Kevin A. Lobo - Stryker Corp. Katherine A. Owen - Stryker Corp. Glenn S. Boehnlein - Stryker Corp..

Michael Weinstein - JPMorgan Securities LLC Robert Hopkins - Bank of America Merrill Lynch David Ryan Lewis - Morgan Stanley & Co. LLC Chris Pasquale - Guggenheim Securities LLC Frederick Allen Wise - Stifel, Nicolaus & Co., Inc. Matt Miksic - UBS Securities LLC Bruce M. Nudell - SunTrust Robinson Humphrey, Inc.

Larry Biegelsen - Wells Fargo Securities LLC Isaac Ro - Goldman Sachs & Co. LLC Kaila P. Krum - William Blair & Co. LLC Young Li - Barclays Capital, Inc. Joshua Jennings - Cowen & Co. LLC Brittany Henderson - Deutsche Bank Securities, Inc..

Welcome to the Second Quarter 2017 Stryker Earnings Call. My name is Tequia 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. 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 8-K filed today 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 Boehnlein, Stryker's CFO; and Katherine Owen, VP of Strategy and Investor Relations. For today's call, I'll provide opening comments followed by Katherine, who will discuss our pending acquisition of NOVADAQ and an update on Mako.

Glenn will then provide additional details regarding our quarterly results before we open the call to Q&A. Our momentum continued in Q2 as we delivered organic sales growth of 6.7% in spite of one less selling day, which impacted total sales by approximately one percentage point of growth.

All of our segments, Orthopaedics, MedSurg and Neurotechnology and Spine, delivered strong top-line gains and growth was well balanced graphically with organic growth of 7.2% in the U.S. and 5.5% in international. We continue to be pleased with our results in Europe and Canada with our Transatlantic Operating Model.

Our first-half results reinforced the strength of our product portfolio, commercial execution and globalization effort. This has enabled us to exceed our original sales and earnings targets and is reflected in today's revised financial outlook for the year.

We continue to deliver on our goal of achieving organic revenue growth at the high-end of medtech as we are gaining market share across the majority of our division and we continue to make investments to help drive growth longer term, while still delivering leveraged earning gains.

The strong top-line and operating margin expansion contributed to an adjusted per share earnings increase of approximately 10%, topping the high-end of our range at $1.53 per share.

As we look ahead to the balance of the year, we are excited about the pending acquisition of NOVADAQ, which will add a key growth driver to our high-performing Endoscopy division.

And despite the product challenges that we have had with Physio-Control and Sage, the latter of which we recently received a warning letter related to last year's recall, we remain on track with the EPS accretion for both deals as their growth will accelerate through the remainder of the year.

Our full-year organic sales growth is now targeted at 6.5% to 7% and EPS of $6.45 to $6.55 per share. This excludes dilution from the NOVADAQ acquisition that Glenn will cover in his section. I will now turn the call over to Katherine..

Thanks, Kevin. My comments today will focus on the recently-announced plans to acquire NOVADAQ, along with an update on Mako and the Total Knee launch. Starting with NOVADAQ, as you know, in June, we announced the planned acquisition for approximately $701 million, net of cash totaling roughly $47 million.

NOVADAQ is a leading developer of fluorescence imaging technology that provides surgeons with visualization of blood vessels and related tissue perfusion in a variety of procedures, including cardiac, general, colon and plastic surgery.

The company, which is headquartered in Canada and was founded in 2000, aligns with Stryker's focus on enabling our customers to see and do more by enhancing cross-specialty surgical visualization.

NOVADAQ's technology uniquely complements our portfolio of visualization technologies and will allow us to further build upon the highly successful launch of our latest generation 1588 Camera by expanding into new surgical procedures, including open surgery where we do not currently compete.

Further, we believe NOVADAQ's SPY technology will help reduce post-procedure complication rates as well as the cost of care for a broad variety of surgical treatments. With our specialized sales force, we will be able to broaden the reach of NOVADAQ's technology as we look to leverage our highly complementary customer bases.

We expect to close the transaction during the third quarter Turning to Mako, during the quarter, we installed a total of 26 Mako robots globally, an increase of over 50% year-over-year and reflecting 20 new robots in the U.S.

Of note, we continue to see solid uptake for Mako upgrades, which remain on track and should position us to largely compete (05:37) all U.S. system upgrades during 2018. With respect to the new robot placement, approximately 40% continue to go into competitive accounts, where we have no to well below our normal market share.

These placements are helping to drive our overall knee sales as our surgeons begin to use Triathlon Total Knee System in anticipation of Mako adoption. Moreover, we are able to introduce our broader knee portfolio to these new customers, including our highly successful 3D-printed tibial base plate and revision augments.

Training on the Mako Total Knee continues at a solid pace with over 400 surgeons trained to-date, helping to drive Mako Total Knee surgery since launch to over 5,000.

We are particularly pleased as we look at utilization rates, which have increased meaningfully for the Mako Total Knee, as well as the total hip application and is supporting the growth we are seeing in both franchises.

On the clinical front, we are continuing to collect data comparing the Mako Total Knee to a traditional knee surgery, both utilizing Triathlon. These studies are looking at a number of standard outcome measurements, including hospital stay, return to work, range of motion, stability, discharge to rehab and patient satisfaction.

We expect to begin to see some of the data at key orthopedic conferences starting in 2018 and beyond as we track these patients over time. As we look ahead to the remainder of 2017, we have strong order demand and continue to see mounting clinical interest. We believe this will help drive ongoing knee market share gains in 2018 and beyond.

And with that, I'll now turn the call over to Glenn..

Thanks, Katherine. My comments today will be focused on our second quarter financial results and the related performance drivers. The detailed financial data and results have been included in today' press release. Organic sales growth for the quarter was 6.7%.

As a reminder, this quarter included one less selling day, which has the impact of reducing growth by roughly 1%. As previously stated, selling days generally do not have an impact on the performance of our capital businesses.

Pricing in the quarter was unfavorable 1.5% from the prior year, while foreign currency had an unfavorable impact of 0.8% on sales. In the U.S., we continue to see good momentum with organic sales growth of 7.2%. This strong growth was evident throughout several of our key divisions within our Orthopaedics, MedSurg and Neurotechnology segment.

International organic sales growth of 5.5% was highlighted by solid performances in Europe and Australia. Our growth in emerging markets continues to recover, but also benefited from favorable year-over-year comparable. Both geographies were impacted by one less selling day.

Our adjusted quarterly earnings per diluted share of $1.53 increased 10.1% from the prior year, reflecting strong sales growth, accretive acquisitions, operating expense control and the previously discussed benefit from the change in accounting guidance for tax benefits from certain stock compensation expenses now included in our tax provision.

Our second-quarter EPS, as anticipated, was negatively impacted $0.04 by unfavorable foreign currency exchange rates. Now, I will provide some highlights around our segment performance. Orthopaedics delivered constant currency growth of 6.5% and organic growth of 6.2%, including organic growth of 8.4% in the U.S. Our U.S.

performance was highlighted by growth in knees of 7% and trauma and extremities at 10%, reflecting strong demand for our 3D-printed products, our foot and ankle portfolio and our Triathlon knee. Orthopaedics international delivered organic growth of 1.8% and included steady performances across all developed markets.

MedSurg continued to have strong results in the quarter with constant currency growth of 6.8% and organic gains of 6.7%, which included a 6.9% increase in the U.S. instruments had U.S. organic sales growth of 4.2%. During the quarter, instruments executed its sampling plan for its newly launched System 8 drill and began several customer trials.

We expect System 8 shipments will gain momentum into the third and fourth quarters as we have now shifted to full commercial launch. Endoscopy had another strong quarter with U.S. organic sales of 15.2%. This reflects continued strong demand for our 1588 video platform, booms and lights and sports medicine products. Medical had U.S.

organic growth of 2.3%. This growth primarily reflects the impact related to the timing of shipments of our core bed, stretcher and power cot products. As you are aware, our core medical business is all capital and can be impacted by the timing of customer orders and the related shipment.

We continue to see strong order growth in the core medical business. Our Sage business momentum improved during the quarter, following the previously discussed product recall. We are actively regaining customers that had switched during the recall and we are seeing solid performances in the other key products in the Sage portfolio.

Subsequent to quarter-end, Sage received an FDA warning letter, which relates to an inspection last September shortly after we closed on the acquisition. We have already taken many steps to address the items outlined in the warning letter and will continue to work with the FDA toward resolution.

This year's (11:04) results were impacted by continued supplier issues took earlier in the quarter in a tough quarterly comparable. Internationally, MedSurg had organic sales growth of 6%, which reflects strong Canadian, Australian sales and an easing of the metrics comparables in China.

Neurotechnology and Spine had constant currency and organic growth of 7.9%. We continue to see strong global demand for our Neurotech products, which is somewhat offset by softness in our Spine business. Our U.S.

Neurotech business posted growth of 10.3% for the quarter, highlighted by continued strong demand for our hemorrhagic and ischemic stroke products, CMF products and our neuro-powered instruments. Our U.S.

Spine business continued to see softness as it recovers from supply issues early in the year, partly offset by high demand for our 3D-printed titanium products. Internationally, Neurotechnology and Spine had organic growth of 13.1%. This performance was driven by continued strong demand for our Neurotech products in Europe and Asia.

Now, I'll focus on operating highlights in the second quarter. Our adjusted gross margin of 66.3% was up 10 basis points from the prior-year quarter, reflecting a favorable mix, offset primarily by price and foreign exchange related to certain businesses. R&D spending was 6.4% of sales.

Our adjusted SG&A was 35% of sales, which was up 10 basis points from the prior-year quarter. This reflects favorable leverage from business mix and continued focus on operating expense improvements through our cost transformation for growth program.

This favorability was offset by planned investments in our selling organization, including samples and sales rep adds, our CTG program, including our ERP implementation, and continued investments in our Mako TKA platform. In total, adjusted operating expenses were 41.3% of sales, which was flat compared to prior-year quarter.

In summary, our adjusted operating margin was 25% of sales and 20 basis points better than the prior-year quarter. Our operating margin reflects good leverage, offset by key investments related to drive future operational savings and product growth platforms.

We continue to remain confident in our ability to deliver our full-year commitment of 30 basis point to 50 basis point improvement in our operating margin.

Lastly, as it relates to our full-year operating margin improvement, NOVADAQ is anticipated to be approximately 20 basis point dilutive to our operating margin for 2017, which would partially offset the expected 30 basis points to 50 basis points of improvement. Now, I will provide some highlights on other income and expense.

Other income/expense decreased from the prior-year quarter primarily due to increased interest income. Our second quarter adjusted effective tax rate of 16.3% reflects a larger-than-anticipated benefit related to the adoption of the changes in accounting for stock compensation expenses.

In the second half of the year, our tax rate will benefit from certain other geographical and operational changes that, combined with the aforementioned change in accounting, will result in an anticipated effective tax rate ranging from 16% to 17%.

Focusing on the balance sheet, we continue to maintain a strong position with $3.7 billion of cash and marketable securities; of which, approximately 89% was held outside the U.S. Total debt on the balance sheet at the end of the quarter was $7.4 billion. Turning to cash flow, our cash from operations was approximately $801 million.

Also, we did not repurchase any shares during the quarter. And now, I will discuss our third quarter and full-year guidance. Based on our past performance on our outlook for the remainder for the year, we now anticipate annual organic sales growth to be in the range of 6.5% to 7% for 2017.

As a reminder, the third quarter will have one less selling day as compared to 2016 and the fourth quarter will have the same number of selling days. The full year has one less selling day.

If foreign currency exchange rates hold near current levels, we expect net sales in the third quarter and full year to be negatively impacted by approximately 0.5% and adjusted net earnings per diluted share to be negatively impacted by $0.02 in the third quarter and approximately $0.10 in the full year.

For 2017, our adjusted net earnings per diluted share is now expected to be in the range of $6.45 to $6.55 per share, which excludes any anticipated dilution related to the planned acquisition of NOVADAQ technologies. Based on the third quarter-end close date for NOVADAQ, the dilution is estimated to be approximately $0.03 to $0.05 per share.

For the third quarter, we anticipate that adjusted net earnings per diluted share will be in the range of $1.50 to $1.55, which includes the aforementioned investment, foreign currency impact and the impact of the accounting change for stock compensation. Our third quarter range does not assume any dilution related to NOVADAQ.

However, if the deal closes earlier than September 30, there will be additional dilution during the quarter. And now, we'll open up the call for Q&A..

Thank you. We will now begin the question-and-answer session. Your first call comes from the line Mike Weinstein of JPMorgan. You may proceed..

Good afternoon and first off congratulations on another excellent quarter. Let me start with Mako, because I imagine it's probably topic one for people. Could you just talk a little bit about the upgrade process? I think when we last spoke probably on the topic, you had a pretty good backlog of centers requesting upgrades to existing systems.

Could you give us a sense for what that backlog looks like today? And talk a little bit about kind of the obstacle, if you would, to installs and upgrades over the balance of the year. Thanks..

Yeah, Mike, thank you. And in terms of the upgrade process, we're really pleased with the pace of it. I think, as you know, the sales force is having to both sell new robots while also upgrading existing customers and we have a pretty sizable number of robots in the field.

And based on how that's tracking, we feel comfortable, we'll be through that process next year.

I think the biggest gating item right now is our ability to identify, hire and train the Mako specialists, who are critical to ensuring that not just the surgeon, but his entire OR staff is prepared to have a really successful experience as they start to adopt the Mako robot.

So, that's really one of the key factors that we're continuing to hire those folks, who are probably looking right now if you wanted a total Mako knee robot today, the issue isn't us being able to build and get you a robot, the issue is getting you in the queue and getting you trained and through that process as we hire additional Mako specialists.

So, you're probably looking at something late in Q4 before you are able actually to be in a position where you had it and you were good to go. So, that's not unexpected for us. That's why we really talked about this very methodical launch and we're really pleased with the pace of that that we're seeing right now..

Okay.

So, essentially this is a five-month waiting period, if you would, if you ordered one today?.

Roughly, approximately..

Okay..

That really depends, Mike, on where you're located in the country, if you already have a MAKOplasty specialist. So, that's sort of an average. It does vary based on where you are in the country and where the MAKOplasty specialists are. But our team is working very hard.

We're obviously investing and Glenn talked about that in the first quarter and again this quarter. We are prioritizing investment to make sure that the waiting list is not too long for our customers and that we're pacing things appropriately. But so far, extremely pleased.

Most importantly, the people who are using the total knee, the over 400 surgeons are having a very good experience and were getting very favorable feedback on the performance of the system..

Okay. And let me ask this if I could about two other businesses and then I'll let some others jump in. One, the Endoscopy business is obviously having a phenomenal year. It's year two of the launch. If you could just kind of update us on kind of where you think you are in this upgrade cycle for that business.

Obviously, very strong first half of this year. And then, second, your U.S. spine business was a little light this quarter and one of your competitors announced a light quarter this evening as well. We had a number of data points kind of suggesting that the spine market was light, not only in the first quarter, but here in the second quarter as well.

So, if you have any perspective on what's going on in the U.S. spine market, that'd be appreciated. Thanks..

Okay. Thanks, Mike. I'll take the Endoscopy question and I'll turn it to Katherine for spine. So, certainly the Endoscopy division is really performing well. I would say that the camera launches – year two we've always said is kind of the year where rib things (20:32) really pick up.

We had a good year last year and even better year this year, but I would say they're firing on all three cylinders. So it's not just about the camera. The booms and lights are also doing extremely well in our communications business. And sports medicine, which is obviously a smaller business, is absolutely on fire.

So, that business has been growing strong double-digits for a number of years, continues to outpace the market and we've done some very good small acquisitions, whether it's pivot for hip arthroscopy or recently Ivy Sports Medicine. These acquisitions are helping to contribute to a really strong growth.

So, across the board the business is being very, very well managed and that gives me a lot of excitement as we do NOVADAQ to really add gas to the fire of Endoscopy. And I'll turn it to Katherine for spine..

Kevin got endo and I get spine. So, I think it's safe to say we still -we have some challenges there and I think also based on some of the numbers have come in, the market overall looks to be challenged certainly in this quarter.

We've had some Stryker issues as we work through some of the supply challenges, but on the positive front, those do appear to be moderating for us. And we're also seeing really strong demand, but we are capacity constrained for our Tritanium products. And so, we're going to continue to invest in that portfolio.

We have a number of products in the R&D queue for that area. And so, over the longer term, we expect to see an improvement, but clearly it's been a little bit more challenging for us both due to some of our issues, but also a market that just seems to be a little bit softer than expected in the quarter..

Thank you. Your next call comes from the line of Bob Hopkins of Bank of America. You may proceed..

Thanks. Good afternoon.

Can you hear me okay?.

Yes, we can..

Great. Good afternoon. So, two questions; first one on clarifying guidance and then one on Mako. On the guidance question, I just want to clarify that the new EPS guidance excludes NOVADAQ dilution. And then, I also was wondering if you could just kind of clarify the new revenue growth guidance as well.

Is the right way to think about it essentially that the back-half guidance or the back-half growth is going to essentially be very similar to the front half growth?.

Yes. Bob, in terms of guidance, the $6.45 to $6.55 per share excludes any dilution from the NOVADAQ transaction. And in terms of revenue guidance, yeah, I think if you think about the back half of the year, it probably will continue at a similar pace as the first half of the year..

Okay. I just wanted to clarify that. And then, the second question I wanted to ask was on Mako. It looks like you had a fantastic quarter in terms of training physicians relative to comments that you offered us on the last quarter.

So, I know you're giving us information on the percentage of placements that are going into competitive accounts, but one thing that I'm really interested in is of the people that you're training right now, these roughly 200 docs it looks like that you trained in the quarter, what percentage of those physicians are "competitive physicians?".

Well, it's going to largely mirror. We're training the competitive surgeons, because as we put a robot in, they need to get trained on it.

And what you're also seeing reflected in our knee numbers, Bob, is as they get a new robot, one of the first steps if they are a competitive account and they haven't any real experience often with Triathlon as they start doing traditional knee procedures, traditional open knee procedures, but now using Triathlon to start to get used to that product.

So, that's some of the halo effect we referenced. But as we start to train surgeons, by definition, as we're putting roughly 40% of the robots into new customers, we're going to have – I don't think it mirrors 100%, but it's going to be a good approximation of who is getting trained..

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

Good afternoon. Just one strategic one for Kevin and a couple of just quick hits. So, Kevin, the growth is stellar, but I want to bring us back to the Analyst Day and the now infamous 9% EPS floor comment, if you would. So, you're certainly delivering above the floor.

There's no question about that, but you're also reinvesting very aggressively for growth.

So, could you just speak to the level of reinvestment for those investors who may expect more EPS drop-through on these very lofty organic growth rates?.

So, David, thanks for the question. And certainly we did raise the EPS as well as raising our top-line. So, I just want to make sure you saw that, but clearly, if we're in a momentum where we're gaining on the top-line, we'll always look to do some level of reinvestment. We have committed to improving our operating margin as well.

So, there isn't a one-for-one like that you used to see maybe in the past where we would deliver more top-line and spend at an even more aggressive rate. But we have this generational opportunity with Mako, where we're going to use some opportunity to invest behind that and also have a responsible level of drop-through.

If the reverse occurred and our sales growth slowed, you would certainly expect us to dial down the expenses. And so, we're being prudent about it, but we have raised our EPS guidance, I think, to an appropriate level. And we'll continue to fuel.

I mean, we have an offense that's been really rolling for the past four years and I think what you've seen in the last two years is really good EPS drop-through. And some of that's come through tax, obviously, but a lot of that's coming through our operations.

So, I think you should continue to expect if the top-line continues to run hot that we will take a portion to reinvest and, obviously, drop through the remainder..

Okay. Very clear. And just two quick ones from me. Glenn, just the components of the $0.10 raise, the components there that are FX and the tax suppression from stock-based comp. And then, Katherine, just on the instruments business, the only business we saw that had kind of momentum was a little weaker.

Obviously, that business tends to bounce around, but anything instruments that's important to call out? Thanks so much..

Yes. On the component of the raise, FX is moderating. So, it won't be as big as it was in the first half. I think in the first half, we probably had around $0.08 per share, if you look at what we had. I'm guessing that it will be about $0.05 or so in the back half. No, not $0.05, probably $0.02 in the back half.

And then, in terms of the components of the tax, I think in addition to the stock comp, we also implemented some other changes geographically that will benefit us in the back half of the year and that's probably roughly a 0.5% point on our tax rate..

Yeah, but the way to think about it, David, is we had said in the last quarter $0.10 to $0.12 was FX. Now, Glenn saying about 10%, so – $0.10. So pretty modest amount from FX and that, obviously, could change if exchange rates change. Obviously, we've had a pretty rapid appreciation of the euro recently and we're using today's FX rates for that.

So it's pretty modest, the FX impact. We also don't have a lot of business OUS as some of our competitors do. And then, if you look at the rest, it's really mostly operational. Again, there's a little bit of tax, but mostly operational..

Yeah and then just on your question on instruments and the U.S. performance, I think the main focus for the team in the quarter was the System 8 launch and it was really about getting the sampling plan in place and beginning some of the customer trials. Obviously, there's not a big revenue generation associated with that.

We're now in full commercial launch. So, we feel pretty excited based on our history of launching next-generation power tools and understanding that upgrade cycle to see an acceleration in that business in the second half as we move away from the sampling stage..

Thank you. Your next call comes from the line of Chris Pasquale of Guggenheim. You may proceed..

Thanks. Let's talk a little bit more about the different components of the medical business this quarter, what the growth rates were for Sage, Physio and then the legacy Stryker product lines..

Yeah. Thanks for the question. Now that they are fully in the business post one-year acquisition, we don't break those out anymore just because they're not material to the total company. So, we typically if it's of size give the growth rates for newly acquired business through the first year, after which we consider it to be part of organic growth.

We did see improvement in those businesses per se.

Did they start to recapture business that they lost due to some of the recall challenges and also for Physio recognizing that they are having some supplier disruption? So feel confident that there's no change to the full-year EPS accretion, associated those deals that we originally announced and also feel confident that we'll continue to see quarter-to-quarter improvement in those businesses as they work through some of those challenges associated with those deals.

But we're not going to break out with specificity as we did through the first four quarters nor do we with other deals that after we announce them..

Okay. Maybe – yeah, go ahead, Kevin.

Just a little extra color. So our legacy medical business, the core medical business of beds and stretchers and cots as you may remember had a huge quarter in the second quarter last year, about 17% growth. And they have very, very good orders, but didn't have a very strong shipment quarter.

And what we've seen in the past with our medical business is it's a bit more volatile from quarter-to-quarter, but the order book is really strong. So although the medical number is a little soft this quarter, the outlook for the medical division is very strong not only for the remainder of this year but for the future..

Thanks for that. And can you spend a minute on the competitive landscape in recon at the moment? By our math, you picked up some solid share again this quarter, particularly in the U.S., and you've really been enjoying that momentum now for the last four quarters or so, even pre-dating some of this recent strength with Mako.

So, how much of that momentum that you've had do you think is related to sort of product-specific things that you guys have been doing versus maybe some competitors who have been in a tougher spot? And do you expect to keep that share as they get back on their feet? Thank you..

Yeah. Thank you for the question. I would tell you that we're focused on executing on a strategy that's been underway for a couple of years now. So, it's nothing new in terms of really having highly focused sales force that we're continuing to make investments in as we talk about making investments to drive longer-term growth. That's part of it.

We also have seen real uptake over the last X number of quarters from our new product portfolio and the investments we made over the years in 3D printing to be able to give us some really unique product offering that if you look at our cementless offering is now approaching, 20% of our knees are now cementless, which is vastly different than to the overall market, which is still in the low-single digits.

And we talk about that Mako halo effect to be able to go in and sell the full portfolio of our knee and hip products when we get into competitive accounts is certainly helping to drive the growth. So, we're gaining market shares in knees as we have been. We feel like we're holding our own in hips, but also are pleased with some of the impact.

Our renewed focus there is having – and expect that business to continue to improve. So, it's really difficult to slice out where all the share is coming from, but we feel confident in our ability to continue to execute on the strategy that's been working really well for us over the last few years..

Thank you. Your next call comes from the line of Rick Wise of Stifel. You may proceed..

Good afternoon, everybody. Kevin, maybe talk to us about where you are in China these days. You had easier comps. That was good. Just maybe some more color on the underlying business growth and what's still left to do from an investment point of view. Just your latest thoughts there..

So, China had a good quarter, double-digit growth in the quarter. But I would say that's more to do with the comparatives than really having a big and strong business in China. As you know, we had a couple years of difficulties in China. We're starting to right the ship.

I'm feeling encouraged by the progress that we're making, but we have a long way to go still. We are looking to appoint a new leader in China. That search process is progressing. Obviously a very important role for the future of our business in China.

We're also doing a lot of work with our Trauson portfolio as well, both for inside of China as well as for export. I would say it's still early days, Rick. We still have a long way to go. I'm glad that it's no longer a headwind for the company and having double-digit growth in China is certainly a positive.

But certainly given our low market share, the potential is enormous and we are just starting to tap into that potential. So many, many more years to come of progress, but it starts with talent and we don't yet have our new China leader, but we're getting close..

Thank you.

And, Katherine, maybe back on NOVADAQ, you highlighted a couple things, open surgery where you don't compete is an opportunity, it seems like connected to Endoscopy, but maybe just add a little bit more color if you could about what you can do with NOVADAQ in your hands that can accelerate growth and the opportunity and if you just expand on some of your comments.

Thanks so much..

Yeah, I think the biggest benefit to us is they have outstanding technology that gives us access to new procedures for a customer base that we call on and we have commercial sales execution that's been built up over decades.

We have a considerably larger sales footprint and the expertise to be able to sell these products effectively to gain access to new accounts where we already have a presence and to be able to sell our portfolio into customers where they have a presence.

So I think it's a really nice marriage of commercial excellence, our own very well accepted in the market visualization technologies and then bringing in what is very complementary visualization technologies to expand the customer base and the procedure that we can address..

Thank you. Your next call comes from the line of Matt Miksic of UBS. You may proceed..

Hi. Thanks for taking the questions.

And just one follow-up on Mako, I'd love to get a sense, if you could provide some sense of the types of hospitals that you're seeing the most active in new system placements? So mid-size hospitals, urban hospitals, any smaller centers, privately held hospitals? Just a couple of examples would be very helpful and then I have one follow-up..

Yes, thanks. It's really all of the above.

The way we have gone about the launch of this, which has proven to be very successful, is focusing on where we have a very strong surgeon champion and that's what's really helping to ensure that the adoption in utilization of the robot continues to accelerate and that includes urban, it includes rural, it's big practices, it's small practices.

There is no single specific type of Mako customer. It really covers the entire landscape that you described. And that's where we focused our activities, first and foremost is there a surgeon champion, and are they committed to the process and that's what really drives both the adoption in the hospital and then the utilization rates afterwards..

That's great. And then same topic, just trying to get a sense of what the sales cycle of the system is like. As you know, one of your competitors is out sort of talking about having a robot in the future.

I'm just wondering if in this environment, whether it's just the health care environment in general or if it's any actions that your competitors have taken have like extended the sales cycle or tightened it or what do you see in terms of just the pace of new placements?.

I'm assuming you're referring to Mako, specifically?.

Yes..

Yes, so, no, we haven't seen any impact.

This is really about identifying surgeon champions and then when our team goes in and does a terrific job of detailing the features and benefits and as they get exposure to it, whether it's events like the Academy meeting we had or another surgeon in their hospital who is using the robot, all of those lead to that word of mouth and mounting interest as they start to hear more about the experience from the key opinion leaders.

So there's been no impact we've seen, whether it's from hospital spending or competitive movements. We're just really focused on what has been a really successful launch as we went from initial launch now to full commercial launch. We're ramping up the number of surgeons trained at 400. We've got over 5,000 procedures.

Obviously that continues to grow quarter-to-quarter. We're upgrading the existing robots as well as selling new robots. So really focused on a game plan that seems to be working very well for us..

And if we have a surgeon that's really interested in the champion in a hospital that gets behind the surgeon, to us, we welcome the competition.

We really believe we have a winning solution and so if there is something competitive that resembles our offering or that even purports to resemble our offering, we sort of welcome that challenge and look forward to it..

Thank you. Your next call comes from the line of Bruce Nudell of SunTrust Robinson Humphrey. You may proceed..

Good afternoon. Thanks for taking my call. Kevin or Katherine, I guess, you've rolled Mako out very carefully to ensure quality outcomes. And I'm sure you have a sense now of the short-term outcomes that are attainable in terms of range of motion, pain, stability, discharge to institutional rehab.

Do you feel that the results that you'll formally publish in the next year or so will be compelling enough to make surgeons feel that they're actually doing their patients a disservice for not using robotically-assisted implants?.

Yeah, I think we're still in a wait and see. We are collecting that data right now, so it'd be premature to get out in front and make claims until we actually have sufficient data collected.

We've got a number of centers collecting data, as I mentioned, comparing Triathlon on the robot to traditional Triathlon and looking at some very standard follow-up measurements that would speak to some of your comments.

But until that data is collected, we have follow-up, we crunch the data, we submit it to the different meetings, it would be premature to get in front of it.

We're really pleased with anecdotal feedback, but that's anecdotal and I don't want to start to make speculation about what the clinical data would look like, other than to say we're committed to collecting the data and continue to believe that this will have a positive impact on patient and customer experience..

And I guess just going back to Sage and Physio, my recollection was, just on a directional basis, you felt Sage or Physio, rather, could sustainably grow in the high-single digits for a period and that Sage had double-digit potential.

And I know you're not going to break things out any longer, but are those aspirational goals still intact?.

Yeah, certainly this is not what occurred in the second quarter. But in terms of over the long term, we absolutely still remain committed to those kinds of goals and we see that in the pipeline of the products and in the teams that we have out there. So these are very good businesses. We are very pleased to have acquired them.

They didn't have those kinds of numbers in the second quarter, but we do see that as a resumption of the pipeline within Physio and as Sage gets the recall behind us, we absolutely see those kinds of numbers going forward..

Thank you. Your next call comes from the line of Larry Biegelsen of Wells Fargo. You may proceed..

Good afternoon. Thanks for taking the question. One on ischemic stroke, one on Mako. You called out the strength in your ischemic stroke business earlier and the Neurotech growth was quite healthy this quarter.

So I guess my question is have we already started seeing an impact from the DAWN trial and what's the timing of the publication? And I had one follow-up..

Yeah, it's really difficult to point to a single factor and that was relatively recently. I will say, we saw solid growth both in ischemic as well as hemorrhagic in the quarter. So, really pleased with the performance on both sides. I don't have an update on the timing for publication of the DAWN data.

I think you really have to look at all of those factors, DAWN and some of the previous studies that have come out, that are contributing to the interest in ischemic treatments that are mechanical based. There's still a lot of work that has to be done on the referral channel as we've talked about.

So, I think that's a business that we expect, overall, very healthy growth, but it's going to vary quarter to quarter based on the timing of some of these studies as well as the investments that we and our competitors are making to really help build the referral channel, which is going to be a multiyear process..

Thanks. And then, on Mako, Katherine, I didn't hear the total number of applications out there. I think there were 90 at the end of first quarter. Can you give us an update on that? And do you still expect to exit the year taking share? You're already growing, I think, your knee business in the high-single digits.

Can that really improve from here? Thanks for taking the questions..

Sure. No problem. So, we give the new robot installations that we've done. We have not reported any numbers on upgrades other than to say that we're pleased with the pace and we're on track to have the upgrades of all of the robots in the U.S. or the vast majority that will be upgraded in 2018. But we haven't broken out specific numbers on the upgrades.

And then your second question? I apologize..

Continued knee growth..

Oh, the knee growth, so, yes, we continue to believe that as we get more surgeons trained and the base of those doing the procedure will allow us to drive stronger knee market share as we exit 2017.

So, I think you should kind of think about a rolling four-quarter knee growth and that's kind of the base we assume we'll improve upon as we get further into the full commercial launch and we think the first evidence of that will be as we exit 2017..

Thank you. Your next call comes from the line of Isaac Ro of Goldman Sachs. You may proceed..

Good afternoon, guys. Thank you. First question was on margins. Would be interested in a status update regarding some of the goals you have to increase capacity across your manufacturing locations as part of the long-term goal to drive margins and then also any status update on your global ERP program.

I know that you're working on eventually consolidating that and so I'd be interested in some of the key milestones we can expect there over the next 12 months or so..

Yeah, Isaac, we outlined the program back at our Analyst Meeting and it was a five-year kind of program.

We actually have made very good progress relative to our product life cycle management, which is what I think you're referring to, which is really a SKU rationalization program that we're putting in place to sort of harmonize what versions of products we sell across multiple geographies.

And so, we're in year two of that plan and it's a multi-year implementation. So, we're not necessarily seeing results, but we are making good progress on the implementation. And then, related to our ERP program, this too was a four-year program where we're putting in SAP globally.

We're also rolling out global processes, which will help us become more efficient in terms of how we manage the various financial functions across the world. Relative to that project, obviously, you can imagine that's a very big project.

We've seen really good progress on the systems side and the business side and we expect sometime within the next six months to have our initial implementation and rollout of the first wave of that. And then, upon the successful wave of that, we'll continue with rollouts across various businesses until we complete all the businesses across the globe..

Great. So, maybe as a follow-up, if I interpret your comments there correctly, is it fair to say that we'll see some of the results of those efforts translated into the P&L early 2018 or could be later in the year? Just trying to think through timing of when this becomes a little more tangible on the bottom line. Thank you..

Yes, I really think it's later in 2018, second half, fourth quarter 2018 before we start to see some of the meaningful results of that work..

And as we laid out with cost transformation, we did say 30 basis points to 50 basis points over the next few years. In the early years, it will be closer to 30 basis points. There are some elements like indirect procurement, shared services where we'll get savings earlier.

The areas like the ERP systems and product life cycle management will drive much higher savings in the outer years, but it's a multi-year multi-facetted program. It's working so far and we're getting some early returns at least as it relates to indirect procurement.

But the bigger prize will come with product lifecycle management and as you mentioned with ERP, which will begin sort of towards the end of 2018 and continue in the years after that..

Thank you. Your next call comes from the line of Kaila Krum of William Blair. You may proceed..

Hey, guys. Thanks for taking my questions. So, just a couple from me. So, I guess, as it relates to the NOVADAQ deal, just a bit more color around kind of initial goals, steps for integration there once the deal does close.

What sort of feedback or initial excitement have you been hearing from your sales force there?.

Yeah, the sales force is extremely excited. This is a highly complementary technology. It expands their customer base. It allows them to further leverage the expertise we have with our own visualization technologies and it's a sell process that they understand. So, there's a lot of excitement.

I think we've got to get to closing before we start to really articulate some of our plans, but, obviously, we anticipate a lot of synergies to be realized given how complementary this business is..

And, Kaila, I'd just add that as surgeons, if you think about the top KOLs within the Sage's group of surgeons, I've received numerous calls directly from surgeons in that leading association who were really excited, because they see this combination as very, very powerful for them.

So, when a customer gets excited about the combination of competencies, that's always a good indicator that we're going to have commercial success..

Great. That's helpful. Thank you. And then, I guess, just touching on your foot and ankle business, has there been any update there as it relates to market trends, your competitive stance? Any additional color there would be helpful. Thank you..

Yes, so this has been a great business for us, as you know, for probably five years now. And we've had terrific success whether it's with our total ankle as well as Anchorage plates. We did an acquisition a little while ago called Instratek, which also fortified that business and that deal is going extremely well.

So, the offense that we have with our dedicated sales force that we put in place a number of years ago, our really good leadership and our product portfolio, we're in a great position, we're growing much faster than the market and have been for some time and we expect that to continue. The beauty of this market is it's a growth market.

So you're having implants put in where they weren't put in before and just like ischemic stroke is for neurovascular, that's what foot and ankle is to our trauma and extremities business. An expanding market and continuing to grow at very, very strong double digits..

Thank you. Your next call comes from the line of Matt Taylor of Barclays. You may proceed..

Hi. This is actually Young Li in for Matt. Thanks for taking our questions.

I guess the first question just on the warning letter, can you maybe talk about any early feedback you've been getting from the FDA so far? Since you've not really changed any deal assumptions, what gives you the confidence that the warning letter won't become a more disruptive issue? And are there any impacts on new product approvals or would it impact any other manufacturing facilities?.

Thanks for the question. I will tell you that this was an inspection that happened shortly after we closed the deal. We have been addressing with the FDA a number of the issues that were raised in the warning letter. And we obviously take this very seriously and will continue to dialogue with them to resolve the outstanding issues.

There are no product holds related with this warning letter nor does it impact other parts of the business. So, we're highly focused on addressing their concerns and we'll continue to provide you updates as we work through some of the items that have been outlined in what were three observations in this warning letter..

Yeah, so what I would say is, it did disrupt our business to some degree. That disruption is now over, as Katherine mentioned, no longer a ship hold, I would say the business is sort of back to business in a very normal way.

Obviously we do need to finish our remediation efforts, but it's not requiring any significant amount of investment and the business is sort of back on track..

Great. That's very helpful.

And I guess a follow-up on the foot and ankle market, but just wondering with the positive CMS reimbursement update for total ankles, can you maybe talk about what that could mean for your business? Is there any ability to take up price? And also I guess how important is having a revision ankle in your portfolio? How impactful could that be?.

So, obviously we're very pleased with the change in reimbursement. I would tell you that we were getting pretty good price all along and so I'm not sure that there's going to be a significant opportunity to increase price. But what the lower reimbursement was doing was dampening the momentum in the market.

It was a very small part of the market and we think now that this will unlock growth for the entire market. So, all competitors will be able to increase growth. I think revision is something that we'll obviously be looking at for the future. It's still a very nascent market. So, I don't believe that that's a major concern within our portfolio.

You've seen our growth. We're able to grow at very high rates without a revision offering, but that's obviously something that we'll address over time..

Thank you. Your next call comes from the line of Josh Jennings of Cowen. You may proceed..

Hi. Good evening. Thank you very much.

I was just wondering, Kevin, do you think Stryker is experiencing a benefit from opportunities in competitive accounts or have your team's been able to hire away high-quality sales reps due to your competitors supply constraint issues particularly in hips and knees? And has Stryker implemented any specific strategies in the short term to take advantage of any vulnerabilities?.

I tell you, Josh, I think really what you're seeing out of our joint replacement group is a focus on a strategy that has worked for us for a number of years. So we're continuing to invest in our sales force and that doesn't necessarily mean it's coming from competitive reps.

We're continuing to leverage the portfolio of products that we've launched in recent years and obviously highly focused on Mako.

So, to the degree there's disruption in the marketplace, obviously we're going to try and take advantage of that, but it really is a strategy that was well under way prior to anything that's been happening on the competitive front and one that we think is working well for us and we're going to continue to execute on..

I would say that we do receive a lot of inbound calls and I'm not saying that that's related directly to supply issues, but if you have an offering nobody else has with robotics or 3D printing and you have momentum in the market, well, obviously, that is felt by the sales forces competitively. So, the phones are ringing. That's a good sign.

I don't believe that it's ever driven by just one thing, whether it's just a supply disruption or just one thing. And our strategy is just to continue to drive high growth and as the phone calls ring, we'll see if these people fit our culture. And if we believe that that'll be additive to our growth, then obviously we'll look to hire them.

But we don't have a specific let's-go-hunt-for-sales-force plan and we don't really need to, given the kind of strength we have in the market..

Understood. Thanks. And just one follow-up on Mako. I was just wondering if implant pricing contracting is evolving, just imagine if some of these centers are dedicating them to developing robotics program that they may be interested in locking in multiyear contracts just to do the exclusivity of the Mako platform.

And the, how do you see, if you're not seeing anything in those early days, how do you see Mako helping on the implant pricing side of the equation in terms of maybe multiyear stabilization in some accounts? Thanks. Thanks for taking the questions..

So, right now, most of the implant pricing is on multi-year contracts to begin with, regardless of whether there's a Mako in the account or not. And most of the procedures are done without the use of the robot.

And so, we continue to want to provide competitive pricing to our accounts and over time, with the adoption of Mako, if it becomes more broad, then obviously that will provide more insulation for us.

But certainly at the moment, it's very competitive, as you see in our price decrease quarter after quarter after quarter is pretty consistent to what it has been over the past eight or nine quarters. So, it's pretty steady. It's a moderating decline, but it's still going to be a decline.

And I would assume, at least for the next foreseeable future, next couple of years, that you should probably see similar types of pricing. Over time, we'll see how that evolves..

Thank you. Your next call comes from the line of Brittany Henderson of Deutsche Bank. You may proceed..

Hey, guys. Thank you for taking the question. Just a quick follow-up on Mako. I know that the focus right now is just on the U.S. total knee launch, but I was hoping you could give us an update as to the demand that you're seeing for Mako in international markets.

How should we just think about the Mako opportunity internationally, especially given some of the variant reimbursement structures that we have in place overseas?.

Yeah. So, we're really seeing a pickup in interest internationally. Australia has been a fantastic market for us. They already did – many of their knees were done and navigated. Probably the highest percentage in the world, so they were – for them it's an easy adoption to move from navigated knees to robotic. That's been a strong market for us.

But we've seen interest across a range of countries. We have a robot in China, in India, in Vietnam. Europe is starting to really pick up, which is exciting. But it's going to vary by country. So we have Germany, Italy, the U.K. Those are going to be very good markets. I think other markets such as France and Canada will take longer.

So, it really is country by country and I think a good analog to look at would be Intuitive. If you think about how they expanded geographically, it was sort of very similar, which certain countries are much more friendly towards the adoption of new technology. We don't yet have any robots in Japan.

We look forward to getting approval for Mako later this year. And, as you know, with Intuitive, you see that's a very attractive market for us and we look forward to being able to launch Mako in Japan.

But I would say it's a broad range of countries and it's very similar, the pattern that we're seeing is a similar pattern to what Intuitive saw with their da Vinci robot..

Okay. That's great. Thank you. And then, just one kind of more big picture question. I was hoping you could just talk to us a bit about your strategy and portfolio positioning in the ambulatory surgery center, especially as it relates to large joints.

And I just ask that because of the recent proposed rule that we saw from CMS, which proposed total knee and total hip procedures be added to the ASC list. Thanks for taking the questions..

Sure. So, we already are pretty active in ASCs for our sports medicine business and we have other products that we sell into that channel. So, it's a channel that we know. Today, there's still a very small percentage of total joints that are done in the ASC.

A lot of noise around it and I do believe that over time that trend will increase, but we're well prepared to win both in the in-hospital as well as in the ASC market, but I do expect that it's going to be a pretty small number at least for the next few quarters..

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

Thank you all for joining our call. As you can see, we have very good momentum in our business and our conference call for the third-quarter 2017 will be held on October 26. Thank you..

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