Stryker Corporation (NYSE:SYK) Q3 2023 Earnings Call Transcript

Stryker Corporation (NYSE:SYK) Q3 2023 Earnings Call Transcript November 2, 2023

Stryker Corporation beats earnings expectations. Reported EPS is $2.46, expectations were $2.44.

Operator: Welcome to the Third Quarter 2023 Stryker Earnings Call. My name is Krista, and I’ll be your operator for today’s call. [Operator Instructions]. This conference call is being recorded for replay purposes. Before we begin, I would like to remind you that the discussions during this conference call will include forward-looking statements. Factors that could cause actual results to differ materially are discussed in the company’s most recent filings with the SEC. Also, the discussions will include certain non-GAAP financial measures. Reconciliations to the most directly comparable financial measures can be found in today’s press release that is an exhibit to Stryker’s current report on Form 8-K filed today with the SEC. I will now turn the call over to Mr. Kevin Lobo, Chair and Chief Executive Officer. You may proceed, sir.

Kevin Lobo: Welcome to Stryker’s third quarter earnings call. Joining me today are Glenn Boehnlein, Stryker’s CFO; and Jason Beach, Vice President of Investor Relations. For today’s call, I will provide opening comments followed by Jason with the trends we saw during the quarter and some other product updates. Glenn will then provide additional details regarding our quarterly results before opening the call to Q&A. Before I discuss the quarter, I would like to address the concerns around GLP-1 and what is being misunderstood. Our knee business is not at risk for a slowdown. There is an oversimplification taking place as it relates to the relationship between weight and knee replacements. This ignores the more important aspects of activity level and genetics.

We are, in fact, optimistic about the positive impacts of these drugs in both the short term and the long term. In the short term, it will help to make ineligible people eligible for surgery sooner. And in the long term, it will likely lead to more surgery as people increase their activity levels. With that said, the rate and persistence of adoption of these medicines is still a large unknown as there are significant barriers to this taking place. Lastly, as a reminder, we have a very diversified business, with knees representing about 10% of our sales. Now moving to our third quarter results. We delivered strong organic sales growth of 9.2% against last year’s nearly 10% comparable despite one less selling day versus 2022. This performance included double-digit growth in MedSurg and Neurotechnology and high single-digit growth in Orthopedics and Spine, reflecting a sustained robust demand environment and our team’s strong commercial execution.

Our results were strong across the globe with high single-digit growth in both the U.S. and international markets. In addition, we remain focused on our pricing initiatives, once again realizing positive overall price. We delivered quarterly adjusted EPS of $2.46, reflecting a 16% growth compared to the third quarter of 2022. This result was primarily driven from the strength of our sales but also demonstrates continued margin recovery. Finally, we are narrowing our expectations for 2023 to the high end of our previously provided guidance ranges and now expect full year organic sales growth of 10% to 10.5% and earnings per share of $10.35 to $10.45 per share. Coming off full year 2022 organic sales growth of nearly 10%, a 10-plus percent organic sales growth in 2023 reflects the strength of our of innovation, and our team’s sustained high performance, and we are encouraged by an important step in our margin improvement this year.

I will now turn the call over to Jason.

Jason Beach: Thanks, Kevin. My comments today will focus on providing an update on the current environment as well as capital demand, including Mako and an update on product launches. Procedural volumes remain strong, and we continue to expect patient backlog will support elevated orthopedic procedural demand through 2024. And while hospital staffing pressures and supply constraints continue in pockets around the globe, these challenges are resolving gradually and will continue to be a tailwind through the end of the year and into 2024. Demand for our capital products remained healthy in the quarter with double-digit organic growth in our Endoscopy and Instruments divisions. Our capital order backlog remains consistent with Q2 and elevated well above normal levels.

Also, demand for Mako remains robust with strong U.S. and international installations, which will continue to drive our hips and knees business. Next, our product super cycle continues to drive positive momentum. In Q3, our 1788 camera platform moved to its full launch, which is gaining traction in the market and driving strong order growth. In addition, we received 510(k) approval for our Pangea plating system in our Trauma and Extremities division. Pangea will be the largest launch in trauma’s history and is a very comprehensive system that will facilitate complete hospital conversions. We are gearing up for a full launch in the second quarter of 2024. We have also extended the capabilities of our Vocera platform to now be compatible with our newly approved Prime Connect stretchers, the first wireless stretcher on the market.

This wireless feature can be added to existing and new stretchers and will help address patient safety in the emergency room setting. These launches will continue to support our growth for multiple years. Our Mako spine and shoulder applications are on track, and we’ve received positive feedback from surgeons who have been exposed to the technology. As a reminder, on November 8, we are hosting our Investor Day with the theme: Delivering Leading Growth, which will be webcast live on the Investor Relations page at stryker.com. We will have prepared remarks from numerous leaders across Stryker, followed by a guided product tour for those attending live. We will showcase several of our exciting product launches with investors and analysts having the opportunity to interact with many members of our leadership.

We’re excited to provide our priorities and expectations for Stryker in the coming years. With that, I’ll now turn the call over to Glenn.

Glenn Boehnlein: Thanks, Jason. Today, I will focus my comments on our third quarter financial results and the related drivers. Our detailed financial results have been provided in today’s press release. Our organic sales growth was 9.2% in the quarter, the third quarter of 2023 had one less selling day than 2022. The impact from pricing in the quarter was favorable by 0.3%. We continue to see a positive trend from our pricing initiatives, particularly in our MedSurg and Neurotech businesses, almost all of which contributed positive pricing for the quarter. Foreign currency had a 0.3% favorable impact on sales. In the quarter, U.S. organic sales growth was 9.3%. International organic sales growth was 8.9% and impacted by positive sales momentum across most of our international markets, particularly Australia, Europe and emerging markets.

Our adjusted EPS of $2.46 in the quarter was up 16% from 2022 driven by higher sales, operating margin expansion and a lower adjusted income tax rate, partially offset by the impact of foreign currency exchange, which was unfavorable $0.02. Now I will provide some highlights around our quarterly segment performance. In the quarter, MedSurg and Neurotechnology had constant currency sales growth of 10.3% and organic sales growth of 10.1% which included 10.9% of U.S. organic growth and 7.4% of international organic growth. Instruments had U.S. organic sales growth of 17.3%, and with strong double-digit growth across both its Surgical Technologies and Orthopedic instruments businesses. From a product perspective, sales growth was led by Power Tools, SteriShield Waste Management smoke evacuation and surg account.

Endoscopy had U.S. organic sales growth of 10.6% with strong double-digit growth in its communications and sustainability businesses. In September, the Endoscopy business continued its full launch of the 1788 camera system, which provided strong sales momentum at the end of the quarter. Medical had U.S. organic sales growth of 5.7%, led by performances in its emergency care and stage businesses and was impacted by a strong comparable — growth comparable in 2022 of almost 14%. Medical continues to have a large backlog of capital orders, and we expect a solid Q4 despite a huge Q4 comparable. Neurovascular had U.S. organic sales growth of 8.7%, reflecting a strong performance in our hemorrhagic business. Neurocranial had U.S. organic sales growth of 14.5% which included double-digit growth in all 3 business units, neurosurgical, CMF and ENT.

Internationally, MedSurg and Neurotechnology had organic sales growth of 7.4% and reflecting double-digit growth in our instruments, endoscopy and neurocranial businesses. Geographically, this included strong performances in Australia, Europe and most emerging markets. Orthopedics and Spine had both constant currency and organic sales growth of 8%, which included organic growth of 6.9% in the U.S. and 10.6% internationally. Our U.S. knee business grew 5.3% organically, which reflects our market-leading position in robotic-assisted knee procedures. Our U.S. hip business grew 3% organically, reflecting solid primary HIF growth fueled by our insignia hip Sam. The growth for both our knee and hip businesses reflects one less selling day in the quarter and a very strong comparable in 2022 of 12.4% per hips and 14% for knees.

Our U.S. Trauma and Extremities business grew 11.5% organically with strong performances across all businesses, led by upper extremities and foot and ankle. Our U.S. Spine business grew 5.4%, led by the performance of our enabling technology and Interventional Spine businesses including the recently launched Q guidance navigation system. Our U.S. other ortho increased organically by 1.8% due to higher Mako placements in the quarter. Internationally, Orthopedics and Spine grew 10.6% organically, including strong performances in Australia, Canada and most emerging markets. Now I will focus on operating highlights in the third quarter. Our adjusted gross margin of 64.7% was favorable, approximately 210 basis points from the third quarter of 2022.

This improvement was primarily driven by the easing of certain cost pressures that we experienced in 2022, decreases in spot by purchases and the benefit of price and mix. Adjusted R&D spending was 6.8% of sales, which represents a 30 basis point decrease from the third quarter of 2022, primarily due to a higher comparable in 2022 related to the ramping of cost for product launches. Our adjusted SG&A was 34.5% of sales, which was 140 basis points higher than the third quarter of 2022 due to continued investments, including sales growth incentives and a more normalized cadence of travel and meetings. We expect our full year SG&A as a percent of sales to be in line with 2019 levels as we continue to invest for growth. In summary, for the quarter, our adjusted operating margin was 23.4% of sales, which was approximately 110 basis points favorable to the third quarter of 2022.

This performance is driven by the aforementioned easing of certain cost pressures, primarily on gross margin. Adjusted other income and expense of $61 million for the quarter was slightly higher than 2022, driven by increased interest expense partially offset by higher interest income. The third quarter of 2023 had an adjusted effective tax rate of 13.2%, reflecting the impact of geographic mix and certain discrete tax items. For 2023, we now expect the full year effective tax rate to be approximately 14%. Focusing on the balance sheet. We ended the third quarter with $1.9 billion of cash and marketable securities and total debt of $12.7 billion. During the quarter, we paid down $100 million of debt. Turning to cash flow. Our year-to-date cash from operations is $2.2 billion, this performance reflects the results of net earnings and higher accounts receivable collections.

Considering our year-to-date results, our robust backlog for capital equipment and continued positive procedure trends, we now expect full year 2023 organic sales growth to be in the range of 10% to 10.5%. We expect pricing to be slightly positive for the full year. If foreign currency exchange rates hold near current levels, we anticipate sales will be unfavorably impacted by approximately 0.6% and adjusted EPS will be unfavorably impacted from $0.10 to $0.15 per share for the full year, both of which are included in our guidance. Based on our performance in the first 9 months of the year, together with our strong sales momentum, we now expect adjusted earnings per share to be in the range of $10.35 to $10.45 per share. And now I will open up the call for Q&A.

Operator: [Operator Instructions]. The first question comes from Larry Biegelsen with Wells Fargo. Sir, you may begin.

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Q&A Session

Lawrence Biegelsen: Congrats on another good quarter here. Kevin or Glenn, you’re guiding to over 10% organic growth this year. What are some of the puts and takes to consider for next year on the top line in the bottom line. Any color on currency at this time. And we’ve seen a lot of companies increase their tax rate beyond ’23 or guide to higher tax rate beyond ’23. Anything we should be aware of with Stryker. And I had one quick follow-up.

Glenn Boehnlein: Larry, I’ll start out here and then Kevin can pile on. First of all, we’re super excited about 10% to 10.5% growth for the full year 2023. And stay tuned to January, and we’ll guide on 2024. As I think about currency, it’s — it was a little bit of a headwind in Q3. It’s a little bit of a headwind in Q4. We don’t necessarily think that it’s going to get worse, but it’s probably going to stay right where it is. We’ll assess that for 2024 when we get to January for that guidance. And then on tax, we just continue to have some favorability on some of our discrete items and also the way our sort of global mix of taxable income is rolling up, and that has helped us tax as it relates to Pillar 2, at this point, we’re not projecting really anything negative next year, if you think about our overall tax position.

But of course, we’ll include that in our guidance early next year. Thinking ahead, I keep talking about the super cycle of innovation. And it is really in full swing. You’ve seen that with the camera launch. You saw that with the amazing instruments performance in Q3 on the backs of the Neptune S launch and the power tool launch, which is really gaining momentum. And then we’ve got a very exciting next-generation professional defibrillator launch starting early next year. So we feel very good about our momentum really driven behind innovation and strong commercial execution.

Lawrence Biegelsen: That’s helpful. And just one on the margins. I know you’re going to talk about the long term, sprinting back to pre-COVID operating margins to next week at the analyst meeting. So I don’t — I know you’re not going to front run that. But my question is, how much visibility do you have? And what’s driving that getting back to pre-COVID margins?

Glenn Boehnlein: Yes. That’s a good question, Larry. And we will give you more color on it next week at the analyst meeting. What I can say for now, though, is that we have pretty good visibility to the sort of our supply chain our raw material purchases. To the extent possible, we enter fixed contracts related to the pricing of that, which certainly impacts our outlook for 2024. We’re not seeing any more spot buys. They basically have gone away for Q3. And so we do feel pretty positive about that. We’re also feeling better about our freight as things get a little more normalized, and we’re seeing less expediting of raw materials or even products. So we’re in a good position there. I would tell you that all of this has a backdrop of inflation that we know we have to offset as we move forward.

And as we sprint back to 2019. So we are working on that. Part of the strategy around that has really been a lot of the positive momentum that we’ve seen in pricing, and we will continue to work on our pricing strategies as we enter next year.

Operator: The next question comes from the line of Robbie Marcus from JPMorgan.

Robert Marcus: Great. I wanted to start on Ortho and hips and knees, and we’ve seen this a lot this quarter with increased seasonality. Wondering if you could speak to the trends in the quarter. Do you think you’re still gaining share? And do you expect normal seasonality to return in fourth quarter?

Kevin Lobo: Yes, sure. I’ll take this question. I would say we did see what I’ll call the more normal seasonality after the last few years of turbulence, starting with the pandemic. And so what that means is we think Q4 is going to be strong, seasonally strong as it was going back to ’17, ’18, ’19. We’re already seeing that kind of with the month of October. So I think we’re doing fine. Our business is — did not surprise us in terms of the results that we had. And obviously, we had giant comps from last year. If you look at the growth we had in Q3 of last year, feel very good about our position in both hips and knees and expect to have a good fourth quarter.

Robert Marcus: Great. And maybe following up, same line of thought. Other ortho had a nice quarter. Maybe you could just speak to trends in robotics and Mako and placements and just the capital equipment environment overall?

Kevin Lobo: Yes. Look, the capital equipment environment overall is healthy. And you see that in Endoscopy and Instruments numbers, even medical. The full year medical is going to be double-digit growth. It will be our fourth consecutive year of double-digit growth in medical. Obviously, Q3 was a little softer than Q2, which was huge. And large capital does — will vary a little bit from quarter-to-quarter. But overall, the environment is healthy. You saw the OUS numbers for other ortho are very big. So Mako is really picking up in both Asia Pacific as well as EMEA. But what we are — so overall, just tremendous momentum across our business on the capital side.

Operator: The next question comes from the line of Chickering with Deutsche Bank.

Philip Chickering: It’s Pito. On the margins. I realized that you’re not giving us margins sort of for 2024 yet. So focus on the third quarter gross margins. Can you bridge us on how you grew 220 basis points year-over-year. And how that compares to the guidance last quarter about gradual margin improvement. Are there any one timers in there? Because you’re already sort of within 100 basis points of where you were in third quarter ’19.

Glenn Boehnlein: Yes. There’s a couple of pieces here. Obviously, one of the pieces is where we were a year ago as you looked at Q3 and the impacts we were feeling pretty severely from spot buys. Fast forward to where we are now, we’re not seeing any spot buys. A lot of that is flushed through the income statement already. So that’s some given improvement right there. We’re also seeing sort of a more normalization of supply chain management. So a lot of that means we can get back to things like ocean freight and not air freighting all the time. We can have regular manufacturing scheduling and cadence which means that we don’t have people cycling in and out, which is really inefficient. And so I think that combined a little bit with sort of the mix that we saw within the quarter just really helped us give a lift to the gross margin.