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

David Ryan Lewis - Morgan Stanley & Co. LLC Robert Hopkins - Bank of America Merrill Lynch Michael Weinstein - JPMorgan Securities LLC Ian Mahmud - Barclays Capital, Inc. Matthew Keeler - SunTrust Robinson Humphrey, Inc. Kristen Stewart - Deutsche Bank Securities, Inc. Matt O'Brien - Piper Jaffray & Co.

Chris Pasquale - Guggenheim Securities LLC Frederick Wise - Stifel, Nicolaus & Co., Inc. Lawrence Biegelsen - Wells Fargo Securities LLC Matt Miksic - UBS Securities LLC Isaac Ro - Goldman Sachs & Co. LLC Joanne Karen Wuensch - BMO Capital Markets (United States) Glenn John Novarro - RBC Capital Markets LLC Kaila P. Krum - William Blair & Co.

LLC Joshua Jennings - Cowen and Company, LLC Raj Denhoy - Jefferies LLC.

Welcome to the Third Quarter 2017 Stryker Earnings Call. My name is Andrew and I'll 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 third 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 have an update on Mako, along with comments on our recently completed acquisition of NOVADAQ and the VEXIM deal. Glenn will then provide additional details regarding our quarterly results, before we open the call to Q&A.

Our Q3 organic sales growth of 5.5% reflected continued strong performance, despite weather-related challenges, the previously announced Sage product issues, and one less selling day. We estimate the combined impact of Sage and weather negatively impacted our Q3 sales by approximately 240 basis points versus 2016.

We benefited from standout performances in Neurotechnology, Endoscopy, Trauma and Extremities, and Mako, as well as double-digit growth in both our legacy Medical businesses and Physio-Control.

Turning to Puerto Rico, as many of you are aware, we have a manufacturing facility on the island which produces products for our Endoscopy and Instruments divisions. We are extremely pleased with how our team has managed through this unprecedented disaster and, most importantly, we can report that we've had contact from 100% of our employees.

Stryker has formed a Puerto Rico fund to aid employees specifically affected by the hurricane and is providing direct financial aid with all employee contributions matched dollar-for-dollar by the company.

With respect to our customers, through the preparation and deployment of our business continuity plans, we've seen minimal disruption to product supply and do not anticipate any material financial impact going forward. The safety stock stored in our U.S.

central distribution center has maintained customer supply, while we restore our manufacturing operations and supply chain. The facility is currently ramping up production, and newly manufactured goods are being shipped from the island.

Against this backdrop, I'd like to take a moment and recognize the outstanding work of our Global Quality and Operations organization in Puerto Rico and around the globe in minimizing these supply disruptions. In Houston and Florida, given the impact of the hurricanes, there were canceled procedures during Q3 and some delays to capital purchases.

We expect those procedures and capital purchases to be rescheduled and don't anticipate any meaningful impact to our business in Q4. Turning to Sage. In August, we announced a recall of certain products and a ship hold of other products as we switched to a new testing methodology.

Encouragingly, we began shipping products during September and have now commenced shipments from all product families. We have work to do with our customers, given the disruption these events caused to their practices.

Given Sage's market leadership position, which reflects the value-add of their product portfolio, we expect to regain lost market share over the coming quarters. Overall, our third quarter presented our teams with a number of unique challenges that were largely unexpected.

Given the strength of our diversified portfolio, effective business continuity planning and commitment of our employees around the globe, we're able to largely meet the needs of our physician and hospital customers.

As we look ahead to the balance of the year, we are excited about the recent acquisition of NOVADAQ and the VEXIM deal, which will help ensure we continue to deliver organic sales growth at the high end of med tech.

We expect full-year organic sales growth of 6.5% to 7% and adjusted EPS of $6.45 to $6.50 per share, despite incurring the added dilution associated with the NOVADAQ acquisition. I will now turn the call over to Katherine..

Thanks, Kevin. My comments today will focus on an update on Mako, the recent NOVADAQ acquisition and the VEXIM deal announced earlier this week. Starting with Mako, during Q3, we sold a total of 33 robots, of which 23 were in the U.S., with roughly 40% in competitive accounts.

We continue to update robots in the field with the Total Knee application, which now exceeds 50% of the roughly 385 robots installed in the U.S. Surgeon training on the Total Knee application is ongoing with approximately 600 trained through the third quarter, enabling 9,400 Mako Total Knee surgeries since launch.

For the quarter, TKA procedures on the Mako increased approximately 50% from Q2 to approximately 4,500. And it's worth noting that total robot utilization rates continue to climb, increasing roughly 50% compared to the third quarter of the prior year.

During Q3, we received 510(k) clearance for our cementless product offering to be used with the Mako Total Knee application. With approximately 20% of our total knees now being performed with our cementless offering, it's clear that there's strong surgeon interest since we first launched the product over three years ago.

On the clinical front, we are building our database with a number of trials ongoing.

At the upcoming (5:41) meeting in November, there will be a poster presented which focuses on the accuracy of implant sizing using Mako for total knees, with the authors concluding that Mako may reduce operative time, improve OR efficiency by reducing the need for instrumentation and potentially decrease revisions.

And in October, we had our first published article on the short-term outcomes with the Mako Total Knee in the Journal of Knee Surgery. The study compared patients undergoing traditional open knee surgery with Stryker's Triathlon Knee versus Mako Total Knee surgery with Triathlon.

Outcomes were measured at six months and included pain scores, physical function scores and total patient satisfaction, with all three measurements comparing statistically significantly better for patients undergoing total knee with Mako.

We remain committed to continuing to invest in clinical studies and believe we are well-positioned with Mako to achieve our goal of driving meaningful market share gains. We believe this is underscored by the fact that our Total Knee sales in customers with the Mako robot are growing at approximately 4 times the rate of our non-Mako customers.

With respect to NOVADAQ, in September, we completed the acquisition for a net purchase price of $674 million. NOVADAQ is a leading developer of SPY fluorescence imaging technology that provides surgeons with visualization of blood flow and perfusion with over 250 clinical studies and array of specialties.

The company's product portfolio is highly complementary to Stryker's visualization platform, augmenting our advanced imaging offering in MIS and expanding our presence into open surgery applications such as plastic reconstructive surgery.

Since completing the deal in early September, we have integrated the teams, inclusive of a large cross-training on the products, education led by KOLs and subject matter experts, and hands-on training sessions for our combined sales force. We also finalized our 2018 sales structure.

We are actively identifying portfolio synergies and collaborating amongst the sales team on combined quotes to our customers, as they look to standardize to this full advanced imaging portfolio. Beyond the sales force, NOVADAQ has an extensive clinical research team and impressive R&D team.

We are excited about the long-term opportunities to advance the visualization market. As Glenn will discuss in more detail, we remain on track with our financial target with NOVADAQ expected to be neutral to 2018 earnings and accretive thereafter.

Lastly, earlier this week, we announced plans to acquire VEXIM, which specializes in the development and sale of vertebral compression fracture solutions for €183 million. VEXIM's flagship product is the SpineJack system, a mechanical expandable VCF implant for fracture reduction and stabilization.

The company's portfolio is highly complementary to the interventional spine business of Stryker's Instruments division whose key products include an extensive and innovative portfolio for vertebral augmentation, vertebroplasty and radiofrequency ablation procedures, along with a diagnostic tool and decompression treatment advances for contained disc herniations.

VEXIM had sales of €18.5 million in 2016, which was an increase of 33% over the prior year. The company's 510(k) clinical trial for the SpineJack system is progressing, and we anticipate filing for approval in 2018. And with that, I'll now turn the call over to Glenn..

Thanks, Katherine. My comments today will be focused on our third quarter financial results and the related performance drivers. The detailed financial data and results have been included in today's press release. Organic sales growth for the quarter was 5.5%. As a reminder, this quarter included one less selling day, reducing growth by roughly 1%.

As we've previously stated, selling days generally do not have an impact on the performance of our capital businesses. Pricing in the quarter was unfavorable 1% from the prior year, while foreign currency had a favorable 0.3% impact on sales.

During the quarter, our sales were negatively impacted by the Sage product action and the hurricanes that interrupted business in Texas and Florida. These events negatively impacted our overall organic sales growth by 240 basis points.

In the U.S., we continue to see good momentum with organic sales growth of 5.6%, which was evident within Orthopaedics, MedSurg and Neurotechnology segments. Our U.S. organic sales were negatively impacted by the aforementioned Sage product action and weather-related matters by 320 basis points.

Our international organic sales growth of 5.2% was highlighted by solid performances in Europe, Asia and Latin America. All geographies were impacted by one less selling day. Our adjusted quarterly earnings per diluted share of $1.52 increased 9.4% from the prior year, reflecting strong sales volumes and some favorability in our effective tax rate.

Our third quarter EPS, as anticipated, was not significantly impacted by foreign currency exchange rates. Taking into account the Sage product actions, the impact of weather and NOVADAQ, we estimate that our adjusted quarterly earnings per diluted share was negatively impacted by $0.05 per share.

Now I will provide some highlights around our segment performance. Orthopaedics delivered constant currency growth of 4.8% and organic growth of 4.5%, including U.S. organic growth of 6.1%. Adjusting for weather-related disruptions in the quarter, our U.S. Orthopaedic business had organic growth of 6.7%.

We experienced a number of canceled hip and knee procedures in Houston and more significantly in Florida as a result of the hurricanes. We anticipate many of these cases will be rescheduled in the coming months, but cannot predict scheduling availability during Q4. Our U.S.

performance was highlighted by growth in Knees of 4.3% and Trauma and Extremities at 9.9%. These growth rates include the impact of weather-related disruptions. We continue to see strong demand for our 3D-printed products, our Foot and Ankle portfolio, our Triathlon knee and our Mako robotics platform.

Orthopaedics international delivered organic growth of 1.2% and included steady performances across all developed markets. MedSurg continued to have strong results in the quarter with constant currency growth of 6.2% and organic growth of 5.6%, which included a 5.3% increase in the U.S.

Adjusting for the Sage-related product actions and weather-related disruptions in the quarter, our U.S. MedSurg group had organic growth of 11.6%. Our Instruments business had U.S. organic sales growth of 6.4%.

This growth is highlighted by continued ramping of our Power Tools business, including our newly launched System 8, as well as good performances of our Sterishield and waste management products. Our Endoscopy business had another strong quarter, with U.S. organic sales growth of 11.8%.

This reflects continued strong demand not only for our 1588 video platform, but also booms and lights and sports medicine implants. During the quarter, Endoscopy completed its acquisition of NOVADAQ Technologies, Inc. Including this acquisition, U.S. Endoscopy sales growth during the quarter was 13.8%. Our Medical business had U.S.

organic sales decline of 1%. This reflects the impact of the previously discussed Sage product action, which is in line with our previous Q3 Sage disclosure, as well as a nominal impact related to weather matters. Adjusted for these matters, Medical's U.S. organic sales growth was 15.4%. This growth primarily reflects underlying strong U.S.

growth across Medical's acute care, EMS and Physio businesses, which include continued robustness in our core structure and power cot products. Internationally, MedSurg had organic sales growth of 7.1%, which reflects strong growth in our Medical businesses, primarily in Europe. Neurotechnology and Spine had constant currency and organic growth of 7%.

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 11.8% for the quarter, highlighted by 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 across many product areas, which is partially offset by high demand for our 3D-printed Tritanium products. Internationally, Neurotechnology and Spine had organic growth of 10.7%. This performance was driven by strong demand for our Neurotech products in Europe and Asia.

Now we'll focus on operating highlights for the third quarter. Our adjusted gross margin of 66% was down 30 basis points from the prior-year quarter, reflecting an unfavorable mix, price declines and the impact from the disruption to our manufacturing facility in Puerto Rico because of Hurricane Maria.

We continue to invest in innovation with R&D spending of 6.6% of sales. Our adjusted SG&A was 35.2% of sales, which was up 30 basis points from the prior-year quarter.

This also reflects some negative impacts from our Sage product actions, weather-related matters and the impact related to the consolidation of our NOVADAQ acquisition during the quarter. Additionally, we continue to invest in our CTG program, including our ERP implementation, and in our Mako TKA platform.

In total, adjusted operating expenses were 41.8% of sales, which is up 40 basis points compared to the prior-year quarter. In summary, our adjusted operating margin was 24.2% of sales and down 70 basis points from the prior-year quarter.

The impact from Sage, weather-related matters and NOVADAQ on our adjusted operating margin was approximately 75 basis points. As it relates to our full-year operating margin expectation, excluding the impact of the one-time items related to Sage, weather and NOVADAQ, we continue to anticipate delivering 30 to 50 basis points improvement.

Lastly, I will provide some highlights on other income and expense. Other income and expense decreased from the prior-year quarter, primarily due to increased interest income.

Our third quarter adjusted effective tax rate of 14.6% reflects a larger-than-anticipated benefit related to the adoption of the changes in accounting for stock compensation expenses as well as benefits in geographic income mix.

In the fourth quarter, 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 full-year effective tax rate in the range of 15.5% to 16%.

Focusing on the balance sheet, we continue to maintain a strong position with $2.7 billion of cash and marketable securities, of which approximately 80% was held outside the U.S. Total debt on the balance sheet at the end of the quarter was $7.2 billion. Turning to cash flow, our cash from operations was approximately $880 million year-to-date.

This includes year-to-date recall-related payments of $492 million. And now I will discuss our third quarter and full-year guidance. Based on our past performance and our outlook for the remainder of the year, we anticipate full-year organic sales growth to be in the range of 6.5% to 7%.

As a reminder, the fourth quarter will have the same amount of selling days as 2016. The full year has one less selling day. If foreign currency exchange rates hold near current levels, we expect net sales in the fourth quarter will be impacted positively by 1% and the full year to be nominally impacted.

We expect a negative impact on adjusted net earnings per diluted share in the fourth quarter of approximately $0.02 per share and $0.10 in the full year.

With respect to the outlook, recall that in August when we announced the Sage recall, we revised our 2017 EPS outlook to come in at the low end of our $6.45 to $6.55 range, which excluded the anticipated $0.03 to $0.05 of dilution related to the planned acquisition of NOVADAQ.

Based on our strong year-to-date results, we now expect our adjusted net earnings per diluted share, including $0.05 of dilution related to NOVADAQ, as well as the impacts related to Sage product actions and weather disruptions to be in the range of $6.45 to $6.50 per share. And now we'll open up the call for Q&A..

Thank you. Our first question comes from the line of David Lewis with Morgan Stanley. You may proceed..

Good afternoon. Kevin, I want to talk about, obviously, growth for a second here. I think, even if you adjust out the weather impact, your growth still represents perhaps 8% organic, which is the best number, I think, we've seen in years. So I wonder if you can just share some broad commentary. I know MedSurg was strong this quarter.

And I know you're not going to give guidance for 2018. But just thinking about broad strokes into next year, could you just touch briefly on where you see improving momentum in the next year and where you see some sustained growth across some of your key franchises? Then I'd have a quick follow-up for Glenn..

So, thanks, David. We're very pleased with the underlying business, even if you look at the Medical division, which obviously had the Sage impact. The other businesses had very strong double-digit growth, whether it was Physio-Control or our core legacy Medical business.

We had strength in Neurotechnology, strength in Trauma and Extremities, really strength in a number of areas. And we feel very good about our business momentum, our new product cycle. As you know, it varies by division.

I'm not going to go through every single division, but I would say you should expect us to continue to deliver sales growth at the high end of med tech going forward..

Okay. And maybe just there two follow-ups, I'll merge them together here.

Just to follow-up on growth is, as you think about growth in Orthopaedics next year, I wonder if you can share with us how much momentum is coming from the Mako halo, the cementless piece versus competitive disruption, and how important Mako cementless knee is for next year? And then for Glenn, just thinking about some of the headwinds to earnings this year, Glenn, Sage, NOVADAQ, FX headwinds, if I think about how those go next year, NOVADAQ should be accretive, Sage obviously gets accretive and no longer dilutive, and FX may move to a slight positive versus negative.

Should we think about that as somewhat of a $0.15-plus swing into 2018? And I'll jump back in queue. Thank you..

I'll take the Mako question. I would say we continue to see the bulk of the benefit is from the halo effect. It's getting into competitive accounts, which is about 40% of our robot installations.

Selling the whole portfolio, typically, the first thing they do once they have the robot is start using our Triathlon implants for traditional surgery to start to get used to it. We've had tremendous success. After a very conservative limited release of our UNI, we've had tremendous success over the past three-plus years. It's 20% of the mix.

It was low-singles to start. And we believe that will continue to climb for a number of quarters. And the Mako procedure volumes are ramping. Utilization rates are ramping. So it's, obviously, becoming more material, but I wouldn't say it's the key driver of our results with respect to Mako.

But it obviously has an impact, as I mentioned, in the Mako accounts. We're growing our Total Knee portfolio in the U.S. about four times faster than that comparable portfolio in non-Mako accounts..

David, as you think about op margin, and we're not giving guidance for 2018, but I can comment that, yes, NOVADAQ was $0.05 dilutive and will be this year. And we're assuming that it will have no effect in next year. So it'll essentially be flat for next year. So, that's a little bit of a tailwind.

As it relates to Sage, Sage will continue to ramp, but it's not going to immediately reach its previous sales levels to where we'll feel a one-for-one impact relative to our operating margin. And then, as we mentioned, the weather goes away and we're anticipating that hopefully we'll be able to make most of that up in Q4 anyways..

Our next question comes from the line of Bob Hopkins with Bank of America. You may proceed..

Hi. Thanks very much for taking the question and congrats on an outstanding quarter. There's a lot of moving pieces this quarter. So I thought for my questions I just want to clarify a couple of things.

First of all, in terms of just the organic revenue growth of the company, I mean, my math ex-hurricanes, Sage and selling days, gets you to 8.9%, just shy of 9% growth.

So I guess my first question is, is that accurate when I just add up all these numbers that you're close to 8.9% this quarter?.

Yeah. Bob, organic growth of 5.5%, Sage and hurricanes of 2.4%, takes you to 7.9%. And then if you estimated a 1% impact relative to one less selling day, you get to 8.9%..

That's quite the number. So, just – second question is just clarifying again on two things. Can we do the same exercise on knee growth? Because that's obviously something that people are really focused on. So knee growth constant currency was 3.9%.

I would imagine the selling day impact was like more – it was more like 1.5% for knees and then maybe 60 basis points for weather.

So, was kind of adjusted knee growth closer to 6% than the 3.9% we see?.

Your math is right. Selling days really don't have an impact on our capital businesses, which is around 20%. It has a more pronounced impact on recon and some of the Trauma business to about 150 basis points. And then knees were probably impacted somewhere around 70 bps from the hurricane. So you need to adjust for those factors.

We're not seeing anything when we look in the quarter or at our rolling four-quarter trends with our knee business to suggest anything has changed. We believe we're taking market share. We need to obviously see everybody else's results.

Q3, as you know, is the seasonally weakest and tends to be the noisiest of quarters, but underlying growth seems very stable..

Our next question comes from the line of Mike Weinstein with JPMorgan. Your line is now open..

Thanks, everybody. And let me just pick up on Bob's question just on the knee business. So, if we try and adjust for everything, which is hard to do this quarter, and with the knee business, it's not an easy comp. But the year-over-year growth in the U.S. is 4.3% on a reported basis here this quarter.

Let's say it's 6% or 6%-plus adjusting for the noise in the quarter of selling day and weather and so forth.

Are you surprised that that's not a little bit higher given the success you're having with Mako? And does it indicate that a lot of the early Mako volume is from existing users? And I'm trying to separate volume from the comment on Mako purchases.

So, just trying to tease out all the progress in Mako this quarter relative to the year-over-year growth in U.S.

knees?.

Yeah. Thanks, Mike. We're not seeing that. We're looking at a number of different metrics, whether it's surgeons trained, the pace of their training, the utilization rates which up 50% year-over-year; they also continue to increase each quarter this year and the number of surgeries being done.

So I think, at the end of the day, we have to obviously wait and see everybody's numbers. And you're right, there's a lot of noise and moving parts. Could this be an incrementally weaker knee quarter or hip quarter than prior quarter? It's possible. These numbers move around quarter-to-quarter.

But nothing we're seeing or hearing from our customers in the field suggests to us that there's any underlying change in market dynamics. So, to the degree that the numbers add up and it looks sequentially a bit slower, if that's the case, I just put it into quarterly noise as opposed to something else.

And just like if Q4 comes in seasonally strong as it typically does, I don't think that's anything other than what's traditionally a really strong fourth quarter in hips and knees..

Okay..

Yeah. Mike, I'd just add we feel very good about our knee business and we're excited about getting the cementless approval so that we can market that with Mako as well, because I believe the combination of robotics and 3D printing will be very powerful going forward..

Understood. Let me just do a couple of quick follow-ups. Katherine, Sage was a $50 million lost sales number this quarter. What are you assuming in your fourth quarter guide for kind of the Sage still headwind that you have in front of you? And then second, Neurovascular continues to do exceptionally well.

The data points we picked up over the course of the quarter just kind of suggesting that the whole shift of endovascular therapy for ischemic stroke had picked up some steam in the last six months. Is that consistent? Are you picking that up at all? Is that what's driving the business? Thanks..

Sure. So, on Sage, probably looking at about $55 million-ish in lost revenue in the third quarter and we think it's going to be a little south of that, maybe in the $45 million vicinity in the fourth quarter, but we really also have to see how we're doing. We have work to do to win back customers.

We really annoyed them with these recalls and shipment issues. But, again, given Sage's leadership position and the strength of that portfolio, we do think we'll win back that business. But that's probably a pretty good approximation. And then on the Neurovascular business, we continue to see really strong momentum, both in hemorrhagic and ischemic.

Ischemic tends to move around quarter-to-quarter. It's healthy double-digit growth, but it does bounce around. But the increasing clinical data out there that continues to expand is really helping drive that business and some really good execution by our team. So we're really pleased with where the Neurovascular, Neurotechnology business is right now..

Yeah. We had also great performance. If you look at our neuro-powered instruments, they also performed very well. But getting back to Neurovascular, it's across the entire portfolio, whether it's hemorrhagic or ischemic, and it's across all geographies. They run themselves as a global business and they are absolutely on fire..

Our next question comes from the line of Matt Taylor with Barclays. You may proceed..

Hi. This is actually Ian Mahmud on for Matt.

Can you hear me okay?.

Yes, we can. Sure..

Yes, we can..

Okay. Great. So you mentioned that there was some softness in U.S. spine in your prepared remarks. I'm hoping you could give us your high level view on the spine market, essentially, what your team is seeing in the field and just your take on overall market strength for the quarter..

Yeah. I think it's pretty clear based on all the results today that the spine market continues to be challenged, and ours were no exception. There's pricing pressure. We've got about 30% of the market that's either physician-owned or PODs or private, so it's a little hard to gauge the market.

But it's a challenging market right now for us and for others. We are doing well in our IVS, our Interventional Spine business as they're putting up some good growth. But the traditional spine business continued to be challenged, and we're not assuming any big recovery near term..

And just as a follow-up, do you think you're gaining share or losing share? Is there movement in terms of on the rep side?.

I think we're probably pretty much in line with the market, give or take. I don't think there's a discernible trend one way or the other..

Our next question comes from Bruce Nudell with SunTrust. Your line is now open..

Hi, Bruce..

Hey. Sorry. I was on mute. This is Matt in for Bruce.

Can you hear me okay?.

Yeah, we can..

Okay. Great.

Just, first of all, on the updated guidance, just wondered if you can give us some more color on – from a revenue perspective, going from the low end of 6.5% to 7% to back to 6.5% to 7%, what kind of changed there? Was it just the strength in the third quarter or was it more the trends that you're seeing in the fourth quarter that caused you to increase those numbers?.

Yeah. I think a lot of it is – first of all, gaining more clarity around Sage is very helpful in terms of us formulating where we think the guidance will come out. Closing on NOVADAQ and getting a much closer look at that was also very helpful in just understanding how those will play into our numbers.

And then the final thing is we know seasonally that Q4 is very, very strong for us and we're coming off a very strong Q3 across a broad swath of all of our businesses. We also see good product momentum, specifically in some of our newer products that have launched, and we expect that to continue.

So I think all of that gave us the confidence in rolling up the numbers to get to sort of a better look at where our guidance is coming out..

Got it. That's helpful. And then just a follow-up to clarify an earlier comment on the storm impact to sales in the third quarter. You said there was procedures, capital equipment, that you think you lost and the cover in the press release is helpful on how much that was. But I guess you said you didn't expect it to be a material impact in 4Q.

And I guess my thought is that some of that would come back there and you might see a material benefit to sales.

Why wouldn't that be material?.

It's just not big enough. It's not all going to come back in the fourth quarter. It depends on surgery schedules for the surgeon, for the patients. And so, given the overall magnitude, we think our overall strength of our fourth quarter business we can manage through any procedures.

And we expect those to come back, whether or not it's all in Q4 or over the next few quarters, we'll just have to wait and see..

Our next question comes from the line of Kristen Stewart with Deutsche Bank. You may proceed..

Hi. Thanks for taking the question. Just a follow-up on the guidance. From the bottom-line perspective, now you're embedding in the dilution.

What gives you the confidence to kind of go with that range? Is it just the confidence in the top line or anything changed on the dilution with NOVADAQ?.

Yeah. Kristen, there's no real change on the dilution with NOVADAQ. I think, really, just the robustness and strength of the top line that we're expecting, and not only just in Q3, but just what we typically and historically have seen in Q4.

And so, that really will allow us to kind of cover some of these things that previously we thought would have a bigger impact..

Okay. Perfect. Thank you..

Our next question comes from the line of Matthew O'Brien with Piper Jaffray. You may proceed..

Thanks so much for taking the questions. Just to start off with the comment that I think either Katherine or Kevin, you made on the Mako growth that you're seeing from a procedural perspective. I think you said, within those accounts, you're seeing the knee business grow at 4x the other accounts.

Can you just expand a little bit on that? Is it a function of those customers are attracting just so many more patients that they're growing so much faster? Or is there some other dynamic going on that's driving that type of growth?.

I think it's really a combination of the fact that we're putting robots into existing Stryker accounts. And if they're doing procedures on the robot, it has to be done with a Stryker Knee. So, that inherently means we're going to be taking more of that business, replacing about 40% of the robots.

And that's been very consistent and competitive accounts, where we either have no market share or it's well below our average. And so, that's all new business. And it's not just selling Triathlon to be done on the robot. It's selling the whole portfolio. Our 3D-printed cementless product offering has been incredibly successful.

Our 3D-printed revision codes and sleeves, that enables us to capture the revision implant business. So it's really the combined effect that really allows us to increase the revenue we're deriving in Mako accounts versus non-Mako..

And that story is the same story in Europe. So we're replacing robots also outside United States. We get the same kind of halo effect and overall growth in our knee business..

Okay. That's helpful. And then as the follow-up, your Trauma and Extremities business again this quarter was really strong with a difficult comp. And I think, as I look at my model, this is the best performance that you've seen out of that business on a tiered stack basis in the last couple of years.

So is there something specifically driving that improvement there? And then how much momentum or juice do you have to continue this level of growth out of that business?.

Yeah. Look, it was a fantastic quarter. And if you recall, going back almost five years, this has been a business that's outperformed the market year-after-year-after-year, quarter-after-quarter. If you go back two or three years, we were regularly posting double-digit growth.

The last year or so, the comps started to catch up with us, but they put up a terrific quarter. And it was really across the board. If I look at Foot and Ankle had a terrific quarter. Our Shoulder business was very strong and even our core Trauma business. So this is something where we focused, we dedicated sales reps.

we made investments, we filled out our product portfolio, and we're bearing a lot of fruit from that. So it wouldn't be just one thing I could point to. I think it's just increased momentum that's been building over a number of years, more specialization, more focus. And it's driving really terrific results..

Our next question comes from the line of Chris Pasquale with Guggenheim. You may proceed..

Thanks. Glenn, I just want to circle back to your comment on operating margin expansion. If I adjust for the 75-basis-point headwind from one-time items this quarter, it looks to me like you're about flat here through the first nine months of the year.

Is that your math as well? And if so, then how do you get to that 30- to 50-basis-point underlying full-year improvement?.

Yeah. I think we're actually a little up year-to-date, but you're right, it's maybe close to flat. If you go back and look at Q4, it typically is our strongest sales quarter and also generates the greatest amount of leverage in every single year. We'll expect that that will also happen this year with our sales growth expectations.

Also, we're beginning to see some of the benefits from our CTG investments, which I think will contribute to that in Q4. And then if I think about excluding those impacts of Sage, weather, NOVADAQ, which are not incidental to the margin, I think we'll be in the range of 30 to 50 basis points for the full year..

Okay. And then, Kevin, emerging markets is a smaller piece of your business than it is for some of your competitors.

But just love to hear your updated thoughts on the strategy in the EM and also how you think some of these markets are going to evolve, particularly China, as they institute some new regulations there going forward?.

Yeah. Look, we had a good quarter in emerging markets. It grew at high-single digits, and that's with a bit of negative growth from India. As you know, they had some severe price controls around knee implants which hit us. But, overall, emerging markets was a high-single-digit growth.

China, for us, is a very important market for the future, even with the impending changes that they're making. We have a very, very low market share, especially in our implant business. And we have a new leader for China, who's starting this quarter and we're very excited about, and we're making a lot of changes.

China actually is contributing to growth this year after a couple of difficult years of destocking. And so we're encouraged. We are very committed to the emerging markets long-term. In spite of some of the temporary challenges related to nationalism and other things, there are going to be big markets, important markets.

We're going to take a bit of a patient approach. So we're not going to invest huge amounts of money. But we are going to make sure we have the right channel in place and then make the appropriate investments to continue to fuel growth. But it's been growing for us this year, and we had a good quarter again in the third quarter..

Our next question comes from the line of Rick Wise with Stifel. You may proceed..

Hey, Kevin. Let me start with Physio-Control. Obviously, you're very early on in some new product cycles, but my sense is haven't fully gotten underway in each segment of the business. Can you help us understand where we are and the potential impact on growth? And maybe as part of that, I saw that Philips recently suspended U.S.

defibrillator production.

Is that something you're positioned to take advantage of and could be helpful?.

Sure. Hi, Rick. Yeah. So, Physio had a terrific quarter and really benefit, a lot of it was in Europe. So their new AED has been launched in Europe. Has not been launched in the U.S. yet, it's pending approval, but has been launched in Europe and it did very, very well in the third quarter.

We also have our new CPR-assist device, the LUCAS 3, which has been launched globally. And that's performing very well. But we haven't yet launched a new manual defibrillator. So I would say we're sort of early in the new product cycle, but that business has performed very well in the third quarter.

And as it relates to Philips, look, this is certainly going to benefit all the other players in the market. But it's capital purchase, so it's not something that – I think you look at something like Sage, which is a disposable. They need to use those every single day. You can't defer those procedures.

So, that market share would shift much more quickly than a capital business. But we do stand to benefit along with other large players in the market..

And just as a follow-up on Mako, one more from me.

I'd be curious to hear just was the quarter on the system side ahead of what you might have expected, Kevin? And if it was, maybe talk about your experience so far? I mean, if it was ahead of plan, what have you learned in terms of the launch and how people are deciding? And I mean, related to capital availability or decision making, is it happening faster than you might have thought despite the need to upgrade? Just, again, any color would be welcome.

Thank you..

Yeah. Thanks, Rick. Look, we've been very pleased all year with the performance of Mako. And the third quarter was no exception. We've done a terrific job of hiring our Makoplasty specialists, of doing knee upgrades as well as selling new capital. It's a tricky challenge that was put on our team. Demand continues to be very strong.

We don't have any manufacturing capacity issues. The real issue is getting surgeons trained. But I would say, every quarter, they performed extremely well. And we have a good pipeline. I expect this momentum to continue. And as you've seen, the buzz about robotics, the story has completely changed.

And now no one is doubting whether robotics are here to stay. It's only a question of which robot and when do we get on the board with robotics. And that's a seachange versus even a-year-and-a-half or two years ago. So I think the tailwind of people seeing the value of this.

And as we start to publish clinically, as Katherine alluded to in her prepared remarks, I think that's only going to fuel the fire. So, very bullish about the future, and the team continues to execute extremely well. But there's no new dynamic.

I would say this is – disruptive technologies take a little while to take hold, as you've seen in other parts of healthcare. And this is one that's really starting to take hold now..

Our next question comes from Larry Biegelsen with Wells Fargo. You may proceed..

Good afternoon. Thanks for taking the question. First question on Sage. Kevin, I heard you say earlier that you expect to recapture share of the coming quarters. I guess could you be a little bit more specific when you think you can get back to the pre-recall run rate? And I had one follow-up..

Yeah. I think we're pretty early. We just resumed shipping all products, which we're really pleased with, and that just started in September. And so I think we're going to have to see how our customers react. We have work to do. Our sales force are focused on that, but it'd be premature to start speculating when it all comes back.

We do believe we can regain the lost share. I don't believe it's going to happen all in Q4. And then we're just going have to get a little bit more time under our belt and more discussions with our customers..

Yeah. Just as a guide, and this is not a prediction, right, but just as a guide, if you look at Neptune and how that came back, it took us roughly a year to regain all of our previous business. Now that of course has a capital component.

So it's not a perfect analog, but this won't happen in one quarter, it won't happen in two quarters, but I do believe we have a pathway to regain the business. I'm very excited with how the team is executing, how they're performing. But we have customers that were upset.

We have some customers that have entered into contracts that don't expire in 90 days. And so we have to work to regain the business..

That's helpful. And then I heard your comments earlier about the spine market but not much on your own spine business and the strategy there, and when you expect that business to start turning positive again. So, any color there would be helpful. Thanks for taking the questions..

Yeah. I mean, clearly our core spine business has work to do. We're going to continue to invest in the R&D pipeline and invest in our sales force. But it's a challenging market right now. And I don't want to pretend that we've got good visibility as to when the market or us will be back to growth.

So we're assuming it remains challenging and I think we need to see some evidence of momentum returning before we start to speculate on where growth will go..

Our next question comes from the line of Matt Miksic with UBS. Your line is now open..

Hey. Thanks for taking our questions and congrats on a terrific quarter, especially, just on the upgrades for Mako. It's impressive to get to 50% penetration at this point in the launch. So I had one follow-up on the U.S. knee growth. I know sort of like adding the pluses and headwinds and so on, I just wanted to make sure we get this right.

If we look at U.S. growth of 4.3% figure, to Bob's point, 1.5% or something like that, and then given the storm impact was primarily in the U.S., I guess it's closer to 1% impact. Just to make sure I'm looking at this the right way, it seems like that growth would be closer to 7% than 6%.

Is that math approximately right?.

Yeah. I think we'd probably split the difference. We think the – and again, this isn't perfect science, but we think....

Sure..

...the hurricanes impacted our U.S. knee business by about 70 basis points. Selling days typically have a 150-basis-point impact on our joint business. And so, if you add that to that underlying 4.3%, you get something at the midpoint between 6% and 7%, and that's what we think our true organic U.S. knee growth was..

Got it. And then if I could, just sort of a combination follow-up question.

One in terms of first time around the horn here with the Mako knee launch and just love to get your sense as to how we should think about the seasonality of capital budgets, et cetera, for systems heading into the fourth quarter? And the second part of that, unrelated, you mentioned the SpineJack acquisition.

Obviously, interesting interventional addition. But, to Larry's question on spine, is there something more significant in terms of investments going beyond R&D that you feel like you need to do on the kind of the fusion and Regen (47:03) side of the business to sort of reinvigorate growth? Is that on the table? Thanks..

Yeah. So I'll take the spine one first. We're going to continue to evaluate opportunities that could augment our product portfolio. But right now the focus of the group is really understanding the market dynamics, executing on the products we have. We've had great success with things like our 3D-printed cage, but there are supply issues there.

And so the team needs to – really to execute. And as I mentioned, this is a challenging market. So I don't see a magic fix near term. The pending VEXIM deal, that really goes into the IVF business within Instruments where they've actually been seeing some pretty good momentum there. And then, in terms of Mako, it's capital.

So the robot, the $1 million (47:28); Q4 is typically the strongest capital business across the board, whether it's MedSurg or Ortho. And I don't anticipate anything different. Hospitals are looking to use up their budgets by year-end. We have a Flex Financial Group that can go in and work with them on lease options and the like.

So I would assume robots have the typical seasonality that we see with our other capital businesses..

Yeah. Just to add on spine, I think we have launched a couple of new products that we're presenting at our NASS conference right now.

Tritanium C, which is the great 3D-printed interbody that we've had great success in the lumbar space and the cervical space, which we're very excited about, as well as Serrato which is a new easy-to-insert pedicle screw. So, a couple of new products. We obviously have more to do in terms of innovating around our new products.

And of course, we'll always, like we do at every division, look for other ways to augment the portfolio..

Our next question comes from the line of Isaac Ro with Goldman Sachs. You may proceed..

Good afternoon, guys. Thank you. So, another question on Mako. I was hoping you could compare-contrast what you're seeing in the U.S. versus Europe with regards to demand, competitive landscape and the types of physicians that are showing interest between the two regions..

It's really – the game plan is the same. We look for where there's a surgeon champion to make sure that when the robot is placed, we're going to see utilization ramp, which is what we're seeing. So there really isn't a different strategy in terms of how we identify who the right target is. It varies by geography. Obviously, with 385 in the U.

S., the U.S. is our biggest market..

Yeah. And I'd just say, in Europe, Europe isn't one country as you know. So there are some very attractive countries and some that are not as attractive. And I'd say the attractive category would be the UK, Germany, Italy. Those are probably the three areas that are most attractive. And some of the other countries will take a little longer.

They're going to want to wait to see more data before they start to adopt. But we're doing well in Europe. We're starting to pick up momentum. The surgeon interest is the same.

And again, as we do more publications, certain countries – just like we've seen with a place like Canada, some countries are slower to adopt this type of technology than in Australia, which already has a very large number of robots and pretty fast adoption..

Great. And then just a follow-up maybe for Glenn on the margin side.

If I think about some of the moving parts exiting the year with the M&A and so forth, would you be able to give us, at some point, an update as to what the normalized margin expansion for the business looks like? Because I would imagine that some of the deals you're doing here will give you the opportunity to at least hit the higher end of the range versus what you previously articulated.

And just trying to get a sense of what the real margin expansion cadence can be as you have a little bit more to work with on efficiency. Thank you..

Yeah, I think going back to when we introduced sort of the cost transformation for growth program we talked about margin expansion over a five-year period of time. That included sort of a range of 30 to 50 basis points of expansion each year and 30 basis points in the earlier year, ramping more to like 50 basis points in the latter year.

And really, beyond that, I think you can look at sort of what we've historically done in Q4 in operating margins, which is fairly more significant than the first three quarters of a year. And that should give you pretty good guidance. And we'll revisit it at Q4 when we give guidance for 2018..

Our next question comes from the line of Joanne Wuensch with BMO Capital Markets. Your line is now open..

Good afternoon.

Can you hear me okay?.

Yes, we can. Sure..

Wonderful. Two quick questions.

First of all, could you please give us an update generally what the capital equipment environment is looking like?.

Yeah. We are not really seeing any changes. Medical, if you look at the numbers I posted for our legacy medical business, that's all capital. That's structures and costs, and we've seen double-digit growth there, double-digit growth for Physio. Q4, as you know, is the seasonally strongest capital quarter.

We feel really good about our capital market right now..

Excellent.

And then because of that and I also so I have to ask this question, how are you thinking about a spying robot?.

I think, as you think about Mako, we believe there's a number of applications beyond the hip and knee joints, but that's really the focus right now. So we do believe that there's going to be opportunities in spine and shoulders and other areas. But right now, we are really focused on ensuring that we have a very successful launch of the Total Knee.

We only have one chance to get this right. And we feel really pleased with the trajectory around there. But we will also be looking at other applications because we do think there's opportunities outside of hips and knees..

Our next question comes from the line of Glenn Novarro with RBC Capital Markets. You may proceed..

Hey. Thanks guys for taking the questions. Very strong knee and hips when you take out weather, when you take out the one less selling day. But I wonder if you're also benefiting from the fact that number one player in the market, they are still struggling with their output and production.

So I wonder if you can talk a little bit about the competitive environment and how much are you benefiting from just the number one player still struggling. And I had one more follow-up on the Mako..

Yeah. It's difficult. We need to wait for Zimmer, Smith & Nephew to report to get a full picture in the quarter. What I can tell you is we believe our strategy is working. Our focus on Mako, targeting competitive accounts, investing in this Mako specialist, investing in our sales force there is driving share gains.

So, regardless who may be challenged in the market, we're going to stick to this game plan because we do believe it's working well. And we'll get a better sense of how market shares have moved around once everybody has reported..

Yeah. Fair enough.

And then the 33 robots that you sold in the quarter, can you remind us what percentage of these are outright sales versus leases?.

The majority are outright sales. We don't break it down between sales and lease. We do offer leasing options through Flex Financials. But even if – once they're walked through the leasing option, more often than not they tend to purchase. So I'd say the majority are purchases..

Our next question comes from the line of Kaila Krum with William Blair. You may proceed..

Thanks, guys, for taking the questions. So, a quick follow-up on spine and then one on Mako. So I know you commented on the spine market, continues to be challenging, and that on your strategy there.

But I guess, can you just talk a little bit more about how that sort of big-picture concern has impacted or changed your investment strategy going forward, i.e.

is it maybe less or more enthusiastic about certain areas within spine? Or has the overall market softness and the need to understand that dynamic sort of negatively impacted your appetite for more heavy investment in that area beyond the VEXIM deal?.

So, I would tell you, we're committed to the spine market. We believe it's an important part of Orthopaedics. There's tremendous unmet need and opportunities to continue to innovate like we did with our 3D-printed products. Throughout the years, we inevitably have businesses that are more challenged. Just look at China in more recent years for us.

We're going to stick to investing in the business. We've got great leadership. And eventually these markets write themselves. It just happens to be a period where spine is particularly challenged. We're big enough, diverse enough and global enough that we can manage through that and still deliver what we believe are exceptional organic growth rates.

So it really doesn't change how we think about the business and we really can't pivot like that just based on quarter-to-quarter results..

Okay. That's helpful. And then just on Mako, I know you mentioned Mako utilization rates are moving higher.

So, first, can you help us understand if there is much of a variance just across your systems in terms of that utilization growth? And then can you also help us parse out through the specific drivers of that? Is it more patient-driven? Is it the clinical work you're doing? And then just what gives you confidence that we can continue to see sequential improvements in that metric going forward?.

So we're early in the launch. We just went into the full launch in March at Academy. I will tell you what we see is where we've got physicians who are interested in new technology, that's where we have the greatest sponsorship, and then it typically can expand into a given practice. We're just in the early stages of the clinical data.

Encourage you to take a look at the recent publication in the knee surgery journal. We're going to continue to invest in those areas and believe all of that will drive utilization rates. It's pre-mature to think about direct-to-consumer because we need to get more robots out there.

But we're going to stick with the same plan; train surgeons, focus where there is a surgeon champion, investing in clinical studies, investing in the Mako sales force and our broader team..

Yeah. I'd just like to add that it's really encouraging to see the adoption occurring across the different types of hospitals, so academic teaching hospitals, rural community hospitals, even surgery centers. So, to see Mako appearing across the spectrum is really exciting.

And especially the academic centers where initially there was some belief that that might take a little longer, we're seeing really good adoption. So it's really across the board..

Our next question comes from the line of Josh Jennings with Cowen & Company. You may proceed..

Hi. Thanks, and good evening. I just wanted to first start off with a follow-up question on the Mako halo effect and just any updated thoughts on the potential future benefit for the hip franchise as you get deeper into the Mako Total Knee launch.

And are there any other catalysts for the USA franchise on the horizon? I think the 3D-printed acetabular cup launch is next year, but just wanted to [Technical Difficulty] (57:46)..

Yeah....

Sorry. You broke up a little at the end, but go ahead. Go ahead..

So, on Mako, you were asking in terms of the utilization uptake, and I think we're going to continue to – we expect that to continue to ramp here. I don't anticipate a real change. We are launching a new 3D-printed acetabular cup..

Yeah. We're in limited launch right now. The early surgeon feedback is very strong on the cup. The full launch won't be until probably the middle part. Second or third quarter next year, we'll move into full launch. But so far the feedback is very positive. And as you know, we've had a bit of a dry product cycle within hips the last year or two.

Prior to that, we had very, very strong market-leading growth in hips when we had the new stems that we launched, including Accolade II. But this is a very modern 3D-printed cup. We're very excited about it. It hasn't started to contribute to growth yet but should be a catalyst in 2018. And the halo effect is very powerful. It's not just also in knees.

I think it's going to start to extend to other parts. Once you have a Stryker sales rep that has a license to hunt inside an (58:59) account and they start to show you the breadth of our offerings, I think that will extend. Right now, obviously we're measuring it as it relates to knee. But getting into places where you've never been is wildly exciting.

It opens all kinds of other doors. And that's something we look forward to in the future..

Great. And just a follow-up on the Sage remediation efforts. Is there any more major work that's still needed to be done? I mean, you guys are not impacted in terms of getting the product back on the market. But any color in terms of incremental costs and where you are in that remediation process would be helpful. Thanks..

Yeah. So we expect to be at full availability of our product portfolio by the end of the fourth quarter, which is consistent with what we've stated in August when we first announced it. We have a lot of work to do with our customers as we touched on.

So, as we mentioned, we disrupted them and inconvenienced them and made it really challenging for products that they use every day. So we have to work to win them back..

And it's been a massive undertaking. We had to expand our test lab facilities pretty significantly. And we have to ramp production. So we have to make all of the SKUs across all the product families and restock the pipeline and that just takes time.

But I'm very excited that every product family we are shipping, we have no more sort of other gating factors, other than just scaling the manufacturing and filling up the supply chain..

Our next question comes from the line of Raj Denhoy with Jefferies. You may procced..

Hi. Good afternoon. I'll ask one on Mako as well.

I'm just curious, as you're starting to get a broader utilization of the robot now, what you're seeing in terms of treatment times? Have you seen treatment times coming down to where they're starting to be time-neutral or does it still take longer on the robot?.

It really depends on the surgeon. There are a number of surgeons that are faster on the robot. I would say the average of surgeons are slightly slower. But time is not a barrier.

So, even for the surgeons who are a little bit slower on the robot, the feedback we get from them is that I liked having a little extra time to make decisions that I could never make before because I can have inter-operative feedback, dynamic feedback through the full range of motion prior to making cuts and I want to be able to make different decisions that I could never make before.

So we were very careful. We took a whole year, if you recall, prior to the full launch to make sure that time wasn't going to be the barrier. And at this stage of the launch, we have enough surgeons trained, enough surgeons doing procedures for us to be able to say, look, time is not the barrier.

And as I mentioned, in some cases, some surgeons are actually faster with the robot. So it really is more surgeon-dependent. And of course, the staff, you have to train the surgical service staff.

There is a change in management that occurs and that's why I feel ramping up this technology doesn't happen overnight as it requires a lot of change management on behalf of the surgeon as well as the surgical staff. And that's what our team has spent a lot of time doing in their training to make sure that it's successful..

No, it's great. And you mentioned also that you're seeing adoption in ambulatory surgery centers. And it's kind of a broader question about your thoughts on knees moving to the outpatient setting and in alternative settings for procedures getting done.

And just really do you have any broad thoughts around what that could do to the business for you?.

Yeah. So, look, there's a lot of noise about it. It's still a very small part of the overall procedures that are done in surgery centers. I do think it's a trend that will continue going forward. And I think we'll be well-positioned to compete in the surgery centers as we are in the hospitals..

There are no further questions at this time. I would now turn the call back to Mr. Kevin Lobo for any closing remarks..

So, thank you all for joining our call. Our conference call for the fourth quarter 2017 results will be held on January 30, 2018. Thank you..

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