Stryker Corporation

Welcome to the second quarter 2019 Strikers Earning Call. My name is Chantelle and I will be your operator for today's call. At this time, all participants are in a listen-only mode. Following the conference, we will conduct a question and answer session. During that time, participants will have the opportunity to ask one question and one follow-up question. If you would like to ask a question, please press star, the number one on your touch-tone phone. 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 GAAP financial measures can be found in today's press release that is an exhibit to Stryker's current report on Form 8K filed with the SEC. I will now turn the call over to Mr. Kevin Lobo, Chairman and Chief Executive Officer. You may proceed, sir.

Welcome to Stryker's second quarter earnings call. Joining me today are Glenn Bainline, Stryker's CFO, and Catherine Owen, VP of Strategy and Investor Relations. For today's call, I will provide opening comments, followed by Catherine, with an update on MACO. Glenn will then provide additional details regarding our quarterly results before we open the call to Q&A. With organic growth of 8.5%, our Q2 results reflect excellent momentum in all three segments, med-surg, orthopedics, and neurotechnology and spine. Med-surg delivered a roughly 12% organic sales increase with strong performances across the board. Instruments had a particularly strong quarter with 17% organic sales growth, and we were pleased with the performances in medical, endoscopy, and sustainability. Looking ahead, we assume continued robust organic growth for all med-surg divisions in the second half. Orthopedics is up 6% in Q2, with hips gaining 4% and knees up roughly 6%, as Mako robot sales and increased robot utilization across both joint applications are driving implant share gains. Neurotechnology and Spine delivered 7% growth, powered by another quarter of double-digit gains in neurotechnology. We have also made considerable progress in the integration of K2M and are on track with our full-year growth target for Spine. On a geographic base, the U.S. was up 9% and international was up 7%. We continue to see the benefits of our transatlantic operating model with high single-digit growth in Europe. Given our lower market shares in this region, we are well positioned to continue to grow meaningfully above market in 2019 and beyond. Our international performance also included strong double-digit gains in emerging markets. With the strong top line and ongoing focus on our cost transformation initiatives, we achieved operating margin expansion of 20 basis points, which includes considerable deal-related dilution. Our adjusted per share earnings in Q2 came in at $1.98, topping the high end of our targeted range of $1.90 to $1.95, which is driven by our robust sales performance. We also continue to benefit from investments in R&D, acquisitions, sales, and marketing, which translate into healthy product pipelines and strong commercial execution. That, combined with our talented employees and culture of performance, positions us well to sustain high growth going forward. With that, I will now turn the call over to Catherine.

Thanks, Kevin. My update today will focus on MAKO and the key data points that allow you to track our success in executing on our orthopedic robotics strategy. In addition, we will continue to provide our new growth, which excludes any robot revenue. As a reminder, sales tied to MAKO continue to be included in our other orthopedic revenue line, while navigation is reported in instruments. In Q2, we sold 44 Mako robots globally, with 35 in the US. By comparison, in the comparable quarter a year ago, we installed a total of 39 robots, of which 29 were in the US. Globally, our installed base of robots is north of 700, with close to 600 in the US. Looking at U.S. procedures, in Q2, MACO total knee procedures exceeded 18,000, increasing approximately 80% from the prior year quarter, while total MACO procedures approximated 27,000. We're also pleased with the acceleration we are seeing in our hip performance. These results reflect uptake for our new 3D-printed Trident II hip cup, as well as increasing utilization of MAKO for hip procedures, where we achieved strong double-digit procedure growth in the quarter. Based on these performances, it's clear we are continuing to see high demand for MAKO, given its unique features, as well as applications that span hips, knees, and uni. Combined with a robots order book, this positions us well to see ongoing success both in robot sales and recon market share gains. With that, I will now turn the call over to Glenn.

Thanks, Catherine. Today I will focus my comments on our second quarter financial results and the related drivers. We have provided our detailed financial results in today's press release. Our organic sales growth was 8.5% in the quarter. As a reminder, this quarter included the same number of selling days as Q2 2018. As we have said before, selling days generally do not have an impact on the performance of our capital businesses. Pricing in the quarter was unfavorable, 0.8% from the prior year, while foreign currency had an unfavorable 1.6% impact on sales. U.S. organic sales growth was 9.3 and international organic sales growth was 6.5. In the U.S., there were strong performances across orthopedics, med-surg, and neurotechnology. International sales growth demonstrated solid gains in Europe, emerging markets, and Australia. Our adjusted quarterly EPS of $1.98 increased 12.5% from the prior year, reflecting strong drop-through on sales growth combined with good operating expense control. Our second quarter EPS was negatively impacted by approximately 5 cents from foreign currency exchange rates, including translational and transactional impacts, which was consistent with our expectations at the start of the quarter. Now I will provide some highlights around our segment performance. Orthopedics delivered constant currency and organic growth of 5.6%, including U.S. organic growth of 6.5%. This performance was highlighted by strong performances in knees at 6.6%, hips at 5.4%, and recon capital of over 30%. Some of the key drivers of performance in the quarter included strong demand for our Mako TKA knee platform, 3D printed products, and shoulder implants. Internationally, orthopedics delivered organic growth of 3.6%, reflecting strong growth in emerging markets. MedSurg continued to have strong growth across all businesses in the quarter, with constant currency growth of 12.5% and organic gains of 11.5%, which included a 12.9% increase in the U.S. Instruments had U.S. organic sales growth of 18.9%, We continue to see benefit from the Salesforce split with robust growth in power tools and waste management products. Endoscopy delivered U.S. organic sales growth of 8.2%. Endoscopy's video business grew double digits as its new 1688 camera platform continues to ramp along with its Novadec product lines. Medical had U.S. organic growth of 11.9%, reflecting solid performance in its bed, stretcher, and sage products. Within Sage, we continue to see strong demand for Prevalon and PrimaFit. Internationally, MedSurge had organic sales growth of 6.2%, which reflects strong sales in emerging markets, including China. Neurotechnology and spine had constant currency growth of 20.8% and organic growth of 7.4%. This growth reflects continued strong demand for our neurotech products, offset by someone's slower spine organic growth, as we continue to integrate our legacy spine business with K2M. Our U.S. neurotech business posted organic growth of 8.9% for the quarter, highlighted by continued strong demand for our hemorrhagic, ischemic stroke, CMF, and our neuro-powered instrument products. The spine business continued to effectively focus on the K2M integration, including the field sales organization. During the quarter, we completed activities related to product training and cross-selling. Sales exited the quarter with mid-single-digit growth in the U.S. Our IVS business continued to demonstrate strong double-digit growth trends. Spine remains committed to mid-single-digit growth for the full year. Internationally, neurotechnology in Spine had organic growth of 12.4%. This performance was driven by continued strong demand across most geographies for our neurotech products. Now I will focus on operating highlights in the quarter. Our adjusted gross margin of 65.8% was down 30 basis points from the prior year quarter. Compared to the prior year quarter, gross margin was favorably impacted by productivity and efficiency, which was offset by price, foreign exchange, and business mix. R&D spending was 6.4% of sales, which was slightly favorable to the prior year quarter. Our adjusted SG&A was 33.5% of sales, which was 40 basis points favorable to the prior year quarter. This improvement reflects the continued focus on operating expense improvements through our cost transformation for growth program, including key projects focused on indirect purchasing and shared services. This is offset by the negative impact of acquisitions and continued planned investments in our CTG program efforts. In summary, our adjusted operating margin was 25.9% of sales, which was approximately 20 basis points favorable to the prior year quarter. Our operating margin reflects good leverage and continued operational savings offset by key investments and acquisitions, the latter of which had an approximately 30 basis points negative impact on the quarter. We remain confident in our ability to deliver on our full year commitment of driving 30 to 50 basis point improvement in our operating margin. Next, I'll provide some highlights on other income and expense. Other expenses decreased slightly from prior year quarter, primarily due to favorable interest income. Our second quarter adjusted effective tax rate of 16% reflects our operating tax rate favorably impacted by the benefit related to stock compensation expenses. Focusing on the balance sheet, we continue to maintain a strong position with $1.8 billion of cash and marketable securities, of which approximately 40% was held outside the U.S. Total debt on the balance sheet was $8.5 billion. Turning to cash flow, our year-to-date cash from operations was approximately $827 million. This reflects strong net earnings offset by increases in core working capital and planned integration costs related to K2M. And now I will discuss our third quarter guidance. Based on our performance to date and anticipated strength in the remainder of the year, we now expect organic annual sales growth will be in the range of 7.5% to 8% for 2019. As a reminder, Q3 and the full year have one additional selling day, and Q4 has the same number of selling days as 2018. Given our year-to-date performance and continuing momentum, we now expect that our adjusted net earnings per diluted share will be in the range of $8.15 to $8.25 for the full year. For the third quarter, we anticipate adjusted net earnings per diluted share to be in the range of $1.87 to $1.92. Foreign currency translation and transaction impact included in EPS is expected to be minimal in Q3 and negatively impacted by approximately 10 cents for the full year. And now I will open up the call for Q&A.

Thank you. We will now begin the question and answer session. If you have a question, please press star, then one on your touchtone phone. If you wish to remove from the queue, please press the pound key. As a reminder, callers will be limited to one question and one follow-up question. Your first question comes from the line of Bob Hopkins with Bank of America. Please proceed.

Well, hi, thanks, and good afternoon. And congrats on a really strong revenue result here and strong result overall. I was intrigued by your comments on hip growth and kind of the growing influence of Mako driving your hip growth. Could you just spend a second talking about the outlook for Mako and hips? And, you know, is this the beginning of a stronger trend? Just trying to get a sense for where you think this is going. Thank you.

Thanks, Bob. We were pleased. We are seeing increased MAKO adoption for the HIP application. Some of it comes as they start to see the benefits from these, which could be, in many cases, what drives the initial purchase. They start to think about using it on more procedures, so it's kind of the natural evolution of the adoption. And I think when you combine that with our 3D-printed cups, it's a pretty powerful impact that we're seeing. So we think we're going to continue to see some strong gains in HIPs on MACO as well as obviously with NEIS.

Thank you for that. Then just one quick follow-up for Glenn on gross margins. Just curious if you could comment on where gross margins are going from here. I recognize that FX and mix were the drag this quarter, but maybe you could quantify FX and just given the really strong results, talk a little bit about where gross margins could go over the course of the rest of the year.

Yeah, Bob, we typically don't guide on gross margin, but I'll tell you that, I mean, gross margin was negatively impacted primarily by price and product mix, especially as the business shifts towards med-surg and neurotech if you look at sort of the growth rates across our businesses. And then, frankly, on the other side, those negative impacts were offset by newly acquired businesses as the spine businesses have higher gross margins. We really expect progressive improvement in gross margin. throughout the rest of this year and for the second half of 2019.

Your next call comes from the line of David Lewis with Morgan Stanley. You may proceed.

Good afternoon. Kevin, just starting with you, a quick follow-up. Instruments were much stronger than expected, and then given that strength and 1688 in the back half for endo, What's driving that instrument strength and giving the product catalyst for endo? Can these two segments deliver double-digit performance in the back half of the year?

So I wouldn't extrapolate Q2's instruments results for the future quarters. We will have a very strong instrument year overall, but it was particularly strong in Q2. Occasionally we've seen this in the past where we've had a, we'll call it an extra pop in one quarter, but we do expect continued strong performance. And think about the 1688. It's a progressive ramp. Normally, the second year of a camera launch tends to be the larger year, but we do expect endoscopy to also have a strong second half, and it's sort of progressive. It'll progressively build related to 1688. So we're optimistic of a very strong med-surg second half.

And then, Kevin, just neurotech, the growth's been very stable the last three quarters. Momentum slowed a bit this quarter. Your pipeline's more impactful next year, but anything that you call out either on share or More market dynamics here now the first half is in. Thanks so much.

Yeah, so we're really pleased with our neurotech business continues to roll with strong performances globally. It was a little bit softer in the U.S. in the second quarter, but nothing particular that I want to call out. I would say that aspiration will be much more meaningful next year than it is this year, and I think we've talked a lot about that on prior calls. No change to that.

Your next call comes from the line of Matt Mixick. With credits, please, you may proceed.

Thanks so much. I also want to congratulate you on a really strong quarter. Following up on the robots in the quarter and the growth year over year, one of the questions we get often is just around how some of the other competitors in the space might be affecting decision cycles or anything like that in the field in terms of evaluations or RFPs. If you could just give us any color on that, and then I have one follow-up.

Yeah, thanks, Matt. We have not and don't expect to see any competitive impact. As I alluded to on the call, the order book is very robust. We're seeing really strong uptake in terms of robot sales as well as the utilization rates. And you can see that in some of the data points provided in the quarter. So we are really pleased with what we're seeing within MACO and the fact that we're now really starting to see indications across all the joint procedures. Reconstructor joint procedures, starting to see more of a lift, too. So really good momentum.

That's great. And then follow-up on spine. You know, approaching the sort of full-year cycle of this integration on the front end, as you've talked about, and across operations. But one of the opportunities there, obviously, K2 had a pretty strong 3D-printed system. you know, spine implant portfolio. And I'm just wondering if you could talk a little bit about the opportunity or the timeline for migrating that to your platform or extending it under your umbrella or any efforts that you see as important opportunities to play out over the next 12, 18 months.

Yeah, thanks for the question. First of all, we only closed in November of last year. So I would call it more like the half year mark right now. Very, very pleased with the momentum. and expecting acceleration in the second half of this year, now that we've trained the reps on cross-selling, and we continue to build the sets and the instruments needed for the K2M products for the legacy spine reps. So we're excited about the outlook for the future. Certainly, we had terrific 3D printing capability, and the Cascadia line of products with K2M were also exciting. they had a very, very complete product line. So we're really excited about having leadership in 3D printing and spine, and we do plan to sell the full range of portfolio products. As related to product and tech transfers, that's going to happen very gradually, and it's not something I really want to get into on the call right now.

Fair enough. Thank you.

Your next call comes from the line of Josh Jennings with Cowan. You may proceed.

Hi. Good afternoon. Thanks for taking the questions. I was hoping to start on margin. I mean, clearly it's a back half weighted here year, and maybe you could just help. I know you talked a little bit about it on the prepared remarks, Glenn, but maybe talk a little bit about the drivers in the back half that can get you out to the 30 to 50 basis points range. I mean, should we be thinking about the lower end of that range, or is there really no incremental guidance there?

Yeah, at this point I'm not going to commit to sort of a more detailed level of guidance other than to say that the 30 to 50 BIPs, we're still sticking to that. You know, a couple things that will help us, you know, obviously things accelerate in the back half of the year in terms of sales and profits. We'll also start to see less integration costs coming through from K2 and more results of their operations, which also should help the margin. And so those things combine really to give us confidence that we'll get to our 30 to 50 basis points.

Great. And then just to follow up on MACO, significant success in these, and it sounds like HIPs are picking up. I just wanted to ask about the pipeline there, and if there's nothing to share at this point, any timelines in terms of when you may share with the street other indications that are in development? Thanks again.

Yeah, thanks, Josh. Nothing additional to share at this point. I think as we've talked before, we're prioritizing our research efforts on new indications in spine and in shoulder, but that's a ways off. And honestly, we have so much momentum right now in knees and in hips increasingly. The organization is really focused on continuing to sell robots and build on that. Just really pleased, especially as we start to see hospitals purchasing additional robots being driven by those utilization growth rates that we're seeing. So that's going to continue to be the focus on what you're going to hear us primarily speaking about.

Your next call comes from the line of Chris Pasquale with Guggenheim. Your line is open. You may proceed.

Thanks. Start with the trauma and extremities business. It was a little bit softer than what we were expecting. I know last quarter you called out the T2 delay. Has that product now launched, and how are you just feeling about the trauma and extremities businesses?

Yeah, Chris, the product has launched. And if you look at it, trauma had sequential improvement in U.S. sales growth sort of as those new products began to ramp up. We also saw improvements in the supply chain, which was one of the things that was slowing things a little bit. You know, moving forward, we expect that the sequential growth will continue to improve in the back half of the year. And so we're confident that it is going to get better.

These launches just do take some time. So there will be a gradual improvement in the availability of implants and instruments for the sales force. So it will progressively improve over the course of the year.

That's helpful. Thanks. And then just could you give us an update on where your cementless mix stands and needs today?

Yes, as we indicated on the last call, we're not going to give quite the level of detail. As you heard in my prepared comments, we've given you, I think, a decent amount to be able to track robots. We're continuing to see uptake for cementless. It does exceed 30%, but we're not going to get much more specific than that other than to say it continues to increase.

Your next call comes from the line of Robbie Marcus with JPMorgan. You may proceed.

Great, and thanks for taking the question. Maybe I could follow up with another spine question and just ask, you know, we've seen so many integrations go by the wayside and have issues early on. What is it exactly that you're doing maybe differently? What have you learned that this integration is going according to plan?

Yeah, I think it's several factors. We spent an enormous amount of time evaluating the market, the targets prior to making the decision to acquire K2Ms. We knew we had a strong cultural fit. We did a lot of due diligence around why prior deals didn't work. And we also have been a very acquisitive company, which has really built up that muscle around thinking about how to integrate. And we also are very comfortable with hybrid sales models as opposed to some of the fine deals that forced a switch totally to direct. And so there were just a lot of lessons learned and our own core capabilities in M&A. So there's been an enormous amount of work done by the organization in the first half of this year, a lot of integration efforts, but we're really pleased. And as we said, we remain on target or on track to hit our full year growth targets in the mid-single digits for Spine.

Thanks. And maybe just one for Glenn or Kevin. As you look at the MedTech sector, you have plenty of balance sheet capacity to do more deals. What's your current view on the space and valuations, and what are your thoughts right now on M&A versus share repurchase? Thanks.

As we've said from the beginning of being the CEO, that acquisitions will be the number one priority for cash, and you've seen over whatever period you want to look at, three-year, five-year, ten-year, more than 50% of our cash does get deployed on acquisitions. We still have a very robust pipeline across our divisions of active targets. Valuation is always a challenge. It's not a new challenge. It's been a challenge for the past few years, and that's the number one reason why we do walk away from deals. We'll continue to be a disciplined acquirer, but we right now don't see any change in our capital allocation philosophy given the robust pipeline that we currently have.

Your next call comes from the line of Vijay Kumar with Evercore ISI. You may proceed.

Hey, guys. Thanks for taking my question, and congrats on a really nice sprint here. Kevin, maybe a big-picture question on pipeline. Given the strength we're seeing, what would you highlight for us when we look at the next year? I know the camera launch and some of the products you spoke about. Is there anything on Sage? I think I heard you guys talk about Sage. There's some talk about a new bed. Just help us put these new product cycles in the context of a really strong CapEx environment.

Yeah, I'll probably take that. I would tell you across the board, whether it's 2019 or looking ahead to 2020, we have a number of product launches similar to prior years that are slated, and that includes medical as well as other divisions. So I think that really is what underscores our conviction in being able to grow sales at the high end of MedTech. Don't want to get into specifics around the launches for obvious reasons, but I would tell you we have a really good cadence and pipelines across all three of the primary businesses.

Yeah, so we've shown a real sustainability of growth. If you go back four or five years and it's been steadily building, and as our acquisitions roll in, they roll into organic growth, and that gives us the ability to continue to accelerate our growth. So right now, as we sit here today, I'm very optimistic thinking ahead to 2020.

And just one quick follow-up. Glenn, on the 3Q, was there an extra day for 3Q? So I'm just curious why EPS for 3Q would step down sequentially. Is there some timing element either on expenses or below-the-line items for the 3Q EPS figure?

Yeah, it's just, you know, it's a little bit of seasonality, and I really don't think there's any one thing to point to relative to our guidance on Q3. And I think, you know, we'll continue with strong sales growth. We obviously took up our range in sales growth, so we'll feel that come through. And we feel that, you know, that level of performance in Q3 will be reflective of that sales growth. Thanks, guys.

Your next call comes from the line of Joanne Wench with BMO Capital Markets. You may proceed.

Good afternoon, and thank you very much for taking the question. Very nice quarter. I have a big-picture question and a specific one. Big picture, Kevin, do you have an opinion on where we're going with the medical device tax?

Yeah, so obviously we're expecting that the medical device tax will not be reinstated. It's due to be reinstated at the beginning of next year. In our strategic plan, we assume it won't be, that there'll be some, there are a number of vehicles between now and the end of the year that it could be attached to. Full repeal, I think, is probably not likely. We're hopeful and we're lobbying throughout our trade association for full repeal. But there's bipartisan support both in the Senate and in the House to not reinstate the medical device tax. So I believe we'll get some type of extension, whether it's two years or more. There's always a risk that it comes back, but I would handicap it as a low risk right now.

Thank you. And then specific to your business, trauma and extremities, while better sequentially, is still not where I would expect it to be. What does it take to sort of move that up closer to the market rate? Thank you.

Well, certainly we're not below the market rate, and we haven't been below the market rate for seven years. We outperformed the market very dramatically four or five years ago. We've moved a little bit closer to the market rate. But I would tell you that the supply chain issues that we had in the first quarter are getting better. We're not fully healthy. And we have the short stem launch and shoulder, as well as T2 alpha launches, which are gradually building. And so we do expect an improvement sequentially in Q3 and Q4. And so the result was a slight improvement from Q1. And I do expect us to continue to improve going forward.

Very helpful. Thank you so much.

Your next call comes from the line of Larry Bigelson with Wells Fargo. You may proceed.

Good afternoon. Thanks for taking the questions. One on pricing, one big picture. So pricing in ortho and med-surg got better and to a point that we haven't seen in a while. So I'm just curious why that happened, the sustainability of it, and how much was just due to lapping the Japan price cuts? And I had one follow-up.

Yeah. Pricing was less negative in Q2 than we've seen in recent quarters. I think the most sort of recent impact were felt from favorability in our implant businesses, but most of that came from positive mix from joint replacement and OUS pricing. And then we also saw some improvements in spine pricing, but mainly because rebates have declined relative to our legacy spine business.

Thank you. And then, Kevin, med surge accelerated across all segments, as you said. I'm just curious how much was driven by healthier end markets versus striker-specific drivers. And if you could just comment on what you're seeing just in the end markets, Q2 versus Q1. It looks like Q2 may be a little more buoyant than Q1 in general. Thanks for taking the questions.

Yeah, it's a little early in the reporting cycle to comment on the full end markets. I would tell you that MedSearch has historically, if you look at growth rates, it's historically been based on our own performance. The launching of our products, the debt splitting of our sales forces. I look at Sage's great performance has really been, after following the recalls a while back, we've really gained momentum. The PrimaFit launch is fantastic and going extremely well. And so a number of new product launches. That tends to be the reason for our success. And that's not any different in the second quarter. Of course, instruments did really pour it on in the quarter, but they had a sales force split at the beginning of the year, and they're really performing extremely well. Thank you.

Your next call comes from the line of Pito Chickering with Deutsche Bank. You may proceed.

Good afternoon. Thanks for taking my questions. I wanted to follow up on the instrument growth again. If you look at the stacked comps for 1Q19 versus 2Q19, it continues to accelerate. Can you give a little more detail on why waste management and power tools are growing this fast and how long this can continue?

So I think we mentioned on the prior quarter call that we split our sales force. So there was one sales force selling power tools and waste management. Part of the catalyst for the split was the acquisition of Imbuity. And so that was put together with waste management and some other products, and we call that part surgical technologies. and then the other part is called orthopedic instruments, which has the power tools, bone cement, the protective device, the protective gowns for the surgeon, and so a number of other products that are in that category. Two different call points, and that split of the sales force is going extremely well, and they have strong orders and converted those orders into strong sales in the second quarter. So we do expect a continued strong performance throughout the year. Again, I believe this was an outsized performance. I wouldn't expect another number like this in the third or fourth quarter, but certainly a strong number expected for the full year.

Great. Then for a follow-up, from a margin perspective, if you didn't have a dilution from acquisitions, what type of SG&A leverage could you see when organic revenue growth is in the 7.5% to 8% range?

If there wasn't – you said if there wasn't an impact from acquisitions, what kind of margin growth would we have? Correct. Yeah, I'm I mean, we usually disclose that number, so it really has ranged anywhere from, if I add back the acquisitions, 50 to even 90 basis points about margin expansion. Thanks so much.

Your next call comes from the line of Craig Bijou with Cantor Fitzgerald. You may proceed.

Great. Good afternoon, guys. Thanks for taking the questions. You called out shoulder and plant growth in the script. So I wanted to just see if you could provide a little bit more color on what drove that strength in the quarter. And when you think about investment in your multiple businesses, how important or how much allocation of your investment, internal investment, is going to the shoulder business?

I think you all know that we have a very low market share in shoulders. We've progressively been launching new products over the past few years, so we have a primary shoulder, a reverse shoulder, a fracture system, and now a shorter stem. We still don't have stemless, so stemless is still in our pipeline. That's coming fairly soon. We also don't have a lot of international approvals for shoulder. We had some regulatory challenges, so this is primarily a U.S. business right now. But just on the back of these launches, we've gained a lot of momentum. in shoulder. These are very good products and it just takes time for our sales force to be able to get that in front of customers. And until you have a fairly full line, we now have what I would call a full line. So even though we're missing stemless, that's not enough of an objection for our sales force not to be able to sell it. So we've been seeing very nice uptake in shoulders over the past year or so, recognizing it's still a very small business within the overall striker picture. But this is something we're excited about. It's a good market and with a lot of growth potential, and we're going to continue to focus on it.

Thanks. And I'll stick with Shoulder for my follow-up. Kevin, I think in the past you guys have talked about going to a specialty sales force for Shoulder specifically. I just wanted to see if you have done that yet to any extent and the plans for the future if you have not.

We have some specialization, but I would call it modest. there's obviously a huge cost burn every time you go to specialization, and you have to be able to drive significant revenue. We've done that in the past, as I already mentioned on this call, with instruments dedicating, splitting the sales force and going to specialization. Shoulder procedures are really more fragmented. A lot of them are done by the same surgeons that do hips and knees. You do have some upper extremity specialists, but the call point is a little more fragmented, so it's not as obvious to go to a fully specialized dedicated Salesforce, there's a huge SG&A burn to do that. So I think this is one that would be a little bit more gradual where it makes sense in certain MSAs we'll go to specialized sales reps, but I wouldn't call it a full, we're not going to go to fully specialized Salesforce for some time.

Your next call comes from the line of Matt Taylor with UBS. You may proceed.

Hi, thanks for taking the question, excuse me. So you did touch on this in an earlier question, but I was hoping that maybe you could expound on the impact the Aspiration launch could have in Neuro and other pipeline enhancements that could help that business moving through this year and into next.

Yeah, with Aspiration, as we're working to get the full range of products on the market, that's really what's behind our comments around thinking about that having more of an impact in 2019. So we're looking at, excuse me, 2020. So we're looking at launching a broader range of aspiration devices than we currently have on the market around the Q1 timeframe. And so that's really how you should be thinking about the impact from that, our entry into that segment of the ischemic market.

Okay, okay. And then just on the instruments, growth was really impressive, as multiple people have highlighted. When you look through to next year, you know, how does this Salesforce split anniversary, can you still grow strongly next year over this initial pop that you're getting?

Yeah, I think what you're seeing is just some really strong momentum. It's from the Salesforce split. It's from acquisitions that have been integrated in. It's from new product launches from internal companies. innovation and R&D, and all of that will continue into 2020. So I'm not going to get into specific numbers, and as we've commented before, this is certainly an outsized quarter, so you'll want to model accordingly, but there's a lot of momentum across instruments and really across the organization.

Your next call comes from the line of Matt O'Brien with Piper Jaffrey. You may proceed.

Hi, good afternoon. This is JP on for Matt. I just want to touch on Spine for a second. You mentioned that the K2 acquisition is kind of going as planned, but I wanted to see if you could touch on first just Salesforce attrition and then, you know, for that business, the scoliosis summer months are usually pretty strong for them. So maybe while we're in the midst of it, comment on how you think your share is holding up in the scoli side of things.

Yeah, I think it's a little early in the reporting season. You are right. June tends to be a strong scoliosis month, and you – heard comments from Glenn around the momentum we saw as we exited the quarter that really does underscore our confidence in the outlook for the full year. I don't think there's anything specific to get into around Salesforce attrition. One of the appeals of this target was the fact that we had a really strong cultural set. We were bringing in a great leader with Eric. We had minimal customer overlap, and we are comfortable with and continue to be a hybrid sales model, all of which were factors behind what we expected to be fairly limited attrition. So I think I'll just leave the comments there.

That's helpful. And then just one on just ortho. There's good all around, but the U.S. continues to outpace the OUS growth rates. And just given how big the opportunity for you guys is, OUS, is there anything you can do to maybe on the investment side to kind of accelerate that OUS ortho growth?

I think the disparity that you're seeing is really related to MACO. because we've had Mako on the market for quite some time in the United States, and we are really just launching Mako in two very important markets, China and Japan. We now have approval for the total knee in Japan as well as hip. In China, we have the hip approval. We're still waiting for the total knee approval, which should be coming shortly. Those are going to be exciting markets for us, so we're just in the very, very early stages of So what you're seeing from a disparity from international to U.S. is really the MAKO effect, which is more pronounced in the U.S., but starting to grow. As you see with our numbers, we are starting to place more and more robots outside the United States. But those two markets in particular are just getting started, and so we're excited about the future that MAKO will be able to bring to those two markets.

Your next call comes from the line of Richard Newiter with SBB Learing. You may proceed.

Taking the questions. I want to ask about a question I asked earlier on new indications for robotics. And I think you mentioned, you know, spine and then shoulder. And I don't want to read into this, or is there anything to read into in that ordering? I had been under the impression that shoulder would potentially be in front of spine, even though you're not giving timelines precisely. Was there anything to that ordering? And then I'm going to follow up on that.

No, just the way the words came out of my mouth. Nothing to that. Again, they're both a ways off. I wouldn't read anything into that.

Okay. Appreciating that they're both a ways off, I guess you guys have been and brought the most attention to the orthopedic robotic category through MAKO. You guys do not have a specific spine robotic application, but You have some larger competitors that are now coming into the marketplace, some new ones. What's the dynamic there being absent as the orthopedic robotic market leader in spine? How are the conversations going there? Do you feel any sense of urgency? Catherine, by your last comment, it sounds like no, and if not, why?

Yeah, I think for us, the key for our spine business was refreshing what had become a bit of a dated portfolio, getting a considerably larger organization and a real strong presence with the key opinion leaders, especially in the areas of deformity that shape a lot of their thought. That was the priority. And what we think is imperative, much like we see with METO INI, is you have to have a meaningful impact on the procedure, an application that really does change the dynamic for how the procedure is done, how it impacts the surgeon experience, and obviously the patient experience. That's what we're focused on in spine, and we think there's a real opportunity there. We are not seeing any pushback in terms of our spine presence by not having a robot at this point.

Okay, thank you.

Your next call comes from the line of Stephen Lichman with Oppenheimer & Co. You may proceed.

Thank you. Hi, guys. You mentioned continued solid emerging markets growth in your prepared remarks. Since you are still under-levered there broadly in emerging markets, is that an area you've been accelerating investments, and are there any particular product segments you see particularly opportunities in in emerging markets?

Given our presence in emerging markets, we have opportunity across our portfolio. And I'm really pleased with the progress we've made. Last year, we grew double digits. This year, it's strong double digits. And really, the big change in the last, let's call it six quarters, is leadership, where we've really bolstered leadership in many of the countries, in Brazil, in India, in China. We bought out our distributor in Turkey, and we're going a little bit more direct in Turkey. And in these markets, we're having really terrific growth. So it really has been a leadership story starting with the managing director in those countries as well as the next level down. And so it took us a few years to kind of get the leadership team that we wanted in place in these countries, and now we're really starting to drive growth across the portfolio.

Thanks, Kevin. And, Glenn, just I apologize if I missed this, but latest thoughts on a free cash flow conversion and tax rate for the year?

Yeah, we – If you look at sort of free cash flow and the way cash flow played out this quarter, we were a little under-pressured, as we mentioned before, with cash expenditures related to the K2 integration. And so we expected the first half of this year to be a little bit lower. You know, typically, cyclically, you know, cash flow generation is always higher in the second half for us. We also see... you know, ramping of some of our initiatives around indirect spending, which will continue to deliver savings as well. You know, we guide in the 70% to 80% conversion range, and we think we'll be near that range again this year. And then as far as taxes, there's really no change to our guidance of 16% to 17%, although we are moderating towards the lower end of that range.

Your next call comes from the line of Raj Dhanoi with Jeffries. You may proceed.

Hi, good afternoon. Maybe one for Catherine just around Mako. You know, I'm curious when you think about the overall U.S. knee market maybe being in the very, very low single digits, you guys going 6.5%, 7%. Of that delta, can you break out what percentage you think is pure kind of volume share gains versus, you know, any uptick you guys are getting, any mixed benefit, price benefits you're getting from using robotics? Sure.

Yeah, that's difficult to parse out. I would tell you the bulk of it is coming from volume and market share gains. We're selling a significant percent of our robots into competitive accounts, obviously, because we wouldn't be able to grow at these rates if it was all into striker accounts. But we do get some modest mixed benefit, but it's powered first and foremost by Mako, as well as our 3D printed products. having them indicated, our cementless knee indicated on the Mako robot is a pretty powerful combination. But trying to break it down with specifics, that's just really challenging.

Okay. But your point is that it is mostly share games. That's the real big delta. It's not any mixed benefits you're getting.

Emphatically.

Okay. And then just, you know, on those lines, I think the question was asked earlier, but you know, you now have a sort of major launch, or at least a launch from a major company, I should say, in robotics. You know, within those accounts, have you seen, you know, within the Zimmer accounts, has there been any change in tone of those customers being willing to entertain using BACO, or just really any change in the market broadly as it gets more competitive?

Yeah, I would tell you when we look at the performance in the core, I think it's just simply too soon. We are not seeing a competitive impact. I think our results really do underscore just how strong our momentum is with robots. We have a very large installed base and building off of that. We're just not seeing anything. Those questions probably better directed at them because obviously they're going to have better insights.

Your next call comes from the line of Jeff Johnson with Baird. You may proceed.

Thank you. Good afternoon. Kevin, understanding your China presence is relatively modest. Any updates or color you can provide on maybe gating of procedural demand or demand for capital in that market, just given some of the macro uncertainty here recently?

Well, you're right. I think you're being generous by saying we have a modest presence. We have a long way to go in China. It's really the most important of the emerging markets. And given our presence, we're really seeing Stryker being the rate-limiting factor, not the market. The market conditions are still, for health care, very good. And we just have to raise our game, which we've been doing over the last two years. And really excited about the leader that we have there. But I don't see anything in the market that should cause us to slow down our momentum, given where we are right now.

All right, great. And then, Glenn, maybe just a clarifying question. You mentioned spine rebates coming down as one of the helpful factors on pricing in the quarter. I just want to, you know, is that an industry-wide comment, do you feel, or is that a mixed shift statement? from older Stryker product to the K2 products that's helping that. Just wondering if it's more Stryker-specific, that commentary, or broader market commentary. Thank you.

Yeah, it's really the result of sort of our integration efforts and really a planned mix shift to the K2 products that we see really causing that impact. Thank you.

Your next call comes from the line of Ryan Zimmerman with BTIG. You may proceed.

Great, thanks for taking the question. Catherine, you called out utilization up 80% in knees on Mako, and I'm just wondering if you could speak a little bit to the disparity between users. Maybe what you see from the top users and how much of the install base has capacity in terms of further utilization or further optimization on those robots.

Yeah, so the 80% reference the total knee procedures that were done in the quarter. It's very difficult to give you a color around that. I mean, we see adoption really across the board, high volume hospitals, lower volume, rural, urban, teaching hospitals. It really, it's driven first and foremost, is there a robotic champion in that hospital? And that's what drives the placement or the sale of the robot.

Okay, that's helpful. And then, you know, we've been asked a little bit before, but as a competitor does come into the market, How is the guidance contemplating the sales cycle for Mako, or what's the thoughts around an elongation of the sales cycle? Just given what we're seeing maybe in the spinal robotics market with an elongating sales cycle, do you anticipate that for maybe the remainder of the year or potentially into 2020? Thank you.

Yeah, I think it's simply too soon. We have no color on that launch, and so I think it's simply too soon. So as we get closer to 2020, we'll certainly contemplate that. But I think as you can see from our guidance, there's just a lot of momentum across the board, and we're just not seeing any impact.

Your next call comes from the line of Kyle Rose with Canaccord. You may proceed.

Great. Thank you for taking the question. I just wanted to ask another one on MAKO. A lot of focus, obviously, on the competitive launch, but I just wanted to see Have you seen any changes as far as how hospitals are looking to acquire and pay for them? I know you've talked about your Flex Financial in the past, but are you seeing any that are looking more for utilization-based agreements and things along those lines?

No. Flex Financial has, for years, been a powerful tool for us when we're selling capital, and we can contemplate different models based on what may be capital budgets versus operating budgets. leasing, et cetera. So we can look at a number and continue to look at a number of different models, but I wouldn't say those comments aren't any different today than they would have been a year ago.

And then the one follow-up is just the outpatient market, you know, both for MACO on the total knees and total hips, but then also more broadly from an orthopedic joint replacement perspective. What are you seeing in the dynamics of that market?

Specifically in the dynamics of, sorry, of the Mako uptake in hip and knees?

Yes, in the outpatient environment.

You know, we do sell some robots in the outpatient. It's the minority. They obviously have a keen interest in it because the outpatient hospital or ASCs, they like the new technology. And obviously, we're seeing more and more evidence of the impact this has for patients and outcomes. That drives their interest. They have different capital challenges. And so, again, we use Flex Financial to work with that. But the vast majority of the robots are not in the outpatient setting. They're still in the hospital-based setting at this time.

There are no further questions at this time. I will now turn the conference over to Mr. Kevin Lobo for closing remarks.

Thank you for joining our call. As you can see, we had very strong Q2 results and strong momentum going into the back half of the year. We look forward to sharing our Q3 results with you in October. Thank you.

Thank you, ladies and gentlemen. This concludes today's conference. Thank you for participating. You may now disconnect.