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

Robbie J. Marcus - JPMorgan Securities LLC Bob Hopkins - Bank of America Merrill Lynch David Ryan Lewis - Morgan Stanley & Co. LLC Frederick A. Wise - Stifel, Nicolaus & Co., Inc. Chris Pasquale - Guggenheim Securities LLC Vijay Kumar - Evercore Group LLC Glenn John Novarro - RBC Capital Markets LLC Isaac Ro - Goldman Sachs & Co.

LLC Lawrence Biegelsen - Wells Fargo Securities LLC Joanne Karen Wuensch - BMO Capital Markets (United States) Lawrence Keusch - Raymond James & Associates, Inc. Kristen Stewart - Barclays Investment Bank Richard Newitter - Leerink Partners LLC Craig William Bijou - Cantor Fitzgerald Securities Mike Matson - Needham & Co.

LLC Joshua Jennings - Cowen & Co. LLC William G. Inglis - Piper Jaffray & Co. Steven Lichtman - Oppenheimer & Co., Inc. Kyle William Rose - Canaccord Genuity, Inc..

Welcome to the Third Quarter 2018 Stryker Earnings Call. My name is Tiffany, 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. 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, with an update on Mako and K2M.

Glenn will then provide additional details regarding our quarterly results before we open the call to Q&A. With organic sales growth of approximately 8%, our strong top line momentum continued in Q3, reflecting the strength of our diversified revenue model.

Neurotechnology and Spine was once again the standout delivering 12% organic growth in the quarter as Neurotechnology grew 17%. MedSurg posted a 9% gain with Instruments leading the way. Orthopaedics increased approximately 5% powered by over 8% growth in Knees as Mako continues to gain traction.

We are now approaching 600 robots globally and continue to feel bullish about the future of robotic-assisted surgery. On a geographic basis, sales were well-balanced in the developed markets and we grew double-digits in emerging markets.

With cost transformation for growth initiatives continuing, operating margin increased roughly 50 basis points in the quarter despite significant acquisition-related dilution. With R&D at 6.7% of sales in Q3, we continue to focus on internal innovation, which is driving a steady cadence of new product launches.

With the strong organic sales growth and operating margin expansion, we delivered adjusted per share earnings of $1.69 towards the high end of our targeted range of $1.65 to $1.70 for the quarter.

Given our solid performance through the first three quarters of the year and our conviction in our Q4 outlook, we are raising our full year guidance for organic sales growth and adjusted EPS. With that, I will now turn the call over to Katherine..

Thanks, Kevin. My comments today will focus on Mako with updates on the key metrics we have shared in recent quarters along with an update on our recently announced plans to acquire K2M. In the third quarter, we installed a total of 37 robots globally with 26 in the U.S. compared to a total of 33 in the year-ago quarter of which 23 were in the U.S.

As expected, upgrades of robots in the field to the Total Knee application were largely completed in the third quarter. Over 50% of the robots installed in Q3 were in competitive accounts with Stryker either has no market share or share well below our average number.

During Q3, roughly 145 surgeons were trained on the Total Knee bringing the total number of surgeons trained since launch to approximately 1,350. Looking at U.S.

procedures in Q3, Mako Total Knee procedures approximated 11,300 bringing the year-to-date total to over 30,000 with all Mako procedures topping 18,700 in the quarter, Total Knees represent the majority of roughly 60%. Utilization rates also continue to increase, up about 40% year-over-year.

We are also pleased with the increasing Mako Total Knee data supporting both the clinical and economic benefits.

Specifically, a prospective study was recently published in The Bone & Joint Journal, which compared early postoperative functional outcomes and time to discharge between conventional jig-based Total Knee arthroplasty and Mako-assisted TKA. The study included 40 consecutive patients in each arm with all surgeries performed by a single surgeon.

Overall, the study concluded that the Mako treated patients achieved statistically significant improvement with respect to decreased pain, improved early functional recovery and reduced time to hospital discharge compared with conventional knee surgery.

And as it relates to hospital stay, patients treated with the Mako robot were discharged over one full day earlier than traditional knee surgery patient. Additionally, just this week, the Hip and Knee Society published a paper comparing 90-day episode of care cost with patients receiving a Mako Total Knee replacement versus conventional knee surgery.

Overall, the study determined that Mako Total Knee patients episode of care cost were $2,391 less than conventional knee replacement. Additionally, index facility cost and length of stay were also less with Mako. And the Mako patients were discharged less the skilled nursing facilities and had a 90-day readmission reduction of 33%.

All outcomes measured in the study were statistically significantly favorable to Mako-assisted knee replacement. Overall, we are pleased with the continued adoption of the Mako robot and it's clearly enabling us to drive meaningful knee market share.

The early clinical data is encouraging and underscores the unique features and capabilities of the Mako robot that are enabling differentiated outcomes. Turning to K2M, in late August, we announced plans to acquire K2M for approximately $1.4 billion.

K2M provides Stryker Spine with a highly complementary and innovative product portfolio which includes an attractive minimally invasive offering. The combined business will have a competitive portfolio across Stryker Spine product categories and leverage a powerful commercial engine.

With the addition of K2M's proven product portfolio, consistent track record of execution and robust pipeline, Stryker Spine business will be well-positioned to sustain innovation and provide our customers and employees with proven product. We are excited Eric Major, Chairman and CEO of K2M, will be joining Stryker as President of our Spine division.

Eric's longstanding relationships with thought leading surgeon as well as his history of driving a strong sales execution culture is expected to optimize the integration and execution of the combined group. With that, I'll now turn the call over to Glenn..

Europe, Australia and Japan. Our adjusted quarterly EPS of $1.69 increased 11.2% from the prior year, reflecting strong drop through on sales growth combined with operating expense control. Consistent with our expectations, third quarter EPS had no significant impact from exchange rates. Now, I'll provide some highlights around our segment performance.

Orthopaedics delivered constant currency and organic growth of 5% including organic growth of 4.4% in the U.S. This performance was highlighted by strong performances in knees of 8.4%. With the Knee business, we continue to see a high demand for our Mako TKA knee platform and 3D-printed products.

Our Trauma & Extremities business had moderate growth and was impacted by softness in the market and product supply issues. We anticipate that the product issues will not impact Q4 and we expect sales acceleration in 2019 as we launch a number of new products in Trauma.

Internationally, Orthopaedics delivered organic growth of 6.2%, which reflects solid performances in Europe, emerging markets and Australia. MedSurg continue to have strong growth across all businesses in the quarter with constant currency growth of 10.4% and organic gains of 8.8%, which included a 10.1% increase in the U.S. Instruments had U.S.

organic sales growth of 13.5%. This included exceptional performances across the product portfolio including power tools including System 8; waste management, including Neptune; Steri-Shield and ProCare Service. Endoscopy delivered U.S. organic sales growth of 6.2%.

Endoscopy had strong performances across its general surgery products and its sports medicine, communications and ProCare businesses. In September, Endoscopy's NOVADAQ acquisition anniversaried and became part of organic growth. The Medical division had U.S.

organic growth of 12.4%, reflecting solid performances at its Sage, Patient Care and Physio businesses. As expected, Medical Sage business drove a significant amount of growth as Q3 2017 included Sage's product hold and the comps were very low.

Medical did face tough comps in the core capital businesses as that segment had exceptionally strong mid-teens growth in the year-ago quarter helping to offset the impact of the Sage recall. For the third quarter, Sage had a 7% impact on Medical's organic sales growth and a 1% impact on overall Stryker's organic growth.

Overall, Medical's core capital businesses have a solid pipeline, which is expected to drive strong Q4 sales. Internationally, MedSurg had organic sales growth of 4% with good performance in emerging markets, Australia and Japan. Neurotechnology and Spine had constant currency growth of 18.3% and organic growth of 11.9%.

This growth reflects double-digit performances across all of our Neurotech businesses and less of a market headwind in core Spine. Our U.S. Neurotech business posted organic growth of 16.7% for the quarter, driven by strong demand for our hemorrhagic, ischemic stroke, CMF and our Neuro powered instruments.

Additionally, we continue to be pleased with the progress of our Entellus acquisition integration. Our Spine business reflects double-digit growth of our IVS business and our Tritanium implant products. Internationally, Neurotechnology and Spine had organic growth of 13.4%.

This performance was driven by continued high demand across most geographies for our Neurotech products. Now, I will focus on operating highlights in the third quarter. As noted in the press release and discussed in our Q1 earnings call, the adoption of ASC 606 primarily had the impact of reclassifying certain expenses from SG&A to sales.

As such, all references to basis point improvements are net of this impact. Our adjusted gross margin of 66.3% was up approximately 50 basis points from the prior year quarter.

Compared to the prior year quarter, gross margin expansion was favorably impacted by comps including impacts from prior year mild weather, productivity and efficiently – efficiency partially offset by price, foreign exchange and business mix. R&D spending was 6.8% of sales which was slightly higher than prior year quarter.

Our adjusted SG&A was 34.6% of sales which was in line with the prior year quarter.

This reflects the continued focus on operating expense improvements through our Cost Transformation for Growth CTG program, including key projects focused on indirect purchasing and shared services as well as some favorability arising from prior year quarter comps as it relates to Sage and weather disruptions.

Offsetting these benefits were the continued planned CTG investments like ERP, the write-off of certain legacy software assets and the negative impact of acquisitions which had a notably higher dilution compared to the prior year.

In summary, our adjusted operating margin was 24.9% of sales or approximately 40 basis points favorable to the prior year quarter.

Our operating margin primarily reflects good leverage and continued operational savings offset by CTG investments, the one-time write-off and acquisitions, the latter of which had an approximately 50-basis-point negative impact in the quarter.

We remain highly confident in our ability to deliver on our full year commitment of driving a minimum of 30 basis points to 50 basis points improvement in our operating margin. Next, I will provide some highlights on other income and expense. Other expenses decreased from the prior year quarter primarily due to favorable interest income.

Our third quarter adjusted effective tax rate of 16.1% reflects an underlying operating tax rate of approximately 18%, offset partially by the benefit related to stock compensation expenses.

Focusing on the balance sheet, we continue to maintain a strong position with $2.2 billion of cash and marketable securities of which approximately 30% was held outside the U.S. Total debt on the balance sheet was unchanged from year-end at $7.2 billion. Turning to cash flow, our year-to-date cash from operations was approximately $1.6 billion.

This reflects increased earnings and lower recall-related payments which were somewhat offset by increases in working capital including higher tax payments as a result of Tax Reform and specifically required payments related to the toll tax on previously untaxed foreign profits. And now I will discuss the fourth quarter guidance.

Based on our performance to-date and anticipated strength in the remainder of the year, we now expect organic annual sales growth to be at the high end of our previously guided range of 7% to 7.5% for 2018. As a reminder, Q4 and the full year have the same number of selling days.

Given our year-to-date performance and continued momentum, we now expect that our adjusted net earnings per diluted share will be in the range of $7.25 to $7.30 for the full year. For the fourth quarter, we anticipate adjusted net earnings per diluted share to be in the range of $2.13 to $2. 18.

This guidance, full year and quarter, includes anticipated impacts from the aforementioned business investments, the previously announced $0.04 of dilution related to Entellus and potential dilution from acquisitions that may close in the fourth quarter.

Additionally, as highlighted in our Q2 earnings call, it also includes full year foreign currency favorability of approximately $0.05. And now, I will open the call up for Q&A..

Thank you. We will now begin the question-and-answer session. Your first call comes from the line of Robbie Marcus with JPMorgan. Please proceed..

Great. Thanks for taking the question. One, I want to ask you on the operating margins. And if we back out the 50 bps with M&A, we're at 90 bps of operating margin expansion for the quarter for the business. Maybe you could just give us your thoughts on where you see the business now following the changes in compensation.

It's clear that the businesses is growing fast on the operating margin line.

So help us understand what you think Stryker is on a go-forward basis in terms of operating margin grower?.

Yeah. I think as you look at operating margin, we're not backing off of our guidance at all in terms of minimal 30 basis points to 50 basis points of margin expansion. We still believe that that is one of the things that we can hold true to even given the sort of negative dilution that we'll get through our M&A or even potential M&A.

I mean, keep in mind, we also delivered fairly good gross margin performance this quarter. That includes sort of the impact of mix, price and productivity and efficiency. I also think that we're starting to see some savings from some of our sort of shorter-term CTG programs, which include indirect spend efforts and shared services efforts.

So overall, I feel very committed and strong it will make our minimum of 30 basis points to 50 basis points and we'll hold firm on that guidance..

Okay, great. And maybe just as a follow-up. You called out Trauma into the quarter. Maybe you could think about as where guidance is raised organically to the upper end of the range of 7.5%. Help us think about some of the pluses and minuses in fourth quarter that can help us get there versus the third quarter. Appreciate it..

Robbie, are you saying specifically for Trauma or for total company in the fourth quarter..

No, no, no. You called out Trauma was a headwind in third quarter. Help us think about some of the pluses going into the fourth quarter across the businesses to be aware of..

Really it's going to be very reflective of this quarter. There's a lot of our businesses that have some really strong tailwinds right now whether it's in Neuro, whether it's in Ortho or MedSurg.

And those getting later in this lifecycle with its 1588 camera and they're gearing up to launch 1688 which will happen in the first half of next year, but they had strength in other parts of the business in the quarter.

So, I wouldn't say there's any one standout, but there is a lot of our businesses that have very strong momentum heading into Q4 which is historically, as we know, our strongest quarter..

Now, the only thing I'd like to add, Robbie, is if you look as to how we've done all year, our year-to-date sales growth organically is roughly in that 7.5%, 7.6%, 7.7% range. So we're basically expecting more of the same in the fourth quarter.

We had a very good fourth quarter last year, but we're really firing on a lot of cylinders right now and feeling pretty healthy about our businesses. From quarter-to-quarter, of course, you will see a little bit more bounce. Maybe in Neurotech, we saw a really big bounce this quarter.

Will it stay up in the 17% range that might moderate just a hair, but overall, we're in a very stable position right now across our business and feeling very good about our growth outlook..

Thank you. And your next call comes from the line of Bob Hopkins with Bank of America. Please proceed..

Thank you.

Can you hear me, okay?.

Hi, Bob..

Sure..

Hey, great. Good afternoon. So two quick questions. The first one just, Kevin, from a big picture perspective. I know we're not finished with 2018 yet, but it is shaping up to be, as you said, an exceptional year from a revenue growth perspective given your new guidance at 7.5% at the high-end.

So just how confident are you that you can continue that growth? What are the things in the pipeline that we should be focused on for next year versus things that might slow? So just trying to check your confidence for next year relative to the super-strong year this year?.

Sure. Thanks, Bob. And as we noticed, it's been I guess five years now we've increased our organic growth year-after-year. It's been rising. Obviously, MedTech markets are also been pretty good, but we've been continuing to outpace the market pretty significantly. As I sit here today, I feel like going into 2019 it's going to be more of the same.

And we have a healthy balance of headwinds and tailwinds, it's very similar to what we had going into this year. We have a good cadence of new products launched. Katherine mentioned a big launch coming within our MedSurg business. We also have a lot of Trauma products that we'll be launching. I look at Mako and we're just continuing to ramp at Mako.

I think that will continue and especially internationally where we're only just starting to receive approvals for – we have the hip approved, but we don't yet have the knees approved in big markets like Japan and China. That will happen next year. So if you look at Physio-Control, we have a number of new launches coming.

So I'm feeling very good about the cadence of new products. And of course, we'll have some other products that are later in the cycle System 8, probably won't be as strong next year as it is this year.

But overall feel very good balance and feel like we're in a very good position to continue the strong organic sales growth momentum that we've had for the last few years..

And then one other – thank you for that. One last follow-up on Mako. Obviously, thanks for giving us the numbers, obviously it sounds like things are going really well there. And you've mentioned every quarter how you're placing Mako in competitive accounts.

And now one of those competitors Zimmer Biomet is going to be launching their own version of a robot over the next couple of months at least in theory.

So can you talk to us a little bit about the stickiness of the competitive business that you've won as we look out over the course of the next 12 months and 24 months?.

Yes. Thanks, Bob. I think it's safe to say given the investment and not just the cost of the capital and $1 million robot, but the investment of a surgeon to be a champion to get trained on the robot to have his OR staff trained on what is a shift in how you do the procedure and then get familiar into a competitive account with new products.

It's very sticky. And so that's why we believe that competitive advantage we have not just in what our robot is capable of doing and that's where the definition of a robot is really critical.

But also having a multi-year lead head-start in getting robots out there, we've got close to 600 globally and continuing to sell new robots with a healthy pipeline. And now you're starting to see the clinical data, the early clinical data come in with our clinical and economic benefit that is specific to our robot.

And so obviously, competition is coming. You don't grow ahead of the market at the rate we are without people thinking that maybe they need a robot, but this is a very sticky business once we get a robot in there..

Yeah, Bob, the one thing I'd like to add is what I found very encouraging with the early studies is that it's pointing to a specific benefit related to our haptic – the haptic feature of our robot and that you don't use jigs.

And by not using jigs, you really protect the soft tissue envelope and really so that less invasive nature of the procedure is a massive advantage. And many surgeons will pick up on that. They are anecdotally seeing that with their patients and I know that the competitive offering will still have a jig, and ours is a jigless offering.

So I do believe our features are going to win out at least in the short-term. Will that have interest? Sure. Some surgeons will be interested and will have to obviously compete in the market, but we like our chances..

Thank you. And your next call comes from the line of David Lewis with Morgan Stanley. Please proceed..

Hi. Thanks so much. So two questions on revenue for me. Kevin, I just wanted to come back to Trauma for a couple of reasons. One, obviously, the softest quarter in years given all the strength you've had here. I think it cost the corporation 50 bps of growth in the quarter, so I think it's a single biggest disconnect versus our model this quarter.

You talked about some market softness. One of your competitors talked about market softness, but you also mentioned some supply issues.

So if you could just sort of flesh out what's happening in Trauma this particular quarter? And what underpins your confidence that this business reaccelerates here over the immediate term? And then I have a quick follow-up..

Sure. Yeah, thanks, David. Yeah, we were – obviously we're a little disappointed with our Trauma performance this quarter. We've had about five years of phenomenal growth. If you look at the comps, we had a big quarter in the third quarter last year, very strong double-digit growth.

So comps has a little bit to do with it, but we did have some supply disruption. We expect to resolve that and that really did affect our overall business. Our Extremities business grew a little less than 10%, which hasn't happened for a long time, but we expected that that's going to pick up as we move forward.

We also have a number of new products that we're launching. So we have a very strong Trauma team. There's still a very healthy business overall. The market did slow down a little bit. We saw that frankly since June. That has happened in the past. It's been transitory, but we still feel very good about that business.

And we are optimistic especially behind new product launches. We have a number of new products that we'll be launching going into next year. That business will pick back up again, and even at this level, we're still outperforming the market leader..

And Kevin, the supply issues resolved in the fourth quarter, they're not fully resolved until early part of 2019?.

I would say largely resolved in the fourth quarter. And so you'll see some pickup in the fourth quarter. They will be even more noticeable in 2019..

Thank you. And your next call comes from Rick Wise with Stifel. Your line is open..

Good afternoon, Kevin. Maybe I'll start with Mako again as well. With the steel upgrades completed maybe with the resources freed up that this suggests that you have resources to more aggressively new accounts? And maybe talk about the Mako penetration theoretical ceiling, I think you are like 15% of the potential 4,000 accounts or so.

Any thoughts on the realistic feeling for Mako?.

It's tough to say, Rick. There's clearly a lot of runway because it's not only placing a robot in the thousands of hospitals in just the U.S. let alone globally, but also as more and more surgeons in the practice want to use the robot then you start to see what is clearly the minority right now, they try to purchase multiple robots.

And we have some hospitals that are further along in their robotic programs that are doing that or have done that. So a lot of runway for robot placements. You are correct with the upgrades complete. That sales force will be focused now on placing new robots.

So again, we feel like we've got a strong ability to continue to drive some meaningful market share gains. We still have to train and hire the service side. But overall, we think we've got a very healthy pipeline of demand here and ability to continue to place pretty significant new robots..

And just as a follow-up, Kevin, the Invuity acquisition, this is the company we thought have always felt the technology is outstanding. Maybe, if you could talk to us a little bit about the acquisition rationale.

And maybe just in a larger sense, how does this fit into your long-term strategy or vision about at least one of your – one of the strategies in terms of where you might be taking Stryker's portfolio going forward? Thank you..

So thanks, Rick. Yeah, we absolutely love the lighted retractors. They are very novel, very innovative, provides tremendous benefits to the clinician. In addition, they have entered the advanced energy space with a very novel product. Our Instruments business, as you know, has been a very strong performer for a very long period of time.

They are now actually focused on waste management as well as they have a surgical procedure. And now this product fits very well with that call point. We call it Surgical Technologists. It's one of the business units.

And then you have the focus on power tools and Steri-Shield and so it really does fit very well with the existing call point of those Instruments salespeople. And so we believe it's a really novel technology that's in a high-growth space. And our call point, our reps are actually in that area.

And so it really plugs really into that – into existing sales force. And most of the deals we do when we have existing products – existing sales forces that we can plug products into, those are the ones that we tend to really grow very, very quickly. So we are excited about it.

It's not wildly outside of our call point, but it will enable us to enter into even more surgical procedures than we do today..

Thank you. And your next call comes from Chris Pasquale with Guggenheim. Please proceed..

Thanks. Katherine, the initial trickle of Mako data has been pretty compelling albeit with some relatively small patient numbers.

Can you talk about what's in the pipeline from a data perspective? Are there big studies that you guys have circled as being key to making the case with physicians that might still be on the fence about the clinical value there? And when could we expect to see those?.

So I think you're going to see a steady cadence on the clinical side. And what you're seeing right now given where we are on the launch are the early outcomes, those 90-day outcomes. But we're also with the KOLs who were initiated studies as part of the launch we are collecting data and then eventually there will be two year data.

So I think what you should expect to see is a steady cadence here. We were really thrilled particularly with the first study. I noted that that was just 40 patients in each arm and it still hits statistical significance on all the endpoints favorable to Mako. So I think we're just going to continue to build on this.

And then as we get further obviously into the launch and have two-year clinical data possibly by August of next year, that's really what you need to have to get published in peer-reviewed journals..

Okay. And then you called out the easy comp for Sage this quarter, the contribution to growth that represented. My recollection is that 4Q should also be a pretty easy comp there.

Can you just remind us of the timing of when that normalizes?.

Yeah. The fourth quarter will be an easier comp. It won't be as easy as the third quarter, so the biggest impact was the third quarter last year. And then there was some recovery in the fourth quarter, but yes, there will be a benefit to us of an easier comp in the fourth quarter.

And then normalization would really occur sort of sometime in the middle of next year..

Thank you. And your next call comes from the line of Vijay Kumar with Evercore ISI. Please proceed..

Hey, guys. Thanks for taking my question. So maybe one question on Mako and I had a follow-up. So it looks like sequentially system placements were down. And it looks- seems to be U.S. was down maybe in international was off.

I'm just curious on what's you see now if you are – or how should we be thinking of system placements?.

I think we really need to look year-over-year. Q3 is always the seasonally softest quarter for reconstructive. There's a long history of that.

There's just simply fewer hip and knee procedures done during the summer months and correspondingly Q4 you typically see a very meaningful step-up given that's a strong capital quarter as a hospital use up the year-end budgets, it's a strong quarter for hip and knee procedures..

That's helpful..

Yeah. We're feeling very good. The interest level is very high and we expect to continue to be able to have robust sales of our Mako robot..

That's helpful, Kevin. And then maybe one on margin. So I think, Glenn, you're mentioning on the commitments of 30 bps to 50 bps of margin expansion.

As you think about where rates are right now and when we look at 2019 and the deals that you've done, are we still on track for 30 bps to 50 bps? I think there's been some confusion on the Street about the commitment of 30 bps to 50 bps for 2019?.

Yeah. We're not. Based on where we are to-date and what we know is in the pipeline, we have not changed the long-term guidance of 30 bps to 50 bps for 2019..

Thank you. And your next call comes from Glenn Novarro with RBC Capital Markets. Please proceed..

Hey, good afternoon. Kevin, I had a question on K2M. You're doubling down on Spine with the K2 acquisition.

Is this a signal that you feel more optimistic about the outlook for the spine market and now was the right time to do the deal? Or was this more signal that spine is strategic synergistic with Orthopaedic and Neuro and you just needed to get bigger. So that's my question and I had a quick follow-up..

Sure. Thanks for the question. I think we've – I've been pretty consistent over the past three years or four years in how important and committed Stryker was to the spine market.

It is very synergistic with both Neurotechnology and as well as Orthopaedic and we're seeing that with a terrific performance of our Tritanium products which is 3D-printed technology that we also use in Orthopaedics. And so this has been a market we're very committed to. The timing just worked out very well for us right now.

We've got our spine business starting to perform better. K2M has really developed stronger and stronger performance with their new product launches. So the timing just came together right now. Deals vary from when you start to get interested in the company, you get to know the company.

We've obviously gotten to know Eric very well and we're bringing him on to be the CEO of the combined organization based on what he's built there, his culture, the way he runs his operations. So, culturally very similar to how Stryker operates.

And when you're doing a large integration, where you're bringing together two organizations of size or you are going to be using the same types of technologies, culture really doesn't matter a lot. And so it took us time to make sure that we have a cultural fit.

And so I'm very optimistic about the two organizations merging very well and performing very well. But there really hasn't been a change strategically. It's always been important. I think I've said that over and over again. The market, it's nice to see that the market is stabilizing and hopefully will start to improve.

But this is a deal that makes sense for us. It will really improve our growth trajectory in our Spine business. And it just felt like a good time to do it and we're very excited about it..

And just as a follow-up both K2 and Stryker are very big into 3D printing. Are there any FTC issues there? Thanks..

No, we don't anticipate any..

Thank you. And your next call comes from Isaac Ro with Goldman Sachs. You may proceed..

Good afternoon. Thanks. First a question on Mako and then a follow-up on the Neurotech.

On the Mako side, can you maybe give us an update as to the mix of sort of leased versus outright purchases that you are seeing for the incremental users? And the reason I ask is I'm interested how you think that will evolve as the market gets a little more crowded in the coming months?.

Yes, so one of the benefits besides of the capital, we have a capital sales force and an implant sales force. We also have our Flex Financial group which has existed for years to work with customers making big capital purchases.

Not just the robot, but a number of MedSurg offerings and they can work depending on the needs of the customer between outright purchases and leases. So some of the robots, the majority are filled, but we have different arrangements.

We're not going to get into a breakdown of that primarily for competitive reasons but the ability of our Flex Financial group to work with the customers is a big part of the strategy that we have..

Okay, helpful. And then just a follow-up. You have a new product cycle in Neurotech that's I'm assuming been part of the growth story there, correct me if I'm wrong this quarter, obviously pretty good. I think you said just about 17% in the U.S. part of the business.

I'm interested in what's going on in terms of the new stroke devices you have is obviously very strong incumbent there. So give a little color as to the nature of market share, overall acceleration of product category, what you're seeing there would be interesting. Thank you..

Yes. So the neurovascular group is just having a tremendous year. I would tell you both hemorrhagic and ischemic had very solid double-digit growth and it's across the board. Broadly speaking, ischemic is more about market expansion.

If you look at hemorrhagic probably one of the standout products is the Atlas adjunctive stent that we launched in the first quarter, early part of the first quarter. We did get to surpass for delivering stent approved. That will launch as we ramp up product and start to work with the early users late this year, early part of next year.

So you do know real impact from that in the U.S. in the quarter. And then we're just in a very early stages of launching our aspiration product and that's really meant to target customers that really want to use aspiration first. And we still believe the most effective given the clinical data is to use the stentriever in combination.

But there is a subset of patients or customers that went out alone, but we're just too early in that launch. So that wasn't a driver.

Certainly, as we look ahead to 2019 given the continued momentum we are seeing, market expansion in ischemic and then the recent new launches, we feel really good about Neuro heading into next year despite what will be some pretty impressive comparisons..

Thank you. And your next call comes from Larry Biegelsen with Wells Fargo. Please proceed..

Good afternoon. Thanks for taking the questions. Glenn, could you give us a little bit of color please on FX in 2019? We estimate it's about a 70 basis point headwind. Any color on the EPS impact at this point and the tax rate in 2019, I heard your comment about 18% underlying year-to-date but the reported has been better.

Any color on that for 2019? And then Katherine, just my second question now. Preview of the Analyst Meeting on November 8, just will you give some color on 2019 and beyond from a financial perspective? Thanks for taking the questions..

Sure, Larry. So if you look at FX and sort of based on the foreign currency exchange rates, we expect a slight negative impact on sales due to foreign currency translation which will have a negligible impact on EPS in the fourth quarter.

And what we're seeing really at the EPS line is we're seeing negative translational FX but is being offset by a positive transactional FX from our hedging program. And these impacts have all been included in the fourth quarter guidance that I referred to.

Flipping to taxes, as we look at the full year guidance that we provided at the beginning of this year of 16.5% to 17.5% for our effective tax rate, we expect that our effective rate will end the year at the lower end of that range.

And really what we're seeing is compared to 2017 we're seeing sort of a slightly higher effective tax rate just really just driven by the new tax legislation..

And for the Analyst Meeting, we won't be giving guidance – formal guidance for 2019. That will be, as it always is, on our earnings call in January..

Thank you. And your next call comes from Joanne Wuensch with BMO Capital Markets. You may proceed..

Good afternoon and thank you for taking the question. We spent a lot of time talking about Knees and the impact of Mako on that business.

Can you give us a little bit of an update on how you're thinking about your Hip franchise?.

Yes, sure. So we launched our Trident II, our new hip cup in the second quarter. It really started to ramp in the third quarter. When I say ramp, these launches do take time because you have to get the sets of Instruments out. We're now about 1,000 sets in the field.

You saw a slight tick up in our hip number in the third quarter and I do expect that that will continue to perform very well. The feedback that we're getting on the cup is terrific. We already have a very good stem portfolio which, as you know, drove us to have outperformance in the market for a number of years.

And then we sort of grew in line with the market for the last couple of years. But this cup is being very well received. We now are fully – the field is fully stocked with their sets and we started to see a little bit of impact in the third quarter and I think you will continue to see us tick up in our hip business.

Of course, the same sales force also focus on knees. And knees is obviously where a lot of action is but we do expect continued moderate sequential uptick with our hip business..

Thank you. And then in terms of M&A, it's no secret you guys have been pretty active with what I would call sort of tuck-ins along the lines of K2M.

And I think sort of outside your core businesses such as Invuity, how are you thinking about acquisitions on a go-forward basis?.

Very consistent with what we've been doing. The vast majority of the deals tend to be relatively small to midsize. They tend to be tuck-in to an existing sales and marketing infrastructure with the occasional larger bits that we have done. And I think as you look forward, you should assume very similar pattern..

Yes. And I would say with Invuity, it is a slightly different technology, but it is a call point. We already have our sales force calling in that area. And so it's not broadly different. We'd love to bring technologies into existing sales forces. That has been a real key formula for success for Stryker for a long time.

So it's not really as adjacent as a Physio-Control or a Sage business. We're actually tucking this within our Instruments sales force..

Thank you. And your next call comes from the line of Larry Keusch with Raymond James. Please proceed..

Yeah. Hi, good afternoon. You guys have made some comments in the past about looking to accelerate the growth in the Spine business. Obviously, K2 plays into that but maybe talk a little bit sort of what are the drivers to move that Spine growth rate up? And I think you talked about wanting it to be above the corporate average..

So within Spine, innovation always wins. And if you look our Tritanium products even the Serrato new products will be re-launched. Innovations were awarded in Spine. And you have seen that across – you can look across the Spine companies. If you provide a good cadence of innovation, you will win in the Spine business.

There's still a huge amount of unmet needs. It's the biggest market within Orthopaedics and that's why we like K2. Obviously, it gives us a bit more market share. They are stronger in certain parts of the country where we are weaker.

And so that obviously you have a sales force that can sell a broader range of products that is exciting and should increase our growth. But also they have a really good R&D engine that produces consistent flow of new products. And that's going to be the formula for success. It's not unique to Stryker.

I think if you look across the Spine market, innovation is really what gets rewarded. And we're committed to continuing to drive innovation within the Spine business. But on a combined basis, we're going to have a lot more impact as a combined organization than we would have separately..

Okay, very good. And then Katherine, I'm just wondering there's certainly been enough experience now with the Mako robots that are being placed. What's your – I guess what I am trying to understand is sort of what's the right way to think about how docs ramp up on the procedure? Certainly, you give the utilization rates so we get that.

But do they tend to do a couple of cases and then wait and then start to grow their cases more? Just trying to get a feel for how that's kind of working in the field..

Yes, what you see is clearly they have an interest because they are going to be the surgeon champion, we have the robot charges. But they don't get trained and then suddenly show up Monday morning and they are doing all of their knee procedures on the robot. It's a gradual process.

They might do five old way and one that day and as they slowly get more and more comfortable with it, so it varies, but it could take anywhere from 12 months to 18 months for them to really be fully flipped over to using it exclusively for all their procedures.

And then the challenge also becomes maybe with the surgeon champion and he can get the robot whenever he wanted, and then slowly his colleagues start to close in and want to use it.

And so sometimes they are limited in how many cases, they can do on a robot because they don't have enough robot time and that's usually the precursor to the hospital bringing in another robot..

Thank you. And your next call comes from Kristen Stewart with Barclays. Your line is open..

Hi, guys. Thanks for taking my call. I just wanted to go back to just clarify a couple of things. On the tax rate, Glenn, I think you were saying that you're expecting to come in at the low end of the range, but you are seeing a higher tax rate.

Is the difference, I don't know if I understood that correctly, is the difference just the stock compensation impact on the tax lien? Or how do we kind of think about that on a go-forward basis?.

Yeah, the real – the largest difference between sort of our effective tax rate which is what I guide to and then I had mentioned the operating tax rate is really the impact of stock compensation. The difference is there. That's by far one of the largest item..

Okay.

And what's the delta expected to be this year between the two again?.

At the upper end of our range, it's 50 bps. It can be as much as 100 basis points difference..

Thank you. And your next call comes from Richard Newitter with Leerink. Please proceed..

Hi. Thanks for taking the question. Wanted to circle back to the Trauma Extremities. Can you parse out with it between Trauma versus Extremities, both where the slowdown is most pronounced, it's kind of two sets of product categories.

And then also where the supply issue was more pronounced as well again between Trauma or product lines within Trauma and Extremities?.

Yeah. Thanks for the question but we don't break out Trauma and Extremities separately. There were supply issues on both size and product launches coming on both sides. And both sides had difficult year-over-year comparisons..

Okay. And just with respect to the market slowdown, any additional color that you can kind of give there with respect to timing or what's happening there..

Yeah, we're struggling a little bit too. And I think we referenced events into June. The market just feels so slowed down. And this has happened over the years where we have these periods for whatever the reason maybe the market growth seems to slow a bit.

So there's nothing that we could really point to right now, but as the results come in, it does seem to support the view that the market did slow down in the quarter..

Thank you. And your next call comes from Craig Bijou with Cantor Fitzgerald. Please proceed..

Hi. Thanks for taking the questions. Just wanted to start with the HyperBranch acquisition, you guys didn't really talk about it and I recognize it's relatively small in comparison to the entire company.

But maybe just strategy there and how that fits into your portfolio?.

Yeah. Sure. So that fits within our CMF business, our craniomaxillofacial business which is a business that we report within our Neurotechnology segment. We've had fantastic growth within that business unit over the past five years double-digit growth pretty much every single year and this was just a product gap.

So we did not have a dural sealant product. There's only one other product on the market for dural sealant. So we've known this company HyperBranch for many years. We've been following them and we're very excited to add that product. It's absolute tuck-in to our existing CMF business and our CMF sales force..

Okay. That's helpful. And maybe just as a follow-up, pricing it looked like you got – it did get a little bit worse during the quarter.

So, anything to call out there? Or any changes to your expectations going forward on price?.

Yeah. No, I think fundamentally we sort of ended price where we thought we would. Obviously, mix plays into that. But for the full year, there's no change in what we're thinking..

Okay. Thanks for taking the questions..

Thank you. And our next question comes from Mike Matson with Needham & Company. Please proceed..

Hi, thanks for taking my questions. Just wanted to ask a couple about the K2 deal. I guess, first, we've seen with Spine deals is that there tend to be a lot of dissynergies.

So, I just wonder if you could shed any light of kind of what your assumptions there are around what that business is going to look like in the first 12 months to 24 months when you integrate the two companies.

How much of the commodities sales do you expect to lose? And then I noticed in the press release you commented on some dilution for this year, but you didn't really comment on whether you expected the deal to be accretive or dilutive beyond 2018? So, is that just because there's just too much uncertainty around these dissynergies and things like that?.

So, a couple of points. So, we did affirm our long-term guidance inclusive of K2M next year of 30 basis points to 50 basis points of operating margin expansion. In terms of – we're not going to break out the assumptions around sales dis-synergies. There's always some as you integrate.

What was really attractive about this target is we have very minimal customer overlap which really helps. And then we also have a model where we're used to having both agents and direct sales reps who are comfortable working in that model, it's how our own Spine business works and I think that will help as we look to integrate the sales force.

And then lastly, bringing Eric in to run the business. He obviously has a very sales execution-driven culture.

We have something very similar, but a sales force that is really thrilled to have a refresh to their product portfolio and then broader footing in the degenerative deformity segment of the market that really drives a lot of the thought leaders.

So, when you add that all together along with our experience in doing deals and integrating deals, we think that will help to limit the dis-synergies and ensure that this integration goes well and we get back to above-market growth..

Okay. Thanks. And then just one follow-up on robotics and Mako. So, look, I understand kind of the single-minded focus here on recon, specifically on the Total Knee, but we're seeing other companies, there's a few spine robots out there, there's about to be another one.

So, I've got to imagine you're working on, bringing Mako, particularly into Spine, maybe other areas. Can you just comment on your strategy there? Thanks..

Yes, you are right, we are very focused right now in optimizing the launch of the Knee given the enormity of the market, our head-start, and the advantages of our robot. But we also have previously stated we have R&D projects actively underway looking at applications for the robot in both Spine as well as Shoulder.

We're not in a position to talk about the timing of that, but this robot has a number of applications and we're going to be continuing to expand it. But right now, the focus really is on the Total Knee..

And as it relates to timing, we really would like to come to the market with something that's really meaningful and not so interested in having an offering that's similar to what's existing on the marketplace. So, even if it takes us a little bit longer, but to provide a much more meaningful benefit, that's what we're more concerned with..

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

Hi, thanks and good evening. I was hoping to just ask quickly about Total Knee is moving off the inpatient-only list by Medicare this year.

Have you seen any type of impact in the market? Clearly it has an impact to Stryker's Knee business, but has there been an impact in the marketplace over the first three quarters of this year? And do you see it as a risk to the Total Knee market going forward? Is there anything that AvMed or American Hospital Association can do to help improve that HOPD reimbursement level? And then my follow-up question is that there have been concerns that one of your competitors is on a path to recovery.

And I just wanted to hear from you if you'd seen any incremental competitive headwinds in the Orthopaedic franchise from that competitor? Thanks for taking the questions..

So maybe I'll start with your last question. I would say if you look at our numbers and you look at our performance, we really just are focused on our own offense. We're focused on driving Mako, we're focused on 3D printing. And as long as we do that, we keep growing and we're growing very well.

And so I would say that's we're going to continue to focus on our offense. And it's really irrespective of what's going on around us. We haven't seen anything, any material change as we approach our customers.

What was the first question, sorry?.

Total Knees..

Oh, inpatient. So, no, we haven't seen any major dynamic change because it's really hospital inpatient only. Medicare still doesn't as you know cover procedures in the surgery centers. If that change were to occur, I think that would create a more meaningful shift.

But we're already starting to place Makos in surgery centers and that's the space we know fairly well from our sports medicine franchise. And so that would be the bigger change if that was to occur. We don't see that sort of in the short-term happening. Overall, the market is actually fairly healthy, fairly stable..

Thank you. And your next call comes from the line of Matthew O'Brien with Piper Jaffray. You may proceed..

Hi, thanks for taking the questions. This is Will on for Matt. So Neurotech, obviously, continues to be a monster growth driver. Can you talk about some of the other products that are really accelerating growth besides ischemic and hemorrhagic stroke? Thank you..

Sure. And within our Instruments business, we have a couple of terrific products. Our neuro power drills are doing extremely well. We have our SONOPET product for tumor ablation, which is also doing extremely well. We have the malis product, which we have picked up through an acquisition a little while ago, which is called the malis forceps.

So really the suite of products that we have for the neurosurgeon, which we – most of it's been through internal innovation but we've also done some small tuck-ins. That's really driving explosive growth, very strong double-digit growth and I would say the neurosurgical tools, the power tools are growing roughly as fast as our Neurovascular business.

And then you have our craniomaxillofacial business growing in the 10%, 11% quarter-after-quarter very steady double-digit growth. So it's really healthy across our portfolio and our businesses are performing very well..

Great, thank you. And then as a quick follow-up, can you elaborate a little bit about the Siemens partnership and the broader strategy specific to spine? Thank you..

Yeah, so we have strategic alliance with them to really provide imaging. So there's – we don't have – as you know we don't have a CRM ourselves. And so that really allows us if you – if we're thinking about competing with the Medtronic that has their arm and they try to bundle their offering with that type of imaging.

This provides a very competitive counter to them. So it runs on our portfolio and we use that – we enjoy that partnership. They have a very, very good product. They make sure that we have a complete and competitive offering for those accounts that are looking for a bundled offering..

Thank you. And your next call comes from Steven Lichtman with Oppenheimer & Company. You may proceed..

Thank you. Hi, guys. So you highlighted emerging markets as a positive driver in the quarter. I know EM is still not a big portion of total sales for you guys.

But would you say overall the environment remains healthy despite some of the broader market concerns?.

Yeah. So I mean emerging markets for us this is three quarters in a row where we had double-digit growth. But as you've seen in the past it has varied for us. Our performance has been a little bit up and down over the past four years or five years. I feel very good about our business in China. I feel good about our business in Latin America.

We've really strengthened it in Turkey and Russia. So there's a number of markets where I think we've really improved our position and that bodes well for the future. India, we just hired a new Managing Director recently. We still have some work to do there to get back on a strong footing.

They actually had a pretty decent quarter this quarter, first good quarter in about a year or so in India. But – so the outlook is still – is positive. It's going to take us some time. We really haven't made the same degree of investments as other large med tech players, but the market conditions themselves are quite good.

And we like our chances to continue to improve our performance in emerging markets..

Great. And then, just on Sage, obviously, a lot of volatility here in the last few quarters that you're now coming out from under.

How should we think about the sustainable growth of that business, now with some of the issues behind you guys?.

Yes. So as we regain the market share and get back in the offence later in 2019, we absolutely believe this will still be a double-digit growth business..

Thank you. And your next call comes from Kyle Rose of Canaccord. Please proceed..

Great. Thank you very much for taking the questions. Just wanted to ask another follow-up on the Mako side. Our competitor in the Spine side of robotics recently talked about leveraging the robot as a means to drive share.

I know, obviously, when you've talked about goal of taking hundreds of share points with Mako, but the competitor talked about being open to different business models rather than outright capital sale.

I know you touched on the Flex Financial, but it sounded like they were more approaching it from a volume-based agreement, given X% of procedural share over the course of the next several years and we'll place the robot.

Are you seeing those types of requests? Have they changed at all? And how do you view that as a business model moving forward when the market gets a little more competitive with new entrants?.

Yeah. I think, first and foremost, it all starts not with the financing options. It starts with what is your robot capable of doing and what value does it bring. And then, increasingly, what kind clinical data do you have. And we're not going to get into other people's business models.

That will be – the burden will be on them to demonstrate first what the robot can do. Secondly, when will they start to have clinical data? We have Flex Financial. We've had that for years. It's been a tremendous benefit to us, as well as knowing how to sell capital and having a dedicated capital sales force.

And that flexibility to meet the needs of our customers, I think, with roughly 600 or close to 600 robots globally and what we have in the pipeline. Our model is working for us and that's what we're going to stay focused on..

Great. Thank you for taking the question..

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

Thank you all for joining our call. As you can see, Stryker continues to deliver strong financial results. Our conference call for the fourth quarter 2018 results will be held on January 29, 2019. Additionally, we hope you can join us on November 8 for our 2018 Analyst Meeting and Product Fair. Thank you..

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