Stryker Corporation

Welcome to the third quarter 2020 Striker earnings call. My name is Sharon 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'd like to ask a question, please press star, then one on your touchtone 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 has been exhibited to Stryker's current report on Form 8K filed today with the SEC. I will now turn the call over to Mr. Kevin Noble, Chairman and Chief Executive Officer, who may proceed, sir.

Welcome to Stryker's third quarter earnings call. Joining me today are Glenn Bainline, Stryker's CFO, and Preston Wells, Vice President of Investor Relations. For today's call, I'll provide opening comments, followed by Preston with some perspective on the recovery trends across our diverse businesses. Glenn will then provide additional details regarding our quarterly results before opening the call to Q&A. I'm pleased to report that we return to growth in Q3, posting organic sales growth of 3%. This represents a rapid improvement in our business, driven by a progressive return of elective procedures, ongoing demand for our medical capital products, and continued strong Mako performance. In the quarter, we saw uneven growth globally that correlates to the state of the pandemic. Preston will speak to this in his section. While we are pleased with the recovery of our business, the environment remains uncertain as flare-ups of positive COVID cases are continuing. We had many achievements in the quarter that exemplify our commitment to innovation and providing our customers with the technologies needed to serve their patients. Beginning with Mako, we celebrated the installation of our 1,000th robotic system in the quarter. We've seen tremendous success with Mako since the launch of the Total Knee application in 2016, and this quarter was no different. we continue to believe that we're well positioned for sustained future success with Mako. Our spine and trauma and extremities businesses benefited from numerous recent product launches, and medical launched an exciting new acute care bed. Our neurovascular business also achieved some new product approvals in important markets, which helped contribute to their double-digit global growth in the quarter. We maintained many of the policies put in place at the beginning of the pandemic, focused on maintaining the safety of our employees and customers and aggressively managing spending. While sales and manufacturing have approached more normal levels, our spending levels were unusually low given the uncertainty regarding the pace of the recovery. Our R&D spending on an adjusted basis with 6.1% of sales, slightly below our expectations, as a result of COVID-related execution challenges and some timing of spending. But none of this has caused any meaningful delays to new product timelines. The combination of sales growth and suppressed spending resulted in adjusted earnings per share of $2.14, up 12% versus the prior year. While some of our measures remain in place, our spending measures, we do expect some return to hiring and investments to support future growth in Q4. Due to the continued uncertainty and lack of stability in many markets, we are not providing Q4 guidance at this time. We saw good momentum across many of our businesses in Q3, although the recovery curve acceleration moderated meaningfully in August and September and has been on a similar trend so far in October. We are proceeding with the integration efforts related to the right medical transaction and are working cooperatively with regulators to obtain the necessary approvals for this transaction. This includes that's previously announced the proposed divestiture of our star total anchors or placement product. We expect to close the transaction in November. Please note beyond this update, we will not be taking any questions regarding right medical on today's call. Finally, I would like to thank our employees for continuing to serve our customers and finding ways to succeed during such challenging times. From our sales and service personnel in the field every day with our customers to the marketing and R&D teams that are finding creative ways to connect globally, to advance new innovations, to our manufacturing teams and office staff who ensured the continuity of our business. We are living our mission statement, which is together with our customers, We are driven to make healthcare better. And now, over to Preston. Thanks, Kevin. Today, my comments will focus on providing additional thoughts on the current environment and the recovery of select businesses and geographies during the third quarter. We've generally seen a V-shaped recovery through the second quarter with continued momentum and growth in the third quarter, although at a more moderated level of month-over-month improvement. The sales growth and improved performance in the third quarter was driven by three main factors, the continued acceleration of elective procedures, strong demand for many of our large capital products, and the return of our more event-driven businesses like trauma and stroke. Small capital products, including our video cameras and power tools, showed nice improvement but lagged other products in their recovery. These products generally trail elective procedure volumes by a few months. Despite a resurgence in infection rates globally, we saw sales growth in most developed markets led by strong recovery in the United States, Australia, Germany, and Canada. These markets were operating around pre-COVID levels throughout the quarter. Our China business returned to double-digit growth in the quarter, with procedures returning to more normal levels despite the government taking a more aggressive approach to lockdowns around COVID infections. The UK, India, and parts of our Latin American businesses continue to lag as they work through heightened impacts of the pandemic. Procedural areas that were deferred or stopped during the second quarter showed significant improvements in the quarter. Our knee, spine, trauma, and extremities in sports medicine businesses all achieved year-over-year growth. This also shows significant improvement in the quarter reaching prior year levels. Each of these businesses benefited from the acceleration of elective procedures during the quarter that was fueled by the addition of new patients and the recovery of the previously deferred backlog. Surgeons and healthcare providers continue to work through the new and existing backlog by adding incremental procedures to their normal schedules. With the continued variability of infection rates, we believe that hospitals are better prepared to ensure that these types of elective procedures can still be performed at some level, unlike the dramatic drop that we saw in April. However, the situation remains fluid, and procedural impacts and recovery will continue to vary across geographies. Demand for our large capital products drove strong growth in the quarter, including ongoing high demand for our MAKO robotic technology. In the third quarter, we were very pleased with the acceleration of MAKO installations both within the U.S. and in markets outside the U.S. where we continue to expand our MAKO presence. Recently, Brazil approved full use of our Mako robotic technology for both hip and knee procedures. We are also experiencing increased utilization with a growing percentage of hip and knee surgeries being performed with a Mako robot. Within our medical division, we saw strength in our emergency care business along with continued high demand for our beds and stretchers. demonstrating the improved financial stability of our customers aided by government subsidies like the CARES Act and the resurgence of positive cash flow driven by the continuation of elective procedures. As a result, our order book remains robust for both MACO and many of our medical products. The launch of the new acute care bed security is a contributor to that order book and a demonstration of our ongoing commitment to innovation during the pandemic. With our specialized business unit, category-leading product portfolio, and innovative technologies, we are well positioned to continue our above-market MedTech growth. With that, I will now turn the call over to Glenn.

Thanks, Preston. Today I will focus my comments on our third quarter financial results and related drivers. Our detailed financial results have been provided in today's press release. Our organic sales growth was 3.3% in the quarter. These results included growth in the U.S. of 3.5% and international growth of 2.8%. As a reminder, the quarter included the same number of selling days as Q3 2019. Pricing in the quarter was unfavorable 1.4% from the prior year quarter, while foreign currency had a favorable 0.4% impact on sales. During the quarter, we returned to growth as demand for our procedural-based products came back strongly in most key geographies, and demand for large capital, primarily make-out and medical beds, remained strong. Our adjusted quarterly EPS of $2.14 represents growth of 12% from the prior year quarter. The foreign currency impact on the third quarter EPS was accretive by 1%. The strong EPS growth was mainly driven by sales drop through, favorable sales mix, disciplined cost control, and better than expected gross margin leverage as our manufacturing output returned to more normal production levels. I will now provide some brief comments on our segment sales. Orthopedics had constant currency and organic growth of 3.8%. This included U.S. growth of 7.5%. We saw growth across knees, hips, trauma, extremities, and Mako, which grew 30.2% in the quarter. Additionally, all these products are growing off strong U.S. comparables from Q3 2019. Internationally, orthopedics had an organic decline of 4.7%, which reflects the slower recovery of elective procedures in Europe as a result of COVID restrictions, partially offset by a positive Mako performance. MedSurg had constant currency growth of 2.9% and organic growth of 2.5%, which included organic growth of 1.4% in the U.S. Instruments had U.S. organic sales growth of 1.9%, reflecting increased demand for our safety-related products, including waste management and smoke evacuation products, the latter of which had double-digit growth. Endoscopy had U.S. organic sales growth of 1%, This reflects a return to growth primarily driven by our sports medicine business, where we had double-digit growth. This was partially offset by moderate declines in core endoscopy and communications businesses. The medical division had U.S. organic growth of 3%, resulting from strong demand across its bed business, growing double digits, and emergency care business, growing high single digits. These were partially offset by a decline in our sage business. Internationally, MedSearch had organic sales of 6.7%, reflecting very strong demand for medical products combined with positive performances across most of our MedSearch product categories in all major geographies. Neurotechnology and Spine had a constant currency growth of 5.5% and organic growth of 4.3%. Our U.S. neurotech business posted constant currency growth of 3.1%, including 1.7% of organic growth for the quarter. Overall, this reflects positive performances in our spine, CMF, and neurovascular businesses and included double-digit growth in our Schemic products. Internationally, neurotechnology and spine had organic growth of 9.8%, including double-digit performances in our hemorrhagic and ischemic products and a very strong performance in our spine business. Now I will discuss our operating metrics in the quarter. Our adjusted gross margin of 65.9% was favorable 20 basis points from the prior year quarter. Compared to the prior year quarter, gross margin was favorably impacted by volume and business mix, which was partially offset by price and some unabsorbed fixed costs. Although our manufacturing output returned to more normalized levels during the quarter, there was a somewhat negative impact related to our idle manufacturing lines at the beginning of the quarter. Adjusted R&D spending was 6.1% of sales. Our adjusted FT&A was 31.7% of sales, which was 210 basis points favorable to the prior year quarter. Compared to the prior year quarter, SG&A was favorably impacted by operating expense savings actions enacted in March, which continued in the third quarter. In summary, for the quarter, our adjusted operating margin was 28% of sales. All of the spend control measures that were enacted in March continued through Q3. These measures covered most of our discretionary spending, including curtailments in hiring, travel, meetings, and outside consultants. As our businesses continue to ramp back to more normalized levels, we do anticipate that there will be increases in hiring, discretionary expenses, and other costs that support future growth and business expansion. Related to other income and expense compared to the prior year quarter, we saw a decline in investment income earned on deposits and an increase in interest expense related to additional debt outstanding. Our third quarter had an adjusted effective tax rate of 16.1%. Turning to cash flow and liquidity, we ended the third quarter with cash and marketable securities of $7.2 billion, which includes $5 billion of funds related to the right medical acquisition. We also generated approximately $830 million of cash from operations in the quarter, which was again ahead of our internal targets. This strong operating cash flow reflects strong net earnings and a reduction in core working capital versus the prior year. The actions that were implemented in the first quarter to conserve cash continued in Q3, which included discretionary spending controls, reductions in planned capital expenditures and project spending, focusing on opportunities and accounts payable, and slowing our M&A activities. As it relates to guidance for Q4 and the full year, we reaffirm our previously announced decision to withdraw guidance given the continued significance of uncertainties at this time. And now I will open up the call for Q&A.