Welcome to the Third Quarter 2022 Stryker Earnings Call. My name is Megan, and I'll be your operator for today's call. 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. Additionally, 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 part of Stryker's current report on Form 8-K filed today with the SEC. I will now turn the call over to Mr. Kevin Lobo, Chair 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 Jason Beach, Vice President of Investor Relations. For today's call, I'll provide opening comments, followed by Jason with the trends we saw during the quarter and updates on Vocera and capital equipment. Glenn will then provide additional details regarding our quarterly results before opening the call to Q&A. For the quarter, organic sales growth was 10% with double-digit growth from our MedSurg and Neurotechnology businesses led by Endoscopy, Medical, and Neurocranial. Our Hip and Knee businesses also delivered double-digit growth, reflecting the continued recovery of elective procedures and our worldwide Mako momentum. Lastly, we continued our strong international performance with double-digit organic growth led by Europe, Canada, and emerging markets despite negative growth in China. For the quarter, we delivered adjusted EPS of $2.12 a share driven by our strong sales performance, partially offsetting negative foreign currency and inflationary pressures. We expect these pressures to continue but at a more moderate level for the remainder of 2022. We are pleased with our strong sales growth, which would have been even higher if not for material shortages, mostly affecting Medical and Instruments. Meanwhile, we are taking actions to deal with the cost headwinds, including inflationary challenges. First, as noted in Q2, given the higher input costs, we took a series of pricing actions across our portfolio. We have begun to see the impact of these initiatives, lessening the negative price impact on our business in Q3, but it will take time to see the full effect given the timing of contract renewals and rebates from contracts expiring. Second, we have taken additional actions around cost, including the reduction of discretionary items, hiring actions, and are proceeding with targeted restructuring plans in parts of our business. We continue to invest in R&D, demonstrating our continued focus on new product pipelines. This includes investments in R&D for enabling technologies, robotics, imaging and navigation, including our recently launched Q Guidance navigation system in Spine. Notably, we are making good progress with the development of our spine and shoulder applications for Mako. We have stopped the Cardan spine robotic project to focus all our energies on Mako and expect that the Mako spine and shoulder launches will occur in a similar time frame. Also during the quarter, we signed an agreement to purchase Cerus Endovascular, a technology leader in the hemorrhagic segment. This deal is pending customary closing conditions. We remain confident in the outlook of our business and expect to continue to deliver sales growth at the high end of med tech, which is reflected in our narrowing of full year organic sales growth to the higher end of our prior range, now 8.5% to 9%. However, worsening foreign currency and continued inflationary pressures have caused us to lower our full year adjusted EPS range to $9.15 to $9.25 per share. Overall, our team has shown good resiliency, and I'm pleased that employee engagement remains very high. We continue to be recognized across many countries, professions, gender, and age groups as a great place to work, most recently as one of the world's best workplaces by Fortune. As we look ahead to 2023, we feel optimistic about growth with high customer demand and exciting new product launches. Though the inflationary pressures and supply chain challenges will continue to impact next year, the strong growth outlook, combined with our pricing and cost actions, will position us well to return to strong earnings growth. I will now turn the call over to Jason.

Thanks, Kevin. My comments today will focus on providing an update on the current environment, including the procedural, geographic, and capital trends during the quarter. In addition, I'll provide an update on the integration progress of the Vocera business. Procedural volumes continue to recover throughout the third quarter in most countries, and we are beginning to reach normalized levels across most of our business. While we are seeing volumes recover, hospital staffing pressures have continued to impact the ability to reduce procedural backlog in a meaningful way. These challenges will likely resolve gradually, and we continue to expect this will be a moderate tailwind into next year. Geographically, procedural volumes steadily improved during the quarter in the United States, Europe, and Latin America. Parts of Asia Pacific have continued to be more volatile due to ongoing COVID-related impacts. Demand for our capital products remained very strong in the quarter as seen from the double-digit growth of our Medical division. However, we did realize some installation delays as well as hospital scheduling challenges. Specific to Mako, installations for the quarter were soft as we realized delays stemming from variability in the hospital environment. However, our order book remains strong, and we expect a good fourth quarter for Mako. We will update you on our key Mako metrics in January. Now to our key integration activities. We continue to be pleased with our Vocera integration progress and remain excited about the strong growth potential of this platform technology. However, in Q3, we elected to delay some installations shifting from on-prem servers to our cloud solution with certain customers. Also, as we do with all acquisitions, we are shifting the legacy sales force to the Stryker model, which has caused some disruption. These delays resulted in revenues that were essentially flat to Q3 2021. However, the order pipeline remains strong and customer retention remains very high at 99% for software renewals. We expect these processes to continue into Q1 of next year, after which we will be positioned to drive robust sales growth. In summary, while the macroeconomic environment remains dynamic, procedural volumes are improving and the underlying demand for our products remain strong, which gives us confidence in our ability to continue to drive strong revenue growth.

Thanks, Jason. Today, I will focus my comments on our third quarter financial results and the related drivers. Our detailed financial results have been provided in today's press release. Our organic sales growth was 9.9% in the quarter. The third quarter's average selling days were in line with 2021. The impact from pricing in the quarter was unfavorable 0.7%. We have started to see the positive impact of pricing initiatives, particularly in our U.S. MedSurg businesses, which all had positive pricing for the quarter. Foreign currency had a 3.7% unfavorable impact on sales. We continue to experience supply chain disruptions that have increased costs and led to inconsistent product availability. This is especially impacting the shipping and delivery timelines related to capital products in our MedSurg businesses. Nevertheless, our capital order book continues to be very robust as demand from our customers remained strong. In the quarter, U.S. organic sales growth was 9.2%. International organic sales growth was 11.8%, impacted by positive sales momentum across most of our international markets, specifically emerging markets, Canada, Japan, and Europe, somewhat offset by lingering COVID impacts in other Asia Pacific countries. Our adjusted EPS of $2.12 in the quarter was down $0.08 from 2021 due primarily to the impact of foreign currency exchange translation of $0.08. Additionally, higher costs associated with gross margin challenges were offset by the benefit from higher sales and cost discipline. Now I'll provide some highlights around our segment performance. In the quarter, MedSurg and Neurotechnology had constant currency sales growth of 13.5% with organic sales growth of 10.8%, which included 9.6% of U.S. organic growth and 14.4% of international organic growth. Instruments had U.S. organic sales growth of 2.2% led by our Surgical Technology business. From a product perspective, sales growth was highlighted by growth in smoke evacuation and Steri-Shield. During the quarter, Instruments experienced supply chain challenges primarily related to its capital products. Endoscopy had U.S. organic sales growth of 14% highlighted by double-digit growth in both the core Endoscopy and Sports Medicine businesses. Medical had U.S. organic sales growth of 13.7% driven by growth in our Sage and acute care businesses fueled by ProCuity and Prime structure demand. As previously noted, Medical continues to experience supply chain challenges that primarily impact emergency care products. Our U.S. Neurovascular business had an organic decline of 2% driven by a strong double-digit comparable in 2021, disruptions due to hospital staffing shortages and slower clinic volumes as well as competitive pressures. The U.S. neurocranial business had organic sales growth of 12.7%, which included solid growth in our Max space and Neuro products. Internationally, MedSurg and Neurotechnology had organic sales growth of 14.4%, reflecting double-digit growth in all businesses. Geographically, this included strong performances in Japan, China, and other emerging markets. Orthopaedics and Spine had both constant currency and organic sales growth of 8.7%, which included organic growth of 8.7% in the U.S. and 8.9% internationally. This reflects the impact of our strong international growth and solid growth in our Hip, Knee and Trauma and Extremities businesses. Our U.S. Hip business grew 12.4% organically, reflecting strong primary Hip growth fueled by the recent launch of our Insignia Hip Stem and continued procedural growth. Our U.S. New York Knee business grew 14% organically, reflecting our market-leading position in robotic-assisted knee procedures. Our U.S. Trauma and Extremities business grew 10.4% organically with strong performances across all four businesses, led by double-digit growth in upper extremities highlighted by our new products Perform and BLUEPRINT. Our U.S. Spine business sales grew 2% from solid performance in our enabling technology business, somewhat offset by the impact of lower surgery volumes in the competitive environment. Our U.S. Other ortho declined organically by 11.2% primarily driven by the impact of the aforementioned delays in Mako installations in the quarter. Internationally, Orthopaedics and Spine grew 8.9% organically, which reflects the strong momentum in Europe as procedural volumes improve as well as strong performances in Japan, Canada, and India, somewhat offset by COVID-related volatility in Australia. Now I will focus on the operating highlights in the third quarter. Our adjusted gross margin of 62.6% was unfavorable approximately 370 basis points from the third quarter of 2021, reflecting the impact of the purchases of electronic components at premium prices and other inflationary pressures primarily related to labor, steel, and transportation costs as well as inefficiencies from supply chain disruptions and the unfavorable impact of price and foreign exchange on sales. Sequentially, from Q2 2022, gross margin was 70 basis points unfavorable. This included the impact from unfavorable business mix, higher-than-expected inflationary pressures, including premium pricing and operational inefficiencies. We expect these adverse impacts to continue throughout the remainder of the year and into 2023. For the full year 2022, we now expect adjusted gross margin compared to 2021 to be adversely impacted by approximately 250 basis points. Adjusted R&D spending was 7.1% of sales, which represents a 40 basis points increase from 2021. This reflects our continued commitment to funding innovation and the related future growth that we'll provide. Our adjusted SG&A was 33.1% of sales, which was 100 basis points lower than 2021. This reflects the impact of an increased focus on discretionary cost control and headcount discipline. In summary, for the quarter, our adjusted operating margin was 22.3% of sales, which was approximately 310 basis points unfavorable to the third quarter of 2021. This performance is primarily driven by the aforementioned gross margin challenges and the net negative impact resulting from foreign currency exchange translation, somewhat offset by cost discipline. Adjusted other income and expense decreased from 2021, primarily resulting from lower interest expense and favorable interest income. We anticipate Q4 OI&E to be approximately $70 million. Our third quarter had an adjusted effective tax rate of 14.5%, reflecting the impact of geographic mix and certain discrete tax items. We now expect our full year adjusted effective tax rate to be at the low end of our previously communicated range of 14.5% to 15%, which is slightly lower than 2021. Focusing on the balance sheet. We ended the third quarter with $1.5 billion of cash and marketable securities and total debt of $12.8 billion. Approximately $250 million of term loan debt was paid down in the quarter, which brings our year-to-date payments to $500 million. Turning to cash flow. Our year-to-date cash from operations is $1.6 billion. This performance reflects the results of net earnings, partially offset by the impact of higher costs for certain electronic components, pre-buying of certain other critical raw material inventory, and seasonal inventory increases. Considering our third quarter results, our strong order book for capital equipment, and the sales momentum in our implant and capital businesses, we now expect full year 2022 organic sales growth to be in the range of 8.5% to 9%. If foreign currency exchange rates hold near current levels, we now expect net sales in the full year to be adversely impacted by approximately 4% and adjusted net earnings per diluted share to be adversely impacted by approximately $0.35 to $0.40 for the full year, which is included in our revised earnings guidance range. Based on continuing inflationary and supply chain pressures, balanced with our strong sales and additional cost-reduction actions, and most significantly, the anticipated future impact of foreign currency, we now expect adjusted earnings per share to be in the range of $9.15 to $9.25.

Congratulations on a great top line performance. I would like to ask my first question regarding operating margins for both the third and fourth quarters, as they came in much lower. It appears that about half of this was due to currency effects. I would like to know how much of the negative impact we experienced in the third quarter was temporary, and what is contributing to the strong sequential improvement expected in the fourth quarter?

Robbie, this is Glenn. Those are good questions. As we reviewed the third quarter and the changes from Q2, we noticed that our supply visibility had improved, and we were experiencing moderate enhancements. However, the rate of improvement in relation to costs was not meeting expectations. We are still facing higher-than-anticipated premium costs and inflation across nearly all categories, particularly in labor, metals, and transportation. This variability in the supply chain has led to inefficiencies in our manufacturing processes, causing numerous interruptions that further increase costs. Looking ahead to Q4, we have good visibility to supply and feel confident enough to raise our sales guidance. However, I still anticipate some ongoing challenges in this dynamic environment, with continued higher costs. Just as we resolve one electronic component issue, we often face another issue from a different vendor. We are navigating through these ongoing supply chain challenges.

Great. And as we go into 2023, where I think everybody is starting to focus, I don't think there's much issue with the top line with 9.9 in the quarter, 8.5% to 9% for the year. That looks really good. I think people feel comfortable into next year. Where there's questions is down the P&L and on EPS. And Kevin, you mentioned the comment about strong EPS growth next year. I see my numbers looking north of 50 basis points margin expansion next year, which might be a little high given the trends we're seeing here, would love to hear if you have any initial comments on thoughts on 2023 and particularly what that strong EPS growth means.

Yes. Thanks, Robbie. We're going to give specific guidance in January, as we always do. But I did make that comment in my opening remarks to signal that this year is an aberration. We will get back to strong earnings, which does absolutely imply margin expansion in 2023. But specifics, we'll get to you in January.

I wanted to ask first about the supply shortages. Kevin or Glenn, I don't know if you are willing to comment on how much you think they impacted you. How much do you expect to be impacted in Q4? And are these sales you expect to get back over time? And I had one follow-up.

Yes. Larry, I think not to give specific guidance on numbers relative to the disruptions, but suffice to say that on some products, we are very hand-to-mouth in terms of how we're getting componentry to complete those products and ship them to customers. On some, we have a little bit better visibility. I would tell you that with our order backlog at an all-time high, we are seeing pretty significant disruptions across our capital businesses. We're very focused on getting product to customers. We know that's important. And we are working hard to make sure that as we can secure supply that we work around the clock to get those products finished and get them out to customers.

Yes. Larry, what I'd add is our problems are in the MedSurg side of our business. And on the MedSurg side of our business, we're not going to lose sales. So if we have problems in the implant side, those sales would be lost to competitors. In this case, customers are waiting. The products aren't urgent. We do have a plan to get these products to our customers. Medical's numbers, which were pretty impressive at 13-plus percent organic, would have been materially higher because of the emergency care demand and the same with Instruments. Those are the two divisions that had the most impact. Frankly, we have a lot of nickeling issues across our portfolio, but those two divisions were severely impacted in Q3. You'll see some recovery in Q4 and into next year. But I really don't expect to lose any of those sales, which gives me a lot of confidence going into next year that our positive sales trajectory will continue.

That's helpful. And then maybe a little bit more color on the softness with Mako this quarter. How confident are you in the rebound in Q4? And Glenn, I know the other line is not just Mako, but when can we expect to see that line turn positive?

Larry, it's Jason. I'll start here and talk a little bit about Mako. And then, Glenn, if you want to comment on the other piece, feel free. But as it relates to Mako, like I said in my prepared remarks, the orders were soft. But if you look at the order pipeline, it is very robust. And we continue to be, I'll say, the robotic-assisted choice in the marketplace. And so we feel good about Q4. And like I said in my prepared remarks, we expect a strong quarter.

Yes, Larry. The only thing I'd add is there are a couple of products in that line item other. But yes, you're right, that's where Mako is. I don't really want to guide you on Q4. I think sequentially, we will definitely see improvement. But in terms of when will we see full positivity, we'll talk about that in January.

I'm really encouraged by the fact that, consistently over the quarters, we're seeing an increase in the percentage of Mako as part of our total Knee sales, as well as in hips and cementless knees. This trend indicates that all these areas are progressing positively. While there have been some delays in the installation and sale of our robots to customers, I believe Q4 will be strong and will help us continue on our positive path.

Guys, congrats on a good top line print here. Kevin, maybe my first question here is on '23. I guess, did I hear you guys say labor situation improves that big tailwind in '23? And how should we think about this capital versus supply chain impact, those dynamics, right? Its strong capital order book versus supply chain dynamics, how does that impact '23? Any new products that we should be thinking of? Again, I'm not asking for specific guidance, but maybe some qualitative comments on these variables.

Okay. I'll focus on qualitative aspects. We are experiencing an increase in procedural demand, which is recovering globally, although a bit slower in the Asia Pacific. Given the impact of COVID, we anticipate this trend will continue, especially with strong growth in our Hip and Knee business, extending into the fourth quarter and possibly maintaining a moderate momentum throughout 2023 and into 2024. Additionally, we have several new products launching: the System 9 power tool early in the year, the 1780 camera mid-year, and a defibrillator with uncertain timing, potentially the Life Pack later in the year. These launches are significant and can create a positive cycle within our MedSurg sector. The Insignia Hips stem is still in the early stages of its rollout, but it's gaining momentum and has positively impacted our Hip sales relative to competitors. On the order book front, we have a substantial backlog of orders, especially in emergency care, with customers willing to wait. This reassures us of ongoing demand, although we need to ensure we can supply our customers. We've been securing various components, but there have been challenges with availability. While progress is being made, it's gradual. We're optimistic about overcoming these supply challenges in the first half of next year. The strong demand, combined with our new product launches, will give us additional momentum as we move into next year. I apologize if I didn't mention all divisions, but those are some key highlights.

That's helpful color, Kevin. Glenn, maybe one for you. At current FX rates, how should we think about EPS impact for '23? In the 250 basis points of gross margin impact, what is being capitalized? What percentage of that 250 basis points is being capitalized on the balance sheet?

Okay, Vijay. Regarding FX rates, while I won't provide specific guidance for next year, it's worth noting that rates significantly increased in the third and fourth quarters of 2022. The comparisons for the first and second quarters will likely have a considerable effect on rates next year, so keep that in mind as you develop your models. As for capitalized variance, I won't get into details, but it's important to remember that spot buys are related to raw materials that are added to inventory, and their future usage typically spans an 8- to 9-month period. This makes predictions a bit more complex, and we will continue to experience some effects well into the second quarter of next year. If we are still in a spot-buy premium situation in the first quarter of 2023, it could impact the third quarter as well.

The first one is the messaging has been very consistent throughout this year about the strong capital demand. And understand that there's a give and take between backlog of orders because the orders to fill orders canceled and new orders. So I guess, can you talk specifically on new orders during 3Q and what you're seeing for 4Q against your expectations?

Yes, Pito, it's Jason. I'll jump in here. I would point you back to some of the commentary around the order book. And if you look at our capital businesses, it continues to be very strong. And so as we look to the fourth quarter, similar to the comments Kevin said around Medical and Instruments, we certainly expect a recovery in the fourth quarter with Instruments and another strong quarter for Medical as well.

And even Endoscopy, who had a very strong Q3, they grew their orders as well in the quarter. So they will also have another strong quarter in Q4. So it's really across our portfolio where the demand is very, very strong. We're not seeing sort of a capital slowdown, which I know I've heard that some other companies mentioned. We're just not seeing that in our orders. We're not having orders canceled. It's something I haven't seen in my tenures here, customers ordering things and then canceling it. So we feel very good about our position. Our orders have not slowed down. They continue to grow. Just one little example, which I really enjoy is on Vocera, we've now integrated that with our ProCuity bed. So the alerts for falls from the bed actually go straight to the badge, and we're already showing this to our customers and getting really wild positive feedback from customers on this. And again, it's early days, but the ProCuity momentum, which really powered our strong Medical growth this quarter, is just building. And it's kind of the second year of the launch. It's really just gaining steam. And now with its interoperability with Vocera, that provides an extra bit of energy to that business.

Okay. Fair enough. And then a follow-up on Neurovascular's a touch weaker this quarter. Just curious how that is market versus competition versus supply shortages?

We've noticed a sluggish market this year in the U.S. for Neurovascular, and it's uncertain why that is. There are several theories about the slow market, and I would say that's a significant part of it. Additionally, there are new competitors in both aspiration and stent retrievers, and the FDA has lessened the clinical requirements in those areas. This has introduced various new participants, which plays a role in the slowdown. It's possible that the COVID pandemic has affected the incidence of strokes, as some patients who would typically have had strokes may not be experiencing them due to the mortality effects of COVID. It's difficult to pinpoint the exact cause, but the slowdown in the U.S. market is noticeable. This is likely a major factor, alongside some competitive pressures. It's important to remember that our U.S. business is much smaller than our international operations in Neurovascular, which has always been the case. This segment behaves differently compared to the rest of our portfolio. However, we're optimistic about the long-term potential in this field. We are currently only reaching a small fraction of individuals who have strokes, and as I mentioned in my opening comments, we've recently signed a deal for an acquisition in the intraocular space.

The first one is just on the restructuring you talked about. Is that something that's going to be impactful to next year, specifically to help drive that EPS growth? And then do you have other levers that are kind of below the line that you can pull on that to help with the EPS growth for next year?

EPS growth will come from a combination of price increases and cost reductions. Some of our businesses are implementing a second round of price hikes, which will start to be noticeable as contracts end. Price increases are one aspect, while cost reductions are another important component. The restructuring efforts are specifically targeted and involve initiatives we planned to implement anyway to enhance our processes. We're accelerating these activities, and we expect to see results this year and into early next year, positively impacting our earnings per share next year.

And Matt, below the line, if you look at sort of in an taxes, there are some opportunities related to how quickly we pay down the term loan. So there could be some pickups relative to interest expense, although those would be minor given the rates. And then taxes, I don't expect any surprises, so steady as we've been there.

Maybe to start on extremities. Just wondering what you're seeing in the foot and ankle market. Did any procedures perform better or worse than others? And then I'll ask my second question upfront here. Maybe can you talk about the Q Guidance System, how that early launch is going? And maybe you can touch on the launch strategy, pricing and feedback you got from NASS.

Yes. Starting with Foot & Ankle, we had an excellent Q3. The strongest growth within Foot & Ankle came from our total ankle segment, where we maintain clear market leadership and experienced double-digit growth. Although midfoot and forefoot procedures are starting to rebound from pandemic-related slowdowns, they performed well in Q3. We introduced several new products in that category, which gives us strong confidence for the future. The solid Q3 in the United States also contributed to the double-digit growth in Trauma Extremities. Regarding the Q Guidance System, we received outstanding feedback due to its speed—much faster than what competitors offer. It also provides suggestions for screw usage, which is quite innovative, and this system will be integrated into Mako for future use, simplifying the workflow. The positive response was significant and helped bolster our enabling technology performance. We saw strong sales of the Q Guidance System in Q3, and we expect this momentum to continue into Q4. We aim to integrate it with Mako, and we have another project internally codenamed CoPilot, focused on drills and haptic feedback. Surgeons at NASS responded positively to it, as this feature is not available in the market today. Our portfolio in enabling technology for Spine is comprehensive, and while it will take time to launch additional products, the response to Q Guidance, particularly for its speed and efficiency without necessitating workflow changes, has been very encouraging.

A couple of follow-ups. Jason, in capital, we talked a lot this evening about supply. But in the prepared remarks, you talked about installation delays due to variability in the hospital environment and scheduling challenges. Can you provide a little more color on what you're seeing specifically when you talk about that and the variability? And were those comments related to both traditional Medical and Mako? And then I just have a quick one for Glenn.

Yes. I'd say a couple of different things just as you think about that and think about capital. Obviously, our larger capital is beyond Mako, right? But what we're seeing is sometimes I think when we talk about staffing challenges, people go right to nurses and some of those things. But really, what we're talking about here is even like if you think about our comm business, you'll have scheduled installations. People show up to do an install. They'll get canceled. They'll have to come back. And so that's the variability that I'm referring to that sometimes delays installs, and ultimately, revenue and gets pushed out.

He didn't ask yet.

Just a quick follow-up. Really just a clarification. Jason, in your prepared remarks, you talked about Mako installs being delayed during the quarter. I think in a follow-up to Larry Biegelsen's question, you talked about orders for Mako being soft. Just was it orders, was it the installs? And maybe a little more color just on what exactly happened in the third quarter and what the confidence is that recovering in the fourth.

Yes. No, my comments were definitely specific to installs. I may have made a comment relative to a strong order book, which is absolutely the case, and we do expect a strong fourth quarter.

Well, thank you all for joining our call. We look forward to sharing our fourth quarter and full year-end 2022 results with you as well as our 2023 guidance in January. Thank you.

That concludes today's call. Thank you for your participation. You may now disconnect your lines.