Stryker Corporation (SYK) Earnings Call Transcript & Summary

I'm Larry Biegelsen, the medical device analyst at Wells Fargo, and it's my pleasure to host this session with Stryker. From the company, we have Glenn Boehnlein, the CFO; and Jason Beach, the Vice President of Investor Relations. In terms of format, it's going to be a fireside chat. If anybody has a question, just raise your hand. We'll come around with a mic. Glenn and Jason, thanks so much for being here. Thank you.

Thank you. Thanks for having us.

So someone -- Louis, can you close the door, please? Can someone just close the door? Thanks. So let's start, Glenn, at a high level here. Stryker had a really impressive first half, I think 12% organic growth. Could you talk about the momentum you're seeing at Stryker? And how are you thinking about the operating environment today?

Yes, sure. I think, yes, we're obviously very happy with the growth that was achieved in the first half of this year. I think it's a combination of factors. First and foremost, we are seeing some relief on the supply chain front and seeing a little more normalization. And so we will to get products manufactured and delivered to our customers. I think secondly, we are also experiencing sort of elevated levels of orthopedic procedures. And that's something I kind of attribute a couple of things to. Obviously, there's just a backlog of patients and I'm sure we'll talk more about that. And then furthermore, it's really this meaningful footprint of Mako robots that we have out there now that are really driving utilization of our products on joint procedures. And then the other thing that really has continued and continues to be very robust, it's just our capital order pipeline and the related shipments that are derived from that, continue to be strong, continue to be robust. We are seeing our backlog at record levels, and it's something that's been stable, which means that the new orders coming in are really matching the shipments that are going out, which just speaks to a strong environment for capital as well.

Okay. That's great to hear. Just maybe check the box here on China. It's a very small part of your business, 1% to 2% of sales. We've heard concerns about anticorruption policies in China. What impact did this up Stryker? What is your expectation?

Yes. I mean we -- I've read the same things and heard about it as well. Our China business people have not necessarily alerted us to any specific impacts that they're anticipating. I guess at the very top level, China is less than 2% of Stryker's revenue. And so any impact that I think we might feel just would not be material at an overall level.

That's helpful. In terms of the guidance, turning to 2023, 12% organic growth in the first half of the year. The guidance implies 7% to 8% in the second half. How are you thinking about the second half of the year? Why would growth slow from the first half?

Yes. Maybe slow is a strong word, but I would tell you that Q3 is just seasonally the slowest quarter of the year for us. And so if anything, this year is starting to really look more normal in terms of the seasonalities that we've experienced in the past pre-COVID. So we'll feel a little bit of that seasonality that normally happens in Q3. There's vacations and breaks and things like that. And so procedures don't run as robust as they normally do. Whereas Q4 is seasonally our largest quarter and will also be our largest quarter this year. But keep in mind, Q4 a year ago, we grew 13%. So we're growing off a very high comparable for Q4 this year. Overall, we are at the midpoint, still forecasting double-digit growth for the full year, which is pretty healthy.

When you set the guidance, the comp is very different in Q4, but you have 1 less selling day in Q3. How did you think about the year-over-year organic growth Q3 versus Q4 when at the time of the Q2 call?

Yes. I mean I think we knew that Q3 was going to experience a little more pronounced seasonality than we had seen sort of in the COVID year. And so that was definitely factored in. And at the point we do the Q2 call, we sort of have July under our belt. So we begin to see how that's unfolding. Definitely thought of that. When you look at Q4, we know based on sort of quotas and targets and where the sales reps are combined with order pipeline and capital backlog to feel confident that Q4 will be a robust quarter like it normally is. But we also are mindful that growing off of a 13% number in the prior year is as a tall task.

Okay. And just on the seasonality, then basically, your comments are that it's normal this year, normal kind of a pre-COVID normal, nothing out of the order, nothing unusual.

No.

Okay. And then you made some comments on margins on the Q2 call that I just wanted to kind of clarify. You talked about continued improvement in the gross margin as you move into Q3 and Q4, and you talked about operating margins following gross margins. Were you talking about sequential or year-over-year or both?

Yes. And let me clarify this. If you think about gross margins and just what we're expecting to see and really the impact of spot buy sort of falling off in Q3 and Q4. So at the gross margin level, we should see sequential improvement and year-over-year improvement in gross margin. Similar to what we experienced maybe not quite of the magnitude in Q2 but similar to that. The op margin level, that will definitely drop through. But keep in mind, too, just because of the seasonality, Q3 op margin is a little more pressured than Q4.

Sounds -- it makes sense. And just transitioning look to 2024. Kevin was asked about it. You guys were asked about it on the Q2 call about this tough comp and this backlog coming through. Does that create a headwind for next year? It sounds like you still expect to grow at the high end of med tech. And it sounds like you haven't given guidance, but you still expect to have robust growth next year despite some of this backlog coming through. Is that fair?

Yes. Yes. We haven't given guidance and we're not giving guidance for 2024 until January. But I would tell you that if I look at the order flow, I look at what's in backlog, I look at new product cycles and where we are and where those are coming out. That gives me a lot of confidence that we'll be positioned very well for the high end of med tech growth for 2024.

Okay. And then we were talking about earlier branding on your call, product super cycle and sprinting back to pre-COVID margins. So let's take the margin one first. I guess, what's giving you the confidence that you can sprint back to pre-COVID margin levels, operating margin, which was 26.3. And this year, by our math, you'll do a little over 24% on the operating margin line. So what kind of visibility do you have to be able to kind of get back to pre-COVID margins?

Sure. Yes, Kevin does a good job of branding these things internally and externally. So that will probably stick for a couple of years here. What I would say is, first of all, I'll have sort of what we'll have accomplished this year. We'll see spot buys moderate and basically disappear from our gross margin, that will carry over into next year, a full year impact of that for next year. And then from a manufacturing perspective, we're back and we expect to get back to sort of a more normalized kind of leverage and efficiency drive within manufacturing. That is a regular manufacturing schedule, which we haven't been able to have because of supply chain interruptions. That helps us drive better fixed cost coverage. We'll get back to a better position with our vendors and purchasing and be able to drive volume discounts on purchasing. We're also seeing more normalization of freight. And it sounds incidental, but when you go from ocean freighting most of the time to air freighting most of the time, it's a big pickup in expense. And so moving that back to more predictable ocean freight and those rates should help to. We'll also dropping down operating expenses. We will also continue with the normalized sort of leverage game plan that we have on operating expenses. The biggest variable operating expenses we have is sales commission. We take a hard look at that every single year. The divisions are pretty active in making commission cuts which helps us drive leverage. And then the single biggest thing that we'll continue to leverage is our G&A spend and making sure that we're only growing that as required, and that we're able to leverage off of that fixed cost spend.

That's helpful. I think when we look at kind of how The Street and we approached it on the margin ramp back to pre-COVID levels. It looks like people say, well, your prior guidance, let's call it, 30 to 50 basis points. You took the high end of at the last analyst meeting, this was 30 basis points plus annual leverage. And people said, "Well, maybe they'll do 60 a year." So we netted out at kind of 60 next year in the following year. I think The Street is kind of about the same level. are people thinking about it the right way, Glenn? I know you don't want to front the investor meeting in November...

Yes. I mean I'm not going to confirm or deny your model, but what I will say is that it will have to be at an elevated level to sprint back to 2019. So that's what you should expect.

Fair enough. That's helpful. Jason, anything else that we can expect at the Analyst Meeting in November?

Yes. Certainly, I think as you think about kind of how we think about growth into the future, I think, I won't get into details of the agenda. But certainly, I think what you can expect to see is how we're thinking about growth organically, inorganically as we move forward will be hot topics in November.

All right. Well, we'll be there. We'll look forward to it. Glenn, switching gears, the worldwide hip and knee market or recon market is still running above the historical growth rate. How long do you expect the backlog to last?

Yes. I mean, right now, based on what we're seeing, just based on even the rough math that we saw, what is the normalized growth, what happened in the last 3 years, patients that did present themselves. Patients we know that also should be coming into the pipeline that just didn't. And then we look at our interactions with the ortho docs that we work with now and what they're telling us in terms of their own backlogs. I think it's safe to say that this ortho joint replacement backlog should continue well into 2024.

And once the backlog is exhausted, do we go back to the 2% to 3% we saw in 2012 to 2019? Or there structural changes that could drive that higher?

Yes. I mean I think a couple of things. There's a consolidated, more consolidated landscape. There's the impact of robotics. There's a smarter consensus around pricing for these contracts. So I wouldn't say that I think it will go back to that lower level, say that 3%, maybe land more like 5%.

Okay. That's helpful. And Glenn, here's one I'm sure you haven't gotten today. The impact of GLP-1 on Orthopaedic procedures. How do you think about the short term and potential long-term impact on hip and knee procedures?

Yes. We haven't gotten that question today. So I'm glad you asked that. No. The -- a couple of things. First of all, we're early days relative to the impact, relative to definitive data that would support us quantifying that impact. I don't have a spreadsheet. I'm pretty sure Jason doesn't have a spreadsheet either that would support a number. What I will tell you is that we have done the work. We've talked to our KOLs, wanting to understand what is their viewpoint and how they look at it. And what they have explained to us is basically -- as they look at their day-to-day practices, to adopt, they are all turning away patients who have certain higher levels of BMI or obesity, and as not patients that can qualify for these procedures. So their thinking is that to the extent there is this drug or a process where those patients can bring their BMIs down to acceptable levels, that makes them qualified for these procedures where previously they weren't. So most docs think that it potentially brings more patients into the product, into the procedure pipeline. The other thing I hear is that osteoarthritis is a degenerative disease. It's highly impacted by activity as one of the indicators of when you might need a procedure. So to the extent that there are patients that lose weight and become more active, that already have the indications for this disease. It might make them candidates sooner rather than later in the process. So to try to follow on this, I guess I would say that our belief in working with our KOLs is that this is a net neutral to a slight positive in terms of the impact that it could have. But I think we'll see more data that will come out. I also think, too, that if you just look at how the drug is used, how it's priced and what that impact could be. You don't have a lot of patients that can afford $17,000 a year in drug bills. We are seeing that most patients are coming off of the drug in 24 months and that the weight is coming back on. So I do think that's a factor, too, in terms of where these patients may end up.

Do you know what the BMI like limit that an orthopedic surgeon will typically treat the patients?

Between 27 and 30. And in this environment, if you think about the backlog of patients that most of these docs have, they're not looking to take on the high-risk patients. So those patients that probably have BMIs of 27 or higher are getting turned away in this environment.

Interesting. So in MedSurg, so the other aspect we haven't talked about is the super cycle. It's mainly in MedSurg. So there's 3 or 4 major new products there. Glenn, maybe just remind everybody of what of these products for people who might not be super familiar with Stryker?

Sure. I'll just give a couple of examples. One of the products that was launched towards the end of last year and that we're in sort of the first full year of launch, is System 9, basically our power tool product line that's used in orthopedic procedures. This System 9 is a meaningful upgrade from System 8 in that it has a new wireless battery capability, new sterilization protocols. It also allows for sort of greater efficiency and more serviceability. So it has features that customers want that drive better efficiencies in their ORs. And so we're seeing a couple of things with that. A meaningful price differentiation between System 8 and System 9. We're definitely feeling that. There is a steady cadence and good backlog of customers that want System 9, and we are experiencing that as well. I would tell you that most customers that have a System 8 or even a System 7, they -- at the point that, that system becomes, say, 5 years old, it has reached its useful life. And so those customers are also entering into the pipeline, the order pipeline for a System 9. Keep in mind, too, that in power tools in the U.S., Stryker has roughly 90% market share. So in any one given situation, we know where these customers are in that spectrum and who to approach. And so that's -- it's a powerful product brand for us and one that will certainly show benefits to the rest of this year and on into next year. Another big product line that I'll feature that will fully launch this quarter in the U.S. is the 1788 camera system. Again, it has meaningful step-up in visualization technology and connectivity within the stack of equipment that Endo uses in the OR. We -- typically, when we see changes in technology, especially in our camera technology, we're able to gain meaningful price increase. So that will happen with the 1788. What we also see is there's sort of 2 camps of customers. There are those early adopter customers who no matter what want the latest technology, they're the leading doctors in their fields. And so those customers will get in line very early, and we'll feel a little bit of an impact from them within this year. And then just like instruments, there's those customers that have reached the end of their useful life of their cameras, say, 3 to 5 years, that will have to upgrade. And so we'll see the benefit of that. I think the real benefit for the camera kind of comes in that next year, next full year. We will have worked through sort of that initial bolus of customers this year that are the early adopters. And we'll also have perfected our cadence for capital trials. Customers will have more wide sort of visibility of what that product can do. And so we're very excited about it. And it should be a big uplift for Endo for next year.

Glenn, you mentioned System 9, you mentioned 1788. You didn't -- but you didn't mention Neptune S and you didn't mention the new defibrillator. Should -- is that because those are 2 most impactful or just more near term?

They're probably more near-term. Neptune S is a -- it's a smaller footprint product, really geared for the ASC and the GI suite, which is a place we haven't played in before. So it kind of opens up some new markets for Neptune, which is exciting. There isn't really a viable competitor per se for Neptune. So these are really -- these are market going in and customers -- Neptune customers are generally very excited about the Neptune system and its ability to collect fluid in a safe, clean, efficient and sterilized way. Nurses literally hugged their Neptune, they love them so much because they don't want to deal with these liquids. And so it really makes a difference in the OR, and we're seeing really good results so far. The defibrillator, it's been a long time coming. It is -- what we'll say is a complex defibrillator, a business defibrillator, if you will. Back of ambulances, emergency rooms. It has a lot of feature sets that our customers have wanted for quite some time. And so we're excited about that launch. I think there will be a line just because of the current defibrillator market and some of the constraints on competitors, there will be a good tailwind for that defibrillator business when we launch.

So you've got the launch in medical, you have 2 launches in instruments, one in endoscopy. Should be MedSurg should have some pretty nice growth next year there?

Yes. They'll have some big targets. I'm sure they're listening.

And you talked about price a few times. I mean, ballpark, when you come out with a new product, 10% premium? How do we think about that?

I would say, it feels like you're looking at me here. I would say, I think high single digits typically. I think as you think about the recent product launches, System 9, 1788, we are getting higher price increases, double-digit think. And partly because of the current environment, right, inflationary pressures and those types of things. So it is a little bit greater than historical on these couple of...

Yes, we're in a weird spot. Inflation plus the technology premium pushes it up to the other ranges that we're used to. And customers are still lining up to order these products. So they understand the price increase.

And Glenn, I didn't hear you talk about beds. You'd have been very strong for you in medical. How is that going?

Yes. ProCuity has been -- we launched during COVID, and so we were maybe a little handicapped in really feeling the big impact related to acuity. ProCuity is a bed that can be configured in a way that it can be in the ICU and in a hospital room and in other hospital settings. So it makes it very relevant for what's going on right now in the marketplace. I also think that we've been able to capitalize on maybe some disruption of our normal bed competitor, and that's been put. And so ProCuity has done very, very well. And another big thing sort of on bed orders, and you saw a little bit of this in Q2, hospital systems are standardizing. They want one bed across their platforms. So we're seeing very large orders in our bed business. And that creates a little spikiness maybe in medical in terms of big capital, but I do think overall, it's very robust, and there's still quite a bit of opportunity out there.

And on the Q2 call, Kevin teased us a little bit with this instrument launch in spine, that would be help you in the market, I think, and maybe be synergistic with the robot, if I'm not mistaken. Any color there? Any timing?

Yes, Kevin loves to put those things out sometimes. I don't think I have anything really to add to what Kevin has said that other than stay tuned when we get closer to these things, we'll give you more details.

Is that close to the '24 when you -- the second half when you're coming out with the spine robot? Or is that sooner?

Yes. No, I think that's right. I think you'll learn more as we get into 2024. But I think -- to Glenn's point, there will be an ecosystem here, right, that is very great for the Spine business, and we'll talk more about it as we get closer to 2024.

And the spine and shoulder robot still second half '24 kind of limited launch, if you will, that I assume we'll learn more about those before. I don't know if there'll be anything before then that we'll learn.

Yes, I would say nothing new to report at this point. To your point, we have said spine kind of back half 2024 shoulder at the end things continue to progress really well. And as we have new updates, obviously, we'll share but nothing new there at this point.

That's helpful. And Glenn, Stryker has obviously been a very acquisitive company over the years. You've talked about maybe pausing a bit here in '23, ramping back up next year. How are you thinking about M&A, even next year, deal size, the last big deal what you did Vocera, I think billion, $3 billion.

$3 billion.

Mako was $4 million, $5 million, something like that.

Mako was -- I'm [indiscernible] medical.

I met mako. Sorry. Right, right. Apologies. Mako was like $1 billion [indiscernible]. I was thinking about a bargain. How are you thinking about Vocera and going forward deal size, we think about Wright and Vocera?

Yes. I mean -- we have done a couple of deals this year. There'll probably be another little one before we finish out the year, but small. That being said, these divisional business development teams have continued working with potential targets, looking at sort of what fits well within their businesses. And those range from tuck-ins to maybe smaller adjacencies. And so I think once we get back to opening sort of the capital flood gates for M&A. There's a pretty known lineup of companies that we would target initially for an M&A. And they're generally on the singles and doubles side of things, maybe $200 million, $300 million, $400 million type acquisitions that are out there. I mean we never stop looking at these larger sort of adjacencies, but a lot of it has to do with how we feel about the timing for it and are we ready to absorb that and things like that. So right now, in the immediate future for 2024, I think you'll see more of these sort of midsized tuck-in deals than anything else.

And when you say midsize, the $200 million, $300 million?

Yes, $200 million, $300 million, $400 million, in the deal size.

Not as big as Vocera or wright?

No.

Okay. And why is that?

It's just -- it's timing. It's what fits into the pipeline now for these divisions. And honestly, it's what the business has prioritized. So we don't sit at the top and go, hey, here's what we're prioritizing. They really are the closest to customers and know where they think the best opportunities lie. And so that's where things have played out thus far.

And so the 26.3, getting back to pre-COVID margins, if people are concerned that you'll do a large deal and it will be dilutive, and it will set you back from achieving that 26.3, it doesn't sound like that.

I mean I think at the point we definitively come out with guidance relative to that, we'll bake in what we know about M&A so that we're giving you the best number and the best timing at that point in time.

And one business we didn't talk about, which is neurovascular, had been a really strong business for you for many years. It's still good -- it's not quite as good as it has been. How are you thinking about that business going forward?

Yes. We're making strides and changes at neurovascular. I would say we need VBP to anniversary and then we'll get back to growing off of a comparable that's normalized for the worldwide NV business. We also just put in a new president there, Mark Paul retired. And so the new President is looking at -- potential changes he's making to the sales force. And I think we'll feel the impact there, especially in the U.S. And then I think to -- as we have some newer products in the pipeline that we'll see over the course of next year, not big products but smaller products that will be helpful. And then Cerus Medical will sort of be fully integrated and digested at least as it relates to their European business next year, and that should help with growth.

On Cerus, you were expected on the Q2 call. I checked clinicaltrials.gov, and it looks like the pivotal U.S. trial. If that's accurate, complete in September '23. Does that -- which would mean it's not that far away. I don't -- maybe clintrials.gov is not always up to date, but we have heard good things about that product?

Yes. I don't think we've commented specifically on the timing, that sounds a little aggressive.

No, it's not a lot. Okay. is accurate or up to date, but that's what it has for the U.S. trial. So -- just curious. Yes, as the person who asked the question on the Q2 call, said the feedback has been good. So...

Yes. We have seen good feedback, and we've known Cerus for quite a while. So we were very aware of their product and the features that it provided. Plus the good news is we're selling it in Europe. So we have good feedback and understanding of what is the use case for that product in Europe.

And the ASC shift you see that continuing in the U.S.?

Yes. I think the customer has spoken if you look at what happened during the pandemic. Patients prefer to the extent they can have a procedure done in an ASC environment, that's where they want to be. And if you're a healthy patient, with not a lot of comorbidities. I think that to the extent you're getting a joint procedure, a sports med procedure, maybe a routine spine procedure or even a GI procedure, you're going to -- you're probably going to go to an ASC for that. So I think we'll continue to see that grow. I think that's a trend that's not ending. I think -- before the pandemic, we set up that offense in how we think about and how we attack the ASC market. It's a unique customer. It's a customer that is not capital rich, doesn't have a lot of back-office complexity or nor can it handle a lot of complexity. So to the extent we have simplified that sales process that billing process, that inventory delivery process and even the capital acquisition process. I think that, that has really advantaged us in terms of how we compete in that market.

And Glenn, how does the -- so you have all these products coming out of MedSurg. MedSurg margin profile is different from the ortho margin profile. If MedSurg grows faster, an ortho. How does that impact your ability to get back to pre-COVID margins?

Yes. I would -- well, I would tell you a couple of things. We have lived with that for decades, MedSurg growing faster than Ortho. And so it's really baked into the baseline delivery that we have. I would tell you that we have looked heavily at that growth in terms of -- it is the kind of growth that is market-leading growth. You're right, it is growing faster than Ortho. It's absolutely baked into our thoughts in terms of getting back to those pre-COVID op margin levels. It's -- in terms of what are the formulas to drive that achievement of those levels, as I said, it's driving efficiencies in gross margin. And it will also be driving some efficiencies down in operating expenses. And that's really where MedSurg drives a lot of efficiency on the operating expense side. They're a little more efficient in terms of their business relative to ortho. So I think the combination of those 2 will help get us back to the 2019 of margin levels.

Perfect. I wanted to give you the last word here 40 seconds. If you want to -- we got a couple of extra minutes if you want, but seriously, I appreciate you guys being here. And if you want to make any closing remarks, please.

Yes. No, I don't know that I have a lot to add. First of all, I hope I see a lot of you at our analyst meeting in November. We are going to put a stake in the ground on both this when we get op margin back to 2019 levels. We also will lay out sort of our long-term growth framework, which is what we've done before. But in this case, it will be updated for the current environment. And then differently than last year, we have a little bit more of a structured product fair, which I think will give you more information into sort of some big sort of buckets of products that we have, both on the MedSurg side and on the ortho side. So I think -- it's I think it's going to be a great program. It will be a little bit of Jason's coming out party as the VP of IR. So we're excited for that too. So anyways, I look forward to seeing everybody there.

We all know, Jason. But look, we look forward to it as well. Thanks, guys.

All right.