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.

Thank you. We will now begin the question and answer session. If you have a question, press star 1 on your telephone keypad. If you wish to be removed from the queue, press the pound key. As a reminder, callers will be limited to one question and one follow-up question. First question comes from Vijay Kumar with Evercore ISI.

Vijay, we can't hear you.

Vijay, are you on mute?

Can you hear me? Perfect. Fantastic. Well, congrats on a really strong sprint here, Kevin. And I guess looking at these numbers here, some of your peers in core work, though, they're seeing low single-digit declines. You guys are seeing positive declines, maybe partial. What is the underlying market versus this constant theme of striker gaining share? Is that what's happening? What's driving the strength here? And perhaps also to touch upon trends you're seeing here in October. Any reason, and I saw that we didn't have a Q4 guidance, but perhaps sequential trends that we're seeing here in Q4, is there any reason to believe that Q4 trends should be perhaps different from what we saw in 3Q?

So thanks, Vijay. We're pretty excited about the performance in our business. It's not a one-quarter thing. I think you've seen our joint replacement division, which includes hips, knees, and MAKO have been performing well for some time. And that momentum is continuing. I mentioned in my opening remarks that we're pleased with October. It's going well so far in the month. But I really don't want to speculate on November, December. Just given all the flare-ups that are occurring, assuming that the market stays fairly stable, we're going to have a good fourth quarter. But that's a big assumption given this is obviously a once-in-a-lifetime type of pandemic. So I'll I don't want to get ahead of myself, but we're feeling good about the business through the month of October.

Gotcha. And then maybe one on the capital side. You guys did mention strong order book for nature, large capital. I know you guys just launched a new bet. Perhaps just talk about the visibility you have on the capital side of the business. And is that a confidence that you can perhaps extrapolate into next year or is this perhaps Q4? And then we'll see how the market shakes out for next year.

Thanks, Preston. Just to expand on that a little bit, I mean, we do continue to have confidence in our capital business.

I think, as I mentioned in my remarks, if you look at our large capital business, the man that we saw on MAKO and on the medical business in particular, we feel really, really good about that.

Small capital, as we talked about in the remarks as well, we expect that to continue to come along that recovery curve as well, although it has shown that improvement but lags a little bit some of the other products in terms of that recovery. I think overall we feel good about it. We feel good about where orders have come in. We feel good about where our customers are. in terms of their financial stability at this point in time, certainly compared to where it was a quarter ago. And because of those items, we feel confident in where our capital business is headed. I think all of that is underscored, as Kevin said, by the uncertainty that still remains with regards to debt flare-ups and how the virus continues to kind of move through different regions.

Next question comes from Robbie Marcus with J.P. Morgan.

Oh, great. Thanks for taking the question. And again, congrats on a much better than expected quarter. Kevin, how should we think about interpreting the comments on a go-forward basis in respect to how much of a backlog is worked through? Are there still patients who deferred procedures that still need to get into queue here? Because it sounds like July was probably the best quarter of third quarter. Would fourth quarter at current trends hold be similar, better, or worse than third quarter here?

Hey, Robbie. It's Preston. So I would say in general it's hard to predict exact percentages with regards to how much of the backlog has been worked through versus what are new patients that are coming into that funnel. Based on the feedback that we've gotten, we know that surgeons are continuing to work through that backlog and that they're also adding new patients. So it's definitely a mix of the two. We also know that there are some patients that are still waiting with anxiety to get their procedures done. But all in all, clinics and surgeons remain busy and they're continuing to look to add additional shifts or additional opportunities to add surgery or even a shift to the outpatient setting. Our expectation is that that trend will continue, again, barring any major disruptions from a COVID perspective.

Got it. And maybe just a quick follow-up. Once again, you had another great MAKO quarter here, even in the tough times of COVID. And I was wondering if you could speak to how willing your hospital systems are to go out still and buy the large capital, considering it seems like your main competitor in robotics has shifted strategy to place a lot more units rather than recognize revenue up front. It appears you're still able to recognize a healthy amount. So just wondering what the environment is like and if you're seeing them on the competitive side. Thanks.

Yeah, look, we continue to feel very bullish about Mako. I think in Q4 we're going to have to, unless something bizarre happens in the marketplace, it'll be a record quarter in Q4 because the order book is still very strong. With over 1,000, we've kind of hit an inflection point, and robotics, the interest in robotics is increasing every day. Teaching hospitals are adopting robotics, and they're feeling the pressure to have robotics as part of their programs. And in some cases, they have been holding off a little bit. So for us, the momentum is palpable. It's continuing. It's strong. And it's even starting to pick up in other markets, such as Japan and countries in Europe. They did a little bit of a pause in that second quarter. We saw them coming back, frankly, in the third quarter. the outlook for makos continues to be very bullish and it's really irrespective of competition this is sort of a market trend that's changing the market's shifting and we really love the offering that we have in this in this category next question we have is david lewis with morgan stanley

Kevin, I wonder if we could just talk about maybe 2021 and if we can't get the kind of specific numbers either relative to 2019 baseline or maybe just some top-line qualitative commentary about how you're sort of seeing the top and bottom line for 2021 or specific product launches and innovation pipeline we should be thinking about for 2021, and then I'd have a quick follow-up.

Yeah, David, you know, we're not going to really get into sort of guidance for 21. You know, we do that in every January. And right now we're planning to provide that in January. I think we've gotten good momentum across a lot of our businesses. You saw the trauma number. We posted a really strong number. They launched a number of new products and feeling very good about that. And that's, frankly, before right medical kicks in. So we're really excited about the momentum we're going to see across trauma and extremities next year. Neurovascular would be one I'd point to that I'm really excited about. We had the Surpass Evolve NextGen flow diverting stent approved in the United States, and that had very good growth, even though we're still having to go through the pains of proctoring, but even in the midst of a pandemic. So I'm literally from a small base, but that's going to pick up steam next year, as will our aspiration offerings within neurovascular. So neurovascular, I feel very good as I look through into next year. And of course, Mako will continue its positive trajectory that affects not just the Mako business, but of course, hips and knees. And so those are all going well. Instruments continues to be a really strong business for us. And smoke evacuation you see is now becoming a standard in many areas. The whole safety push, I think, will continue beyond, frankly, the pandemic. And we've really established a really great stable of products related to safety. So A lot of tailwinds, I think, that will continue on a sort of underlying basis. The big unknown is sort of how this pandemic evolved, and it's still going to be with us, obviously, through the first half of next year in some way, shape, or form. And so that's the big unknown. But a lot of the businesses that we have, we're feeling good about the momentum, the product cadence and new products, which I've already touched on some of them, we think will position us well for 2021.

Okay, very, very helpful. And the one business I wanted to highlight was just spine. Obviously, that's been a sore point these last several quarters, and some of your performance, frankly, was better than some of the emerging mid-cap spine players. Just what you're seeing in spine, have we finally turned the corner from an integration perspective? Are you seeing more traction on sort of rep hiring? But it was a surprisingly strong quarter for you in spine. Just curious and underlying drivers. Thank you.

Yeah, we're really pleased with the performance in Spine. I think that K2M, which was obviously a tough integration, we knew it would be tough. It was tough. We feel that that's largely behind us. I think we actually got a little bit of a reprieve in the second quarter, honestly, to sort of get our inventory and get our position more stabilized. OUS, it's been strong, frankly, from the beginning, but getting that U.S. business on a better footing, we feel very good about that. They launched some new products, including Niagara, which is a lateral access product. a colpectomy cage. And so getting back to launching products, which, as you know, is a big part of the K2M offense, excited that we're now back to launching new products versus sort of dealing with all of the integration challenges. As it relates to Salesforce, very stable. In fact, we're actually having sales reps wanting to come to join Stryker now in Spine. So we really do feel the tide is starting to shift in Spine, and it was definitely a very good quarter.

Next question comes from Bob Hopkins with Bank of America.

Hey, thanks, and good afternoon. The first question I wanted to ask, Kevin, about your hip growth in the quarter and then just hips generally. Your hip growth in the quarter was maybe a smidge below peers. So I just wanted to talk about or ask you about dynamics there. But probably more importantly, I also wanted to get your view on your pipeline and hips and when you've got new launches coming because I think in previous conversations we've talked about some exciting launches potentially in that area. Yeah, thanks, Bob. We're actually very pleased with our hip performance. We had good growth in hips, and we had a very tough comp from the prior year core where we outperformed the market in hips. So overall, yes, competitors did well in hips. We also did well in hips. As you know, hips are a little less deferable than knees, which really speaks to the strength we had in knees. But as it relates to hips, we're very excited about two aspects of the pipe arm. The first is on NACO, we have a new software upgrade system for hips that we launched in the second quarter. Because of the pandemic, we haven't really been able to roll that out fully. It'll get fully rolled out probably by the end of Q4. So it's a progressive rollout, but really will have more of an impact next year. And the second part of the pipeline is a new stem that we have planned sometime in the middle of next year. We'll get more specific around timing maybe in the January call, but that's going to be an exciting stem, which has some features that surgeons like and a little bit of a gap in our portfolio. But overall, still pretty good quarter. Yeah, yeah, okay, thank you. And then I also wanted to ask you a little bit about the potential for durability of growth in the medical division. And I'm not asking about fourth quarter. I'm thinking a little bit more longer term because there are a lot of moving pieces in that division right now. It sounds like, you know, Sage might be struggling a little bit, but then OUS Strength has been enormous. You're, you know, launching a new bed, and then there's the core underlying bed market. Maybe just talk about your thoughts on the durability of the growth outlook for that business in light of all the moving pieces. Hey, Bob, a question. I think, as I mentioned before, specifically on the capital side, we feel very confident where we're heading in terms of the durability on that business, particularly as we think about things like bedding stretchers with the launch of the new bed. adding to that portfolio. Very, very excited about what that's going to bring and do for us. Sage had a slower quarter in terms of its growth, obviously an improvement from the second quarter, but still a little bit of a decline versus prior year. Given that business in terms of stocking and the purchase cycle, we really do expect that business to turn the corner as well as we go into the next quarter and into 2021. So I think we'll see some positive dynamics from that business. And then overall, obviously, we've seen some impact from the pandemic, and we would expect that we'll continue to see momentum on our businesses as we go forward. Specifically, as it relates to the OUS business, as you noted, we had a very strong Q3 really across both emergency care and our acute care businesses. I think it's important to note that we were really having good performances in the OUS space even before really the impact of the pandemic.

And our expectation would be that even though while we're seeing some benefits, certainly from the pandemic, that we'll continue to build on the momentum that started even before that as we go forward.

So I think all in all, feeling very good about the future from a medical standpoint.

Next question comes from Ed.

Just like that, one comment. The other part of the physio business is called public access. So that's outside of the emergency and the hospitals. And that business really got very, very quiet in the second quarter. It came to a halt almost. And so that will come back. That will probably be a little slower, maybe more in the first quarter, second quarter of next year. So SAGE will come back a little bit sooner, maybe towards the end of the year, and then public access will come back. maybe in the first or second quarter of next year. So there are parts of the business that are drags right now that will turn positive. And there are, of course, some pops that we got from the pandemic that will start to moderate. But we love our medical business. We love the leadership we have in that business. And it will continue to be a really good performer for us.

Next question comes from Matt Missick with Credit Swift.

Thanks so much for taking the question. Kevin, I just had a follow-up on this AS strategy you've been pursuing and talking about a little bit. I know you don't want to tip your hands too much as to exactly how that all is going to work, but I would love to get anything you are willing to share, you know, progress so far, how it complements your other efforts to grow and maybe how it complements your relationships with some of the larger networks which have, you know, an outpatient channel often. And I have one follow-up.

Yeah, look, I'm not going to get into too many of the details about how we're doing it, but we are very pleased with our performance in ASCs. The MACO number in the third quarter in ASCs was the highest number we've had so far in ASCs. So MACO is part of the solution. We have double-digit growth in our sports medicine business, and, of course, that plays in the ASC primarily. And so those are the proxies that you could use to figure out sort of how we're doing in the ASC is look at our sports med business, look at the growth that we're having with Mako. There's a lot of other products that we have that play very well in the surgery center market. And we've just basically created an aligned offense that aligns our divisions. As you know, in the hospital, we tend to operate very separately. and we go in by product category, we're not doing that in the AFC. And this aligned offense is really working very well, and I want to give credit to Andy Pearson, the entire team that sort of established this offense. It's working ahead of what I was expecting and I feel very bullish about it going forward.

That's terrific. And then just to follow up on, you mentioned strength and growth in China. despite some of the pandemic controls they're putting back into effect there. And you mentioned last call and the call before just about the move into China with MAKO going forward and understanding that I'm guessing that a lot of that early activity is in the sort of premium self-pay market and maybe any update or progress as to how that's going and any early results that you've seen in terms of feedback or uptake.

sure thanks matt so let me start with mako so we only have the hip approved right now in china we don't have yet have to totally we hope to get that in the first or second quarter of next year it's taking longer than than we had uh expected but we're on track so it will get eventually approved but we are we are getting sales and they go for hip but uh of course once you get the knee on the on the robot then of course the sales will start to really accelerate There's just been a general pickup in general. So the pandemic, they've done a good job controlling the pandemic in the country. We've seen a pickup both in our Charleston business, which is our lower priced products, as well as in the premium segment. So it's kind of, I would say, an across the board pickup that's occurring and really related to the coronavirus. We had a great year last year in China, our best year on record, and a good year the year before. We have a strong management team, both on the Charleston side And in the premium segment, as you know, that's been a more recent thing for Stryker. So I would expect that we'll continue to see that kind of performance since the market conditions have improved markedly.

Your next question comes from the line of Larry Bikleton with Wells Fargo. You may proceed.

Good afternoon. Thanks for taking the question. To Kevin, I'm on the operating margin. In Q3, you know, it obviously stood out, the 260 basis point or so improvement year over year. And, you know, I heard the comments that, you know, some of it was, you know, spending that you deferred because of the pandemic. But my question is, how much of this may be durable because of things you've learned, you know, to do more efficiently during the pandemic? And how does it make you feel about, you know, the 30 to 50 basis points of operating margin improvement on an annual basis that you've targeted?

Yeah. Yeah. Hi, Larry. This is Glenn. You know, you're right. During Q2 and Q3, we obviously continued a lot of the cost containment measures that we had enacted in March. And these were, you know, kind of things that other companies probably have looked at, travel, meetings, training, consulting, and just the real whole gamut of discretionary spending was really kind of locked down. We also slowed our hiring. We slowed project spending on sort of non-R&D type projects. And I would say coming out of this, you're absolutely right. We've learned sort of new ways to work. We're doing this call virtually, and it seems to be working fine. We also have launched virtual training with customers and also internally that has worked very well. And so I would say some of that very definitely will carry over to the future in terms of how we sort of emerge from the pandemic and what our operating structure looks like. That being said, though, as we get back to more normalized operations and back to a growth trend that we expect to be at, there will be increases to all those expenses. And some of them will return to pre-COVID levels just because that's what we'll need to support sort of the growth assertions that we'll have. You know, key projects will start back up. We'll see hiring pick back up. So all of that will start to grow as we emerge from this. As you think about the 30 to 50 basis points, I do think that probably a more normalized basis to look at would be looking at 2019 in terms of an op margin that we might assert relative growth off of. But we have not backed away at all from our financial assertions. We will grow at the high end of MedTech, and we will continue to expand our op margin 30 to 50 basis points.

That's super helpful, Glenn. And one follow-up question just, I think, for Kevin. On M&A, you know, with the exception of the Wright deal, you've been relatively quiet on the M&A front. Any thoughts, you know, and is it due to valuations? Just any thoughts on kind of your appetite and pipeline for M&A? Thank you. Yeah, thanks. We intentionally slowed down M&A in the second quarter just because we were not sure what was going to happen with the pandemic. We asked the teams to sort of put their pencils down, stay active in discussions. But we really wanted to be sure that we didn't know the recovery would happen quite this quickly. So we're pleased with that. We do have our M&A teams back up and running. Because of the right medical and the debt that we're taking on because of that, we don't expect to be doing very large deals in the next year or so. but we look for more tuck-in deals. But we do want to stay busy with M&A. We've said that to the rating agencies. Our teams are actively looking at targets that they sort of never really stopped. They did just slow down a little bit while we saw sort of a pace of recovery. But you should expect us to get back to our normal kind of tuck-in offense, which will complement the right medical acquisition.

Next question comes from Matthew O'Brien with Piper Sandler. You may proceed.

Good afternoon. This is Patrick on for Matt. Thank you so much for taking our questions. I want to start with NACO. You've done a really nice job with placing NACO, and the underlying demand is really strong. But I'm curious if you could give us more color on the sales cycle. Specifically, I'm wondering if there's a chance that the sales cycle kind of over the longer term remains elongated as some of these hospitals work through financial pressures. So any color you have there would be really helpful. And then I have a quick follow-up.

Just to answer that, no, we don't expect that the sales cycle to be elongated. As a matter of fact, it's one of the things that we've seen over the last couple of quarters is we've actually been able to get out and drive MAKO even faster. And so there's still quite a bit of runway as we think about opportunities for MAKO.

So we don't expect that cycle to elongate. Great. That's really helpful, Collar. And briefly, I know this might be kind of a longer way out, higher level, but I'm just curious if there's any changes to the way you guys are thinking about the robotic offering in Spine, either through, you know, a Mako platform or the Mobius asset. I'm just kind of curious about how you're thinking about that pipeline as the Spine business really picks up momentum and starts, you know, heading in the right direction. Thanks for taking the questions.

Yeah, thanks. You know, we're really not ready yet to publicly talk about what the robotic offering is. It will be important for our spine business, no question. Mobius did come with a robotic pipeline product. Once we're ready, we'll share. We're actively working on an offering. We're just not quite ready to share what that will be and what the timeline is, but stay tuned.

Next question comes from Ryan Zimmerman with BTIG, Maker CD.

Thank you. Appreciate taking the questions. Congrats on the quarter. Kevin, you called out Sage performance being maybe a little weaker than expected. Was that a reflection of procedural volume, or is there anything from a protocol perspective in terms of preoperative sterilization that may have changed for some customers given the pandemic?

Yeah, look, I would tell you, first of all, we weren't surprised by the sales. It wasn't weaker than expected. It was certainly negative sales growth. In fact, everything we had was a little better than expected in terms of the pace of recovery. The nature of the sales cycle per stage, you need to have a lot of activity in the hospital where you have procedures being done, where the products are being used because they're consumed as you have people in the ICU, people that are getting procedures done. And so the census in the hospital was lower in the second quarter for sure, and certainly even in the third quarter. And these products are bought in bulk and they're put on the shelf because they're consumed daily. So you have this sales cycle that it sort of has to be depleted. The inventories have to be depleted before they're reordered. So that's not at all a surprise, the fact that the sales were negative. It just sort of explains why that that was a drag in the U.S. on our medical business. We don't have a very big stage business outside the U.S. It's more of a U.S. phenomenon. But we love the products. In fact, we launched a new product, a self-oral care product, which is really exciting in the midst of the pandemic, which is getting great customer feedback. But, of course, that's just going to take time for that to be ordered and then put on the shelf. So once the usage starts to happen and the inventory starts to bleed down, we're going to get sort of this bolus of reordering. And again, that may not occur fully in the fourth quarter, but towards the end of the fourth quarter and into the first quarter, we'll expect SAGE to get back to its normal, very strong growth.

Okay. And then just as a follow-up, one on MAKO, not so much on the unit volumes, although it was certainly encouraging, but I think there was a software upgrade cycle earlier in the year. I could be wrong on that. You certainly called out the HIP software upgrade. But how should we think about the upgrade cycle for software of Mako in the installed base and what that can do for growth maybe over the next 12 to 24 months within your existing customer base?

Yeah, look, software upgrades are important. They just help with the ease of use and really productivity for the surgeon. We did a software upgrade on hips in the second quarter. We are working on one for knees as well. The hip one had some very important, but it wasn't just a software upgrade that had ease of use to do with registration, which is one of the frustration points for hips, but it also provides new information to the surgeon on pelvic tilt, which they're finding really beneficial. So I do expect it will cause, it was already increasing the use of NACO for hips, but that'll probably accelerate into next year. But that software upgrade is still being deployed in the field and And we'll share more about the knee software upgrade when that happens as well. So this is not new. We constantly look to provide better usability and usage factors for our surgeons, and that's a common thing. But I wouldn't call that an inflection point. It's just a continued good customer experience, which we'd like to have with all our products. The real boon is just the adoption of MAKO, the success surgeons are having, the hospitals purchasing their second and third and fourth Makos, the growth in teaching hospital, the growth in surgery centers. It's just kind of an inflection point that we're seeing that I think will continue to last for many quarters ahead.

Next question comes from Joanne Lynch with CD Bank.

Good evening and very nice quarter. Two questions. The first one is MAKO related. There's a lot on this call, so I'll throw mine in. Can you give us an idea of what percentage of hospitals currently have a robot, and where do you think it ultimately goes to? And it's sort of a two-part question because when we do our survey work, I talk to hospital administrators and physicians that have one, two, three. They seem to not be able to get enough robots or enough type of robots. I'd love your sort of view on the landscape. And then really the second question has to do with seasonality. Is there anything happening in the big, broad world outside of the pandemic that you think will impact the fourth quarter? Thanks.

Okay thanks Joanne so look the first question it's really just about when you're in a new market adoption it's not easy to predict right how far will it go you know could robotics become standard of care as we've seen happen in some other procedure areas maybe and if it becomes standard of care you can do the math of how many hospitals do robotic procedures and surgery centers that are being added that do robotic procedures there's a there's a huge number of robots still to be sold. And so that's the underlying question is will it become the standard of care that's expected in all procedures? And we're obviously striving for that. The industry is moving in this direction. The pace of the curve is really hard to predict. But your point's right. And what we're seeing is, you know, we always like to have surgeon champions with every robot that we sell. So we don't do mass sales of robots. We don't do C-suite sales of robots without surgeon champions. That's just not the way we operate. And so what happens is the robots that we do sell get used right away. And when they're used, the surgeon shares their experience in the surgeon lounge with the other orthopedic surgeons. And then they want to watch this procedure. They get interested, and then they'd like to use it. And then what happens is the robot's fully booked. And that surgeon gets frustrated and then goes to the administrator and says, I'd like a robot for my procedures. That's a dynamic that we've seen happen over and over again, and that will continue. So at this point, you know how many hospitals there are that do the procedures. It's a large number. And we think that there's a long, long runway. We're still in the early stages of robotic adoption in orthopedic procedures. Sorry, I lost it. What was the second question again, John? Do you mind repeating that?

Of course. The second question had to do more with seasonality. I get we have a pandemic.

Oh, yeah, seasonality. There you go. Thank you. Yeah, sorry. Yeah, on the seasonality question, Q4 is normally our strongest seasonally quarter that we have. And so November, December, it's really hard to predict this year. Will we see the same type of seasonal impacts? The surgeons are saying they still want to be busy. Hospitals have realized the importance of elective procedures to their own profitability. And so will we see the normal push? Don't know. The surgeons we talked to seem to think that they're going to be busy. But it's a question I can't answer because we've never been through this with a pandemic. Right now, we're not seeing any signs of something changing. It seems like there's a normal dynamic outside of the pandemic. So as long as surgeons can go to operate, they're going to operate. And they've become very creative in terms of figuring out how to do their cleaning protocols. They're actually very efficient. Some hospitals are opening longer hours or even opening up on a Friday or on the weekends to stay busy. We'll have to watch it closely, but I really don't have any new insights to provide. I don't expect something different from what we've seen in the past.

Next question comes from Josh Jennings with Cohen. You may proceed.

Good evening. Thanks for taking the questions. Congratulations on the strong recovery. I wanted to ask a future MAKO indication question. I know you're not giving timelines, but just thinking about the development of the shoulder indication, Should we be thinking about the development there being exclusive for right medical upper extremity portfolio? And does just the push out of that acquisition do anything to the timeline of MAKO shoulder indication?

You know, we're not really going to get into the timeline. We believe that the robotics for shoulder is going to be compelling. Shoulder is a very difficult procedure to do as sort of more akin to partial knee. than it is to total knee or total hips, and we believe it's going to be very, very compelling. We're excited about the progress that our team has made on the application, and we're not going to talk yet about what implants are going to be married with the robot, but we will be sharing that at a later date.

Okay, understood. And this follow-up of the start ankle divestiture, just thinking about the striker extremities portfolio, are there any other divestitures that need to occur before – the close of the deal, and just wondering if you could help us with that as we think about forecasting out in 2021 and making sure we account for any other divestitures outside of STAR. Thanks a lot for taking the questions, guys.

Yeah, no problem. So as we talk about, we're not really going to get into too much more in terms of the right medical offering. Kevin mentioned the divestiture of SAR. We believe that we're on the path with the regulatory agencies to close the deal in November. And so we'll just leave it at that.

Next question comes from Kayla Kroom with Truist. You may proceed.

This is Sam on for Kayla. Thanks for taking my question. First of all, I just wanted to ask about the AeroSystem out of Mobius. I'm just curious how you would describe about a year in now how that's performing and then generally how the capital market for imaging versus, say, the strength in robotics is performing and then any impact you're seeing on Pulsar to other businesses from that system.

Yeah, listen, we're thrilled with the Mobius acquisition. We bought a terrific technology product. Our biggest challenge, honestly, has been scaling up the manufacturing. So we've had very, very high demand for Mobius. It was a small company based in Shirley, Massachusetts. Our challenge is really scale up. And it's the same challenge we've had, frankly, with TSO3, which is the sterilizing company that we bought. And a lot of times when we buy smaller companies, the demand tends to overwhelm us and we have to go back to the design robustness and be able to scale the manufacturing, build new production lines and So that's a high-class problem, I would call it. We were really, really pleased with the Aero product. It performs extremely well. It frankly had an increase in demand. In some cases, they were using it to look to do imaging for COVID. And so we've been, frankly, struggling to keep pace. But it's, like I say, a high-class product. We're really excited about it. They also have good products in their pipeline as well. So it's a deal that will very much help our spine business for the long term. But we're still in the scale-up phase.

Great. Thanks. And then just with resuming more spend on rep hiring into the fourth quarter, if you can maybe tease that out a little bit, should we actually think about that in terms of more return to normal rep hiring, or are you thinking about maybe pressing your strength a little bit and getting a little more aggressive while some of your competitors may be struggling? Thank you.

Yeah, that's a good question, Sam. You know, I think as the divisions look out towards 2021 and they're planning sort of their budgets and where they can get to, it always will include new rep hiring. And so absolutely our regular cycle is that we would get started on that in Q4. So I think that... you know most divisions are planning to expand their rep sales forces towards the end of q4 and certainly on into january of next year and that would be just part of the sort of the general territory management that we go through every single year next question comes from matt taylor with ubs please go ahead

Hi, thank you for taking the question. The first one I had, I wanted to follow up on your comments on your bed launch and the bed market. And I had kind of a two-part question. Really trying to understand if you're seeing a trend towards the bed market expanding and that could create more opportunity for you. And then was just hoping that you could comment on how this new rollout could go. Do you expect it to go into your own base and do mostly conversion of your older beds? Or do you think there's a share gain opportunity?

So in terms of the bed market itself, I think there's probably a bit of both, right? So there's obviously going to be the replacing cycle of beds that's going to continue to happen. But I think the pandemic has also created some opportunity for expansion in that market as well. So I think there's going to be a mix of both of those items. as we go forward. With regards to procurity and what that's going to do for us, again, we feel really strongly about that bed and the opportunity. And there will be some opportunity, like I said, both in terms of replacement cycles that will fit into and then expanding into competitive opportunities as well.

And could I just ask a follow-up? I was really interested in your comments about standard of care robotics at MAKO. And I think we've seen that the knee value proposition is very strong and I was wondering if you also think that you can convert that to be the standard of care for hips over time in other areas. Is that your vision, that it'll be standard in many areas or more siloed?

Yeah, no, the vision is for it to be standard of care everywhere where we have an application. Now, I think it'll take longer. You've seen the adoption of hips as trailed knees. The adoption in partial knee was very, very strong. I think the adoption in shoulder will be very, very strong. Knees will continue. And I think hips eventually, it's just going to take a little longer because, frankly, the satisfaction level of patients with hips has been quite good relative to knees or relative to shoulder. And I think over time, total ankles, there's many other areas that robotics will play in. And our expectation is that it will become standard of care. Just a question of how long will that take and what iterations are required for us to get there.

Next question comes from Richard Newiter with SVB. Please proceed.

Hi, this is Jamie on for Rich. Thanks for taking my questions. I guess the first one I wanted to ask, you guys had called out some strengths in the smoke evacuation product line. I wanted to make sure I heard you correctly. Did you say that that grew double digits in the quarter? And then just kind of, you know, digging into that a little bit, what's really driving the strength in that product category? Is it something that you're really starting to see pick up now, kind of just in the wake of COVID?

Sure. On the smoke evacuation, yeah, I did reference that we had double-digit growth in that product line. And, you know, honestly, even before COVID, most hospitals and caregivers have been very focused on safety, and smoke evac lines up extremely well with that safety focus. I think with COVID, it's just sort of even more emphasized in terms of

um what that product does to the environment that they operate in and how it contributes to the overall safety sort of platform and focus that we're seeing across all hospitals okay and then just as my follow-up um you know talking about double growth in the neurovascular business just curious thing to get your thoughts on how sustainable you think that is with some of the new product losses you have heading into 2021 thanks

Yeah, look, we're accustomed to seeing our neurovascular business do double-digit growth. This is something they've been doing for, you know, since we acquired the business almost. Once the target launches got rolled out and the ischemic segments started to grow, and now that we have the photo-verting stint in the U.S. market, the China market's continuing to grow very, very strongly. So, no, we expect to continue double-digit growth for some time with the tailwind in ischemic and now, you know, really addressing photo-verting stints and aspirations. We've had a terrific management team for a long time. They continue to be humming, and we expect that business to continue to perform extremely well.

Once again, to ask a question, please press star 1 on your telephone keypad. And we have a question from Steve Beauchamp with Wolf Research. You may proceed. Thank you.

Hi, thanks. I wonder if you could spend a bit more time on the ASC and outpatient environment. I think once upon a time, there were questions around the category that were probably rooted in some concern about pricing, but in this environment, it's clearly a tailwind. I know there was a question already about market share, but can you speak a little bit about the procedure growth trends in ASCs and outpatients relative to hospitals and how much you think that's a sustainable trend beyond COVID, and how do you think about that commercially in as much as it could be a structural advantage as a multi-line player versus a more concentrated line-specific player? And then I do have a follow-up.

Yeah, look, first let's start by keeping in mind that a small number of our procedures, let's call it around 10%, of our large joint spine procedures are being done in the ASC. So it's not a big, big part of our business yet, but the trend is no doubt headed for more of these procedures being done in the ASC. Part of that's the change in Medicare around knees, and we expect that to happen in hips. And so it's a trend that was already happening pre-pandemic. It's a trend that will accelerate going forward. There's all kinds of prognostications about how much it'll be. Could it be 50% of our procedures? It's hard to predict how fast it'll move, but we believe we're really, really well positioned for this trend, and we do intend to be a multi-line player. That's what the ASC actually wants. It's unlike how the hospitals buy. They have a different buying pattern in the surgery center, and the breadth of our portfolio is a huge advantage, and we plan to to really leverage that strength wherever we can. So we're feeling very good about it. It's a trend that, in terms of pricing, we're not seeing really any change so far in the pricing dynamics. There is a constraint around capital. ASCs are much more capital-sensitive, so we do tend to have more financing involved in surgery centers, but we're well-equipped to do that with our flex financial. We've been doing financing for a long, long time, so we're feeling very good about our position to be able to win in the ASCs, and we do think it's going to be more important and the trend will accelerate.

Okay. That was actually a fantastic answer. You answered my next question, so I'll leave it there. Thank you so much. Okay, great. Thank you.

And at this time, I will turn the call over to Mr. Kevin Noble.

So thank you all for joining our call. We look forward to sharing our Q4 results with you in January. And let's conclude the call. Thank you.

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