disruptive change. Those are also typically, whether it's a new build or a remodel, the ASCs where you're going to see the majority of new business in total joints, for example, as you think about that trend out of the hospital into the ASC taking place. So falls beautifully into our sweet spot. As you know, as we've talked about in the past, we built an ASC team, a dedicated ASC team. That's about 2.5 years in the making, and that's been, dare I say, wildly successful for us.

Yes. When you look at the beds -- hospital bed market, obviously, there was probably some pull-forward with COVID. How is that going? You also have a competitor going through an acquisition. Are you getting some incremental wins on the margin from that? Any additional color you want to provide on the hospital bed purchasing?

Yes. The comment that I would make on the hospital bed market is, sure, very robust 2020, 2021. But we've continued to see that activity in our order book. Again, we're working through some of the supply chain challenges. But our order book is very strong, continues to be very strong. Our ProCuity bed has been a terrific success. Our customers love it. They love the connectivity aspects of that bed. And we are absolutely taking share. Now are we taking share because our competitor -- our primary competitor has gone through disruption? Not sure, and only because we have a brand new product, and we have an invigorated sales force, a customer base that loves it. I think we'd be taking that share anyway.

Yes. When you look at the ASC in your portfolio today and the things that ASCs are doing, where do you think the gaps are in your portfolio? What are some of the other opportunities and technologies and markets you could build out within your business to take advantage of the ASC?

Sure. Yes. Again, I would just say that as far as companies in our space, particularly in the orthopedic space, we're as well positioned as anyone. I'll take our portfolio all day long. Now that being said, and if you're going to build out the capital equipment of an ASC, you could look at anesthesia, not necessarily an interest of ours, but they need those products; sterile processing, whether it's washers, sterilizers. We do have a low-temperature sterilizer in the company today, but those are areas where we could continue to build out on the capital side. And then also, when you think about flexible visualization for urology, for example, colonoscopy, those types of procedures, those aren't products that we have today that would be down the road natural fits for our company.

Okay. When you look ahead to 2023, obviously, you have a really good backlog with pushing forward, probably some new product -- I'm assuming product launches, Vocera. Like can you just help frame some of the puts and takes on 2023? And [indiscernible], some of the product launches could be in Vocera going organic?

Yes. Well, Vocera, again, even in the stub period here, if you pro forma it out in the first quarter, had nice mid-teen growth. That's been consistent for some time. We expect that to continue. But if you look at our pipeline of new products, we are really aligning towards sometime in '23. I would say we'll probably reap the majority of these benefits in '24, and new product launches in our power tool line, our flagship power line, our flagship camera line. And we're also launching a brand-new defibrillator, which we have not done in a long, long time, which is a very big business for us next year as well. So the product cycle is lining up nicely. And again, I would say we'll see some of that benefit in the back half of '23. We'll really start to see that take hold in '24.

Fair to say your business in MedSurg is going to be above corporate average Stryker?

We always want to be above. And as Preston knows, not speaking out of school here, we generally are. We do pull the company up. We have some faster growth markets. We have some greater differentiation. If you think about our portfolio, some more niche products that exist inside of MedSurg and Neurotechnology, we are, we will continue to be for the foreseeable future. And it's our expectation that we will grow faster than the corporate average.

And Preston, I did want to touch on the Mako. It sounds like there's a little bit of staffing issues that impacted the Mako placements this quarter. Are you starting to see that ease a little bit more as you move into Q2 a little bit?

Yes. I mean, I think Mako, just like we talked about with any of our capital products, especially the larger capital products, we saw component challenges, staffing challenges, some -- just supply disruption that's happening. And so I think that will -- we'll continue to see some of those bumps along the way, but we certainly expect that Mako is going to have a strong year.

Okay. And what incremental like innovation on Mako, is it shoulder, maybe next potentially? Any update on what we can see something on shoulder or kind of what you're planning to do there if it's going to be more share gains or mix shift or...

Yes. Absolutely. So I mean we are constantly looking at innovation across Mako. And it's beyond just applications. I mean applications are the easy thing to talk about. So you could talk about when is shoulder, when is Spine, when are those things coming? But we just recently launched our new Hips software along with our Insignia Stem and we expect that to bring tailwinds to our Hip business as we go forward. We have a new software coming for the knee business, total knee business. And so we expect there to be some real enhancements there from a surgeon perspective. So I mean we are still looking at some of those areas. As we think about some of the additional applications, I mean we are excited about what hip -- I mean what shoulder could be. And I think that's going to bring some real differentiation in terms of that market. We don't have any new time lines or anything of that nature to share with you at this point, but it is something that we think will be a driver of share for us in the future.

Okay. And then M&A across Stryker, just the appetite for additional M&A. If you look at where some of the areas, adjacent areas, portfolio gaps that you may have today, where do you see the most opportunity markets to move into?

Yes. I mean I think what we've talked about and we talked about this at our Analyst Day. We're going to continue to look not only within the existing businesses that we have today, but we are going to look at spaces that are adjacent to the businesses we are. And some of those may be large adjacencies, and others might be smaller that fit in with our existing call points that we have. And we've seen some of those acquisitions, even over the last year with something like a Gauss Surgical and things like that. So I think you're going to continue to see those. On the ortho and spine side. I would say you're going to see a lot of focus around the technologies of the procedure and how do we continue to enhance the overall outcomes from a procedural standpoint. And within MedSurg and NeuroTech, and I'll certainly defer to Andy here to give you more insights, but we're certainly going to look at how we can continue to build out those call points that we have and adjacencies on the side of that business.

Sure. Yes. I would say that, first off, our hit list of opportunities, if anybody's thinking there's a shortage of opportunities in the marketplace from an M&A perspective, I will quickly correct that. It's long, it's robust, and we feel terrific. And frankly, we probably had to -- even as we think out over the next several years as we sort of refill our coffers, we're going to have to prioritize more than we ever have. We have so much opportunity across each of our businesses. And that's not a hyperbolic statement. We really do. That being said, Preston is absolutely right. We do have some more large-scale adjacency opportunities that we would love to do over time, and we're tracking very closely. But the majority of what will happen and what will continue to happen is what's always happened in our company, and that are -- those are complementary tuck-ins in our existing businesses that bolster our franchises. And if you track Stryker over time, you'll also see that we oftentimes use those acquisitions to split our businesses and drive even greater domain expertise in a certain area. So Jason has been leading our finance function in our Instruments business, and there's no greater example than that business in how we build a big business, split it, look for greater opportunity and split again, and we'll continue to do that. But most of that is through the tuck-in approach.

Right. And on -- I do want to touch on smoke evacuation. There's been some new legislation going into place. What are you seeing in that market? Are you seeing it accelerate some as the new legislation comes in? And how do you think about your contracting ability there? Are you winning share because of your contracting ability with the whole portfolio?

We definitely have an advantage because of our scale and our breadth and depth as a company, particularly when it comes to working with our administrative customers on the contracting side. Certainly, Stryker is big, and we can leverage that scale. That being said, in the smoke evacuation space, there is critical mass. There's momentum there. Whether you have a state that's legislated smoke evacuation or not, that market across the board is growing fast. Technologies that benefit health care professional, particularly our nurses, are very much in the spirit of being invested in today. Smoke evacuation is one of those. That market is growing robust. We are growing robust. In fact, we believe that we're growing above market in smoke evacuation, and that's going to continue for some time.

Where do you think the market is growing?

We believe that it's a mid- to high-teen growth market. It's a fast-growth market, maybe our fastest-growth market in the company. It's relatively small in terms of the scale of Stryker today, but it is a wonderful market. It's a market that leans very much into our mission around making health care better. And yes, we think we're going to continue to lead in that space.

Right. And then I know you don't have a big China business, but I did want to ask a last minute here. Are you seeing China recover at all into Q2?

Yes. I mean, I would say, certainly is -- China was a little bit later in that cycle from an impact from a COVID standpoint. And there's still with the 0 tolerance policy. I mean we still see impacts happening in terms of procedural volume there. So I think China is going to be one of those markets for this year that you're going to continue to see some slowdown just as a result of the policies that are in place.

Okay. All right. Great. Well, we'll end it there, and thanks a lot for being here in person in Vegas.

Yes, it's nice to be here.

We love it. Thank you.

Thank you, Travis.

Thanks, everybody.