Earnings Call Transcript
STRYKER CORP (SYK)
Earnings Call Transcript - SYK Q2 2023
Operator, Operator
Welcome to the Second Quarter 2023 Stryker Earnings 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, Chair and Chief Executive Officer. You may proceed, sir.
Kevin Lobo, CEO
Welcome to Stryker’s second 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 some other updates. Glenn will then provide additional details regarding our quarterly results before opening the call to Q&A. In the second quarter, we delivered organic sales growth of 11.9% with double-digit growth in both MedSurg and Neurotechnology, and Orthopaedics and Spine. This comprehensive performance demonstrates the diverse and attractive markets that we play in and our ability to drive growth through strong commercial execution. We are also pleased with the continued positive outcomes of our globalization efforts. Our international business demonstrated strong performance with double-digit growth, complementing our strong and fast-growing U.S. business. In addition, we continue to see traction with our pricing initiatives, again delivering positive pricing in the second quarter. During the quarter, we continued to realize improvements in component availability, although disruptions remain in parts of our business. Our teams have demonstrated good agility in addressing these situations, proactively mitigating much of their impact. We delivered quarterly adjusted EPS of $2.54 a share, reflecting 13% growth compared to the second quarter of 2022. This result was primarily driven from the strength of our sales but also marks the beginning of our margin recovery. We expect margins to continue to expand throughout the remainder of the year. Finally, with half the year behind us and our solid momentum, we have increased our expected full year organic sales growth to a range of 9.5% to 10.5% and increased our expected earnings per share to $10.25 to $10.45 per share. I will now turn the call over to Jason.
Jason Beach, Vice President of Investor Relations
Thanks, Kevin. My comments today will focus on providing an update on the current environment as well as capital demand, including Mako, acquisitions and an update on product launches. Procedural volumes have largely recovered to pre-COVID levels in most countries. And while volumes are strong, patient backlog still remains, and we believe the elevated orthopedic procedural demand will continue well into 2024. While volumes have largely recovered, hospital staffing pressures and supply constraints continue in pockets around the globe. These challenges are resolving gradually as we expected and will continue to be a moderate tailwind as we move through the second half of 2023 and into 2024. Additionally, demand for our capital products remained healthy in the quarter as evidenced from the double-digit organic growth of our Medical, Instruments and Neuro Cranial divisions. Also, demand for Mako remains robust with strong U.S. and international performances, which is helping drive our continued growth in hips and knees. Next, capital order backlog remains elevated, well above normal levels. Also, during the quarter, we executed a small tuck-in deal and also closed on the Cerus Endovascular acquisition. Furthermore, our product super cycle continues to drive positive momentum. In late Q2, we successfully completed a limited launch of our 1788 camera platform and are poised for full launch in Q3. We also received FDA clearance for Cranial Guidance, our newest application under our Q Guidance platform. This empowers surgeons to quickly plan a safe surgical approach using multiple imaging modalities and then navigate instruments with specific surgical procedures. Finally, we remain on track for the launch of our LIFEPAK 35 defibrillator outside of the U.S. in the fourth quarter of this year and in the U.S. in early 2024. These launches will continue to support growth over multiple years. With that, I’ll now turn the call over to Glenn.
Glenn Boehnlein, CFO
Thanks, Jason. Today, I will focus my comments on our second quarter financial results and the related drivers. Our detailed financial results have been provided in today’s press release. Our organic sales growth was 11.9% in the quarter. The second quarter’s average selling days were in line with 2022. The impact from pricing in the quarter was favorable by 0.5%. We continue to see a positive trend from our pricing initiatives, particularly in our U.S. MedSurg and Neurotech businesses, all of which contributed positive pricing for the quarter. Foreign currency had a 0.7% unfavorable impact on sales. In the quarter, U.S. organic sales growth was 12%, International organic sales growth was 11.4%, impacted by positive sales momentum across most of our international markets, particularly Australia, Canada, Europe and most of our emerging markets. Adjusted EPS of $2.54 in the quarter was up 12.9% from 2022, driven by higher sales and operating margin expansion, partially offset by a higher adjusted income tax rate and the impact of foreign currency exchange, which was unfavorable $0.03. Now, I will provide some highlights around our quarterly segment performance. In the quarter, MedSurg and Neurotechnology had both constant currency and organic sales growth of 12.9%, which included 13.5% of U.S. organic growth and 10.9% of international organic growth. Instruments had U.S. organic sales growth of 12.9%, led by strong double-digit growth in the Surgical Technology business. From a product perspective, sales growth was led by power tools, waste management, smoke evacuation and surge account. Endoscopy had U.S. organic sales growth of 3.5% against a strong comparable. This included strong growth in its ProCare sustainability and sports medicine businesses. The Endoscopy business completed its limited launch of the 1788 camera late in the second quarter. Consistent with prior camera launches and the related transition period between the legacy camera and the new camera, this also contributed to muted growth in Q2. Medical had U.S. organic sales growth of 27.2%, reflecting very strong performances in all three of its businesses, acute care, emergency care and Sage, and benefited from continued improvement in product supply during the quarter. Neurovascular had U.S. organic sales growth of 9%, reflecting a strong performance in our hemorrhagic business. Neuro Cranial had U.S. organic sales growth of 9.6%, which included double-digit growth in our Bone Mill, bipolar forceps and Max Space product lines. Internationally, MedSurg and Neurotechnology had organic sales growth of 10.9%, reflecting double-digit growth in our medical and Neuro Cranial businesses. Geographically, this included strong performances in Europe, Australia and Canada. Neurovascular’s growth continues to be negatively impacted by VBP in China. Orthopaedics and Spine had both constant currency and organic sales growth of 10.6%, which included organic growth of 10% in the U.S. and 12.1% internationally. Our U.S. Knee business grew 10.6% organically, which reflects our market-leading position in robotic-assisted knee procedures. Our U.S. Hip business grew 8.8% organically, reflecting strong primary hip growth fueled by our Insignia hip stem and continued procedural growth. Our U.S. Trauma and Extremities business grew 14.3% organically with strong performances across all businesses, led by very strong growth in upper extremities and foot and ankle. Our U.S. Spine business grew 5.2%, led by the performance of our enabling technology and Interventional Spine businesses, including the recently launched Q Guidance Navigation System. Our U.S. Other Ortho declined organically 1.6%, primarily driven by the impact of deal mix changes, specifically more rentals related to Mako installations in the quarter. Internationally, Orthopaedics and Spine grew 12.1% organically, including strong performances in Australia, Canada and most emerging markets. Now, I will focus on operating highlights in the quarter. Our adjusted gross margin of 63.9% was favorable, approximately 60 basis points from the second quarter of 2022 and 70 basis points sequentially compared to Q1 2023. This change was primarily driven by the slight easing of certain cost pressures, decreases in spot buy purchases, improved productivity and the benefit of price, partially offset by the impact of foreign currency exchange. Adjusted R&D spending was 6.4% of sales, which represents an 80 basis points decrease from the second quarter of 2022, due primarily to a higher comparable in 2022 related to the ramping of costs for product launches. Our adjusted SG&A was 33.1% of sales, which was 70 basis points higher than the second quarter of 2022, due to a disciplined ramp of spend and investment to support our growth. We expect our full year SG&A as a percent of sales to be in line with 2019 levels as we continue to invest for growth. In summary, for the quarter, our adjusted operating margin was 24.3% of sales which was approximately 60 basis points favorable to the second quarter of 2022. This performance is primarily driven by the aforementioned easing of certain cost pressures, primarily on gross margin. Adjusted other income and expense of $66 million for the quarter was slightly higher than 2022, driven by increased interest expense. The second quarter of 2023 had an adjusted effective tax rate of 15.2%, reflecting the impact of geographic mix and certain discrete tax items. For 2023, we reiterate our full year effective tax rate guidance to be in the range of 14% to 15%. Focusing on the balance sheet. We ended the second quarter with $1.5 billion of cash and marketable securities and total debt of $12.9 billion. Approximately $100 million of the term loan debt was paid down in the quarter, reflecting year-to-date payments of $200 million and a remaining balance of $650 million. Turning to cash flow. Our year-to-date cash from operations is $1.1 billion. This performance reflects the results of net earnings and higher accounts receivable collections. Considering our year-to-date results, our strong backlog for capital equipment and continued positive procedural trends, we now expect full year 2023 organic sales growth to be in the range of 9.5% to 10.5% with pricing to be slightly positive for the year. If foreign currency exchange rates hold near current levels, we anticipate sales will be unfavorably impacted by approximately 0.3% and adjusted EPS will be unfavorably impacted from $0.05 to $0.10 per share for the full year, both of which are included in our guidance. Based on our performance in the first half of the year, together with our strong sales momentum, we now expect adjusted earnings per share to be in the range of $10.25 to $10.45 per share. And now I will open up the call for Q&A.
Operator, Operator
Our first question comes from Robbie Marcus with JPMorgan. Please go ahead.
Robbie Marcus, Analyst
Congrats on a great quarter here. Two for me. First, a great quarter. It looks like you’re raising more than the beat on both the top and bottom line. Looks like you’re taking a good amount of share still in Ortho across hips, knees and extremities, trauma. Just as we think about the balance of the year, you touched on some of them, but would love to get a sense of what gives you the confidence these elevated trends are going to continue. And any visibility on the margin side that gets you comfortable moving it up more than the beat?
Kevin Lobo, CEO
Hi Robbie, it’s Kevin. I’ll start by discussing our confidence in the procedures. Since the third quarter of last year, we've noticed a strong demand stemming from surgery backlogs and conversations with physicians, particularly as there was pent-up demand during the pandemic. We anticipated an increase in procedures at the beginning of the year, and that expectation has been fulfilled. Providers in the industry have shared similar observations. The surgery backlogs are extending—what was previously considered a two-month backlog is now closer to four months. This gives us confidence that we will continue to experience elevated procedural growth through the end of this year and into next year. We also see this reflected in the demand for our small capital equipment, which is used for ongoing procedures. Now, I’ll turn it over to Glenn for the margins.
Glenn Boehnlein, CFO
Yes. Hey Robbie. As we got through the quarter, as I mentioned, we really started to see some positive and easing of some of the cost pressures that we had felt in Q1 and certainly last year. I think we also are starting to feel some of the improvements in supply chain. That’s not to say that everything is rosy. We are still feeling inflationary pressures in transportation, some of our commodities, labor, certain electronics. But I will say that spot buys in Q1, spot buys in Q2 have not been material. And we’re getting near the amortization of the impact of spot buys from last year. So I feel like that gives me good confidence that I think we’ll see continued improvement in our gross margin as we move into Q3 and Q4. And so, we really will feel that gradual improvement, and we’ll feel it all the way down to the operating margin line.
Robbie Marcus, Analyst
Great. Just a follow-up for both of you or however you want to address it. People are quite satisfied with the year so far, but we are always focused on the future and already looking ahead to next year. You mentioned, Kevin, that these trends will continue. You talked about the super cycle in MedSurg. What are your thoughts on how we might view these elevated trends persisting? I know you are committed to returning to your 2016 or 2019 operating margin of 26.3%. How far out do you think that might take us?
Kevin Lobo, CEO
I believe Jason’s comments at the beginning indicate that we anticipate the positive procedural trends to persist well into next year. While I can't predict the exact degree of improvement, whether it will be 100 basis points or 200 basis points higher than the levels seen during the pandemic and last year, we do expect an increase. The product super cycle is very promising; for instance, Neptune S has had an excellent start in the instruments segment, and the 1788 is set to launch later this quarter, which will significantly influence next year. We also have a new defibrillator coming soon. These product launches, including ProCuity, which spans multiple years, and the Xpedition stair chair, which is a brand new category that launched in Q1 of this year, will continue to drive strong growth across our businesses. Thus, we expect to remain a high-growth company moving into next year. Additionally, we are fully committed to returning to pre-COVID margins and achieving growth in our margins afterward. This quarter has marked an important first step in that journey.
Operator, Operator
We’ll take our next question from Larry Biegelsen with Wells Fargo.
Larry Biegelsen, Analyst
Thanks for taking the question. And I’ll echo Robbie’s congratulations on a very impressive quarter here. So Kevin, I wanted to start on MedSurg, the new products. Just talk about how the new camera in endoscopy might have impacted Q2? And what you expect the impact to be from that in ‘23 and ‘24? And Medical growing 27% organically after Vocera anniversaried. What drove that? And how did Vocera do in the second quarter? And what’s the outlook? And I had one follow-up.
Kevin Lobo, CEO
We’re really excited about the performance of our MedSurg business, which continues to be a strong segment of our company. Regarding the endoscopy side, the camera launch had minimal impact as it was limited and aimed at ensuring the product performs as expected. The test cases have gone extremely well, and the full launch is set to begin in the latter half of Q3. We expect to see some impact in Q3, with acceleration in Q4 and even more growth next year. Historically, these types of launches tend to see momentum build in the first two years, so we anticipate significant effects moving forward. Although there will be some impact in Q3 and Q4, any contributions from endoscopy will be modest initially. The segment appears softer due to a strong comparison from last year and the typical slowdown before a new product's impact becomes evident. The Medical division had an outstanding quarter with over 25% growth, a trend seen in the fourth quarter as well. Over the past six years, Medical has evolved into a consistently high-growth division, with fluctuations from quarter to quarter. However, looking at a rolling four or eight-quarter period reveals strong growth. This division is often underestimated within our portfolio. We’re integrating acquisitions like Sage, Physio-Control, and Vocera, and launching new products such as the Power-PRO 2 ambulance cot and ProCuity bed frame. There’s increasing awareness regarding safety, which is driving new demand for our AED portfolio, along with the LUCAS automatic chest compression product and a strong management team in Medical. While I don't expect another 25% growth in the next quarter, I believe Medical will continue to sustain high growth for the foreseeable future. For Vocera, both sales and orders increased in the quarter as we anticipated. We had mentioned earlier that Q3, Q4, and Q1 of this year would be relatively flat after the integration, but both sales and orders picked up significantly in Q2. Vocera has contributed positively, showing strength across our entire portfolio.
Larry Biegelsen, Analyst
Thank you. And just I’ll keep my follow-up really brief. Glenn, the comps are very different in Q3 and Q4. Should we be thinking about stronger growth in Q3 relative to Q4? Just the cadence for the rest of the year? Thank you.
Glenn Boehnlein, CFO
Yes. I mean, a couple of things. Q3 seasonally is usually not a super strong quarter, but I think if you focus on Q4 and you look at the comp that we’re up against, that probably plays into how much we’re going to grow against that comp. The big number last year, it was $5.2 billion in the quarter, which is a big number. So, I think what you’ll see is you’ll see slightly higher growth in Q3, and then that will come down a little bit because of the comp, but I think we’ll end the year nicely, well within our guidance.
Operator, Operator
We’ll take our next question from Pito Chickering with Deutsche Bank.
Pito Chickering, Analyst
Very nice quarter. A follow-up on the Medical. Can you talk about the CapEx environment? How much has changed in the last sort of 90 days or so and possible increase in CapEx as the revenues and costs are looking pretty good for hospitals? And on the backlog, did you guys reduce the backlog in the quarter? And was that a bolus for 2Q and should that be normalizing in the back half of the year? And then also on Microchips, is that should we view that getting better as a gross margin improvement from lower costs or increasing revenues as you reduce that backlog?
Jason Beach, Vice President of Investor Relations
It’s Jason. I’ll start here and then maybe some follow on. But as we think about the capital environment, we continue to see great strength from a capital environment standpoint. And even as you think about the backlog in our business, I think your question was, was there a bolus. But if you look at our backlog, it continues to be at very high levels, higher than what we came into the year with. So, still strength there on the capital side.
Pito Chickering, Analyst
Okay. Regarding gross margin, it seems that many of the positive factors in the second quarter are likely to be long-lasting. You mentioned that gross margin should improve in the latter half of the year. Could you update us on how many months of inventory you currently have on the balance sheet? Additionally, when do you expect the deflationary pressures we're observing to impact the profit and loss statement? I'm curious if this timing is the main factor behind the anticipated gross margin improvement in the third and fourth quarters as we wait for those effects to take place.
Glenn Boehnlein, CFO
Yes. I think the big thing that really sits in inventory and worked its way through sort of in the first quarter and the second quarter was the impact of those spot buys. And generally, inventory turns depending on the product, anywhere from 6 to 9 months. So yes, we will generally see the impact of spot buys reduced for the rest of this year. Keep in mind that we still have this sort of inflationary headwind that we will be working against in Q3 and Q4. But just the mere fact that I feel like we’re getting to the end of the impact of spot buys, gives me confidence that we should see gradual gross margin improvement in the rest of this year.
Operator, Operator
We’ll take our next question from Vijay Kumar with Evercore ISI.
Vijay Kumar, Analyst
Kevin, the guidance is pretty impressive, 10% organic. Are comps something that we should worry about from a fiscal ‘24 perspective? I know you mentioned certain product tailwinds. Just help us contextualize that 10%. And given that some of these procedure trends, it looks like it could sustain into ‘24.
Kevin Lobo, CEO
Thank you, Vijay. Last year, we achieved an organic growth of 9.7%, indicating a solid performance, and we are continuing to grow from that base. The current innovation cycle is significant, and the demand for procedures remains strong. Despite an elevated market, we are outpacing it in nearly all of our sectors, which gives us confidence in our ability to grow at the higher end of the Medtech industry. We are already through half of the year, and while the fourth quarter of last year saw an unusually high growth rate of over 13%, our guidance does incorporate a slight slowdown due to those comparisons. Nonetheless, we anticipate that factors such as a backlog of surgical demands, an aging population, and increased physical activity leading to injuries will continue to serve as positive influences. We expect this trend to persist throughout much of next year, although we acknowledge that conditions could change. We had forecasted this during the third quarter of last year, and it is now manifesting even more positively than we had anticipated regarding the number of procedures and hospital staffing. While there are occasional challenges, hospitals are better prepared, and patients are eager to proceed with their procedures.
Vijay Kumar, Analyst
That’s helpful, Kevin. Glenn, maybe one for you. It looks like we’re on track, actually well north of 50 basis points of margin expansion in fiscal ‘23. Is this something that’s sustainable when you look at the operating model, assuming there’s nothing crazy on the inflation side for next year. I’m curious how we should be thinking about leverage.
Glenn Boehnlein, CFO
Yes. You’re going to force me to divulge all the things we want to tell you in our investor meeting. But I would say, our old mantra of expanding 30 to 50 basis points every year was absolutely doable, and it’s absolutely something that we are planning on getting back to. We’re working through some of these higher costs through the P&L. There’s this ongoing inflation that we will solve for. But I don’t think that as we look forward over the longer term, the margin expansion is something that I think you’ll continue to see out of us. I don’t want to pinpoint a number just yet. But yes, it’s something we’ll continue to have.
Kevin Lobo, CEO
Yes. The one thing I would add, so Glenn wasn’t necessarily referring to ‘24, when you said 30 to 50. We’re on a ramp and on a major focus to get back to that 26.3%. And then thereafter kind of get into a normal rhythm. So, we’ll give you more clarity around that at the Analyst Day in November.
Operator, Operator
We’ll take our next question from Matthew O’Brien with Piper Sandler.
Matthew O’Brien, Analyst
I really don’t want to make too much out of one quarter here. But when I look at the two-year stacked growth rate for you guys versus your biggest competitor in hips and knees, you had been outperforming them massively in the last several quarters. This quarter, it really tightened up the delta between you two, specifically in knees. So I’m just wondering if there’s anything you’re seeing competitively, maybe in cementless or on the robotics side, that you should call out or that we should think about as you go forward, just in terms of being able to significantly outperform the market in hips and knees over the next year or so?
Kevin Lobo, CEO
I’m quite pleased with the double-digit growth in our Knee business. We are starting to see significant progress internationally. Mako is just beginning to gain traction, and that previous strong performance was mainly due to Mako and cementless options. We expect to see similar results outside the United States, and our performance domestically remains robust. While it's only one quarter, I don't want to get overly enthusiastic. We continue to be the fastest-growing company in the Hip and Knee segments. Historically, if one area performed well, the other did not, but this time we’ve seen growth in both hips and knees simultaneously. We haven't noticed any significant changes in competition. Our focus is on executing well with our market-leading robotics and strong product portfolio, especially with the rollout of Insignia, which has been extremely successful. We anticipate continued strong performance ahead.
Matthew O’Brien, Analyst
I appreciate that, Kevin. And then on the pricing side, I know it’s now flipped from kind of a headwind this year to a tailwind. But I’m assuming we’re working through some of those benefits. So, is pricing going to be another tailwind or positive for Stryker into ‘24 and even ‘25 as well as you’ve got these long-term contracts? Thanks.
Glenn Boehnlein, CFO
Yes. I think I’ll make some couple of comments around that without maybe providing exact guidance on 2024. But, if we look at the initiatives that we executed this year, we had a very targeted program that looked kind of product by product. And in general, what we’re seeing is MSNT is generally gaining positive price. And I would say Ortho is less negative and has much larger, longer-term contract negotiations. Keep in mind too that our price comparison that we report on includes sort of same product sales compared to prior year. So, if you think about increases that we gain on prices, say, on next-gen products that we’re going to launch, that’s not necessarily included in the number we say for price. But I would tell you that we generally see meaningful price increases on these next-gen products, especially when we bring newer technology to the market or a feature set that currently isn’t provided. So, I do think that we’ll continue to see price as a tailwind. It’s a muscle that we’ve certainly grown this year, and I think it’s going to be part of our game plan for sure.
Operator, Operator
We’ll take our next question from Ryan Zimmerman with BTIG.
Ryan Zimmerman, Analyst
Congrats on a really nice quarter, guys. I wanted to ask, Kevin, a little bit about the Cerus deal and Neurovascular. It was slower before, but 9% organic growth in the U.S. is really nice to see, especially in hemorrhagic. When we look at what Cerus has done in the UK, it’s been pretty impressive. And so, I’m curious kind of what your expectations are for the contribution in the U.S. and when we start to really see that in numbers, especially if you’re doing 9% U.S. organic growth in Neurovascular.
Kevin Lobo, CEO
Yes. The first thing to note is that Cerus has not yet received approval in the United States, so the 9% growth did not benefit from Cerus. I want to make that clear to everyone; the trials are currently ongoing. We are looking forward to that approval in the U.S. We launched two new products, the Tetra small coil and a 46 size Vecta catheter. These two new products are contributing to our growth in the hemorrhagic segment. The U.S. market has posed some challenges, especially when reflecting on the previous quarters, but we are pleased to see the improvement this quarter. We are very excited about the deal we closed during the quarter, although it has not had a significant impact yet. However, there is a lot of enthusiasm surrounding the product, which we know performs exceptionally well based on its success outside the U.S., and we eagerly await the approval. It will certainly provide a much-needed boost once it is granted in the United States.
Ryan Zimmerman, Analyst
Yes. No question. We saw that at SNIS this week. I wanted to ask a follow-up on robotics. We didn’t hear you say much on your Shoulder and Spine programs. And just given that there is some other commentary out there from competitors about kind of Shoulders and Spine. What’s your latest thinking about potential timing, launch cycles and so forth on Mako shoulder and/or spine.
Kevin Lobo, CEO
Yes. Great. Nothing new to report. We’re kind of on schedule with what we had said before. Spine in the back half of next year and shoulder towards the end of next year. And frankly, we’re not really concerned about competitive activity in this space. We already know Globus and Medtronic have robots in spine. We are really excited about our overall enabling technology starting with Q Guidance. We have an additional product that we’ll be launching and Mako Spine. So, by the end of next year we’ll have a really compelling suite of enabling technology tools for Spine, which we’re really excited about. If someone else is first in shoulder it doesn’t concern me in the least. We have Blueprint already. We already have a very powerful enabling tech platform for shoulder, whether it’s patient matched ID, whether it’s using HoloLens to do the procedure with virtual reality, whether it’s the Blueprint technology, which is amazing. And we’re going to use that amazing Blueprint technology to feed Mako, and that will just be icing on the cake on an upper extremity business that is cooking on gas right now with amazing growth quarter after quarter after quarter.
Operator, Operator
We’ll take our next question from Shagun Singh with RBC.
Shagun Singh, Analyst
I was just wondering if you could refresh us on your capital allocation priorities and M&A just in terms of deal size valuation in areas of interest? And then on the product side, if you could just touch on trauma and what’s driving the strong growth there and the durability? Thank you.
Kevin Lobo, CEO
Yes, of course. As we've mentioned before, our primary focus on capital allocation right now is to reduce our debt, particularly the debt from acquiring Wright Medical and Vocera. This doesn't prevent us from making smaller deals. We completed one small acquisition in instruments and finalized the Cerus deal. We are mainly focusing on tuck-in acquisitions this year. Our deal teams are actively engaged, having discussions, and developing lists, resulting in promising pipelines. As our cash position strengthens, we'll shift to a more aggressive acquisition strategy. Our first use of cash will be in this area. We have a strong history of mergers and acquisitions, and we're eager to resume that activity. However, our top priority remains paying down debt, which we are currently addressing. What’s the second part of your question?
Jason Beach, Vice President of Investor Relations
Trauma.
Kevin Lobo, CEO
Yes. So trauma, I’ll tell you this Wright Medical acquisition has been spectacular. The upper extremities business growing very strong double-digit growth every quarter. Foot and Ankle really starting to pick up. So we’re really excited about the performance this quarter was terrific in Foot and Ankle with strong double-digit growth. And then core trauma has actually been a big beneficiary of Wright Medical. So in the past, our core trauma business was really diluted in its focus. It was focusing on Foot and Ankle, focusing more on extremities because they’re faster growing. And we were sort of not paying as much attention to core trauma. We have a great leadership team on core trauma with now dedicated focused R&D resources. And obviously, they launched Gamma4. We had the T2 Alpha product launch. We’re going to have PeriPRO products launch soon, excited about some other innovations we plan to show at OTA later in the fall. So, really refreshing the portfolio, great focus on core trauma and they had a really excellent quarter as well. So trauma, we expect to continue to be a very high-growth business for a long time to come.
Operator, Operator
We’ll take our next question from Josh Jennings with TD Cowen.
Eric Anderson, Analyst
This is Eric on for Josh. I was curious to hear your thoughts around smart implants. One of your competitors is moving closer to a full launch of a smart implant technology, and I was just curious to hear your updated thoughts there. And if there are any updates to share from your work around OrthoSensor, that would be great to hear as well.
Kevin Lobo, CEO
I think smart implants are intriguing. We have MotionSense, which is a wearable device that measures similar dynamics to those obtained from smart implants. Factors like range of motion are important, but we're still uncertain about how to utilize that data. We're unsure if it will influence patient selection or the methods we use in procedures. For now, I view it as more investigational—we'll be learning as we go. However, I believe it could be significant in the future, so I’m not dismissing it. Regarding OrthoSensor, we've launched MotionSense, a wearable that attaches to both the femur and tibia to monitor mobility and various other metrics. We're going to gain valuable insights about what really matters to measure during the post-surgery period and how that influences patient care, selection, and possibly the types of implants used. There's a lot we don't know yet and many questions to address, but this will provide us with new data to learn from. That's how I’d describe the current situation.
Operator, Operator
We’ll take our next question from Matt Miksic with Barclays.
Matt Miksic, Analyst
I wanted to ask a question regarding Mako based on your comments, and I apologize if this has already been discussed. You mentioned an increase in the mix of rental deals affecting the dollar revenues from Mako this quarter. This trend has been noted by others as well, particularly with more hospitals opting for flexible leasing or pay-as-you-go arrangements for robots. First, how closely is this correlated with growth in Ambulatory Surgery Centers? Second, Kevin, I remember you mentioning previously that different hospitals have varying preferences for payment methods based on their financial situations. Are you now seeing a hybrid approach where hospitals want to scale into Mako with a lease arrangement? I'm curious if this shift is occurring in the market. I also have a follow-up question.
Kevin Lobo, CEO
Yes, certainly. The growth of ASCs is clearly rising, particularly with Mako, and nearly all ASC agreements are financed due to physician ownership being a factor in ASCs. Unlike hospitals, these facilities don't have large capital budgets. As ASC adoption grows, we naturally see more financing and rental agreements emerge because they are predominantly financed. Regarding the hospital dynamic, if competing systems aren't charging, hospitals may hesitate to spend their available capital. They might say, even though they have funds, let's discuss what you're offering. We provide a complete range of services, and some hospitals are choosing financing options that they might have previously bypassed in favor of purchases. Our order book remains strong, and we are not concerned about whether clients want to pay upfront or finance their purchases. Both options provide us with value; whether that value is realized immediately or over time is not an issue for us, and it has certainly contributed to our robust implant growth.
Matt Miksic, Analyst
That's great. Regarding endoscopy in the camera, while it hasn't had much impact yet, this cycle is quite different with the opportunity to test surgical margins around tumors, indicating a new phase for camera and imaging functionality. Do you have any insights, even though it's early, on how this might shape the current product cycle compared to previous experiences? Fluorescence imaging was significant for you in the last launch, and this seems to enhance that. Any details you can share regarding your expectations and early interest in the camera aspect?
Kevin Lobo, CEO
Yes, thank you. It's still a bit early for me to get too ahead of myself, but the advancements in fluorescence imaging were significant, especially with the releases of 1588 and 1688, where the integration of fluorescence eliminated the need to switch between black-and-white and fluorescence views. These were important developments. You're correct that the ability to assess tumor margins and utilize new dyes beyond ICG is very exciting as we expand into lung and bladder applications. This is particularly thrilling with pharmacological agents. Additionally, the camera performs exceptionally well in neuro and sports applications, areas where we haven't historically had as strong a presence. It excelled in general surgery but had its limitations. This camera overcomes those challenges, which truly excites me. However, it is early, and while the test cases have been promising, I would anticipate its performance to at least match our previous launches, and it might even surpass them. The initial feedback has been quite encouraging. We have some excellent features on this front.
Operator, Operator
We’ll take our next question from Joanne Wuensch with Citibank.
Joanne Wuensch, Analyst
I apologize, there’s a lot going on tonight. But your operating margins were really impressive. And I’m curious how we should think about those for the back half of the year? And if you can give a full year guide on it, or even how we should think about this into next year, if you’re willing to waive that far? Thank you.
Glenn Boehnlein, CFO
Yes, Joanne. We have seen a significant improvement in our operating margins, particularly in Q2, thanks to some easing of cost pressures. The spot buys have not been a material factor in either Q1 or Q2. Additionally, with a more stable supply situation, we are experiencing better productivity gains. All of these factors give us confidence that gross margins will improve in the latter half of this year, albeit gradually, as we are still experiencing some inflation. While we won't provide specific guidance at this time, we anticipate some gradual improvement for the remainder of the year, and this trend may carry into next year.
Joanne Wuensch, Analyst
Maybe this is an analyst question at the meeting or the next time you gather all together for an update. But how do you think about in a more normalized post-pandemic environment sort of operating margin expansion on a regular go-forward, maybe even year-over-year basis?
Kevin Lobo, CEO
Yes, Joanne, earlier in the call, I think this question was asked, I’ll just repeat that we are laser-focused on, I would say, trying to sprint back to the 26.3% that we had in 2019. And so we’re going to try to move margins on a more ambitious way to get back to that. And then once we get back to that kind of level, I think you’re going to see us wanting to expand margins in a kind of a more consistent way. I don’t know the exact number, something like 50 bps. We’ll get more specific as time passes. But more like an annual, more moderate, nice progression year after year after year, especially with this kind of high growth that we’re experiencing organically. You’re going to expect to see more normalized margin expansion. But in the meantime, we’re looking to move at a faster clip given the falloff that we’ve had since ‘19 and try to restore those margins.
Operator, Operator
We’ll take our next question from Rick Wise with Stifel.
Rick Wise, Analyst
Kevin, could you provide us with more insight into your strong international performance, which is in double digits and nearly on par with the U.S. performance, though slightly slower than the first quarter? You mentioned the strong emerging markets. How sustainable is this? I have a couple of questions regarding that. You discussed some of your key initiatives; could you share your thoughts on sustainability and the drivers behind this performance? Additionally, where do we stand in terms of procedure volume recovery to normal levels in Europe from a broader perspective? Thank you, and it's great to see such an excellent quarter.
Kevin Lobo, CEO
Thank you. Over the last five years, international growth has outpaced the U.S. growth, although the U.S. growth this quarter was impressive. We are confident about ongoing international growth in the future, as we still have room to improve our market shares compared to the U.S. in many international markets. Procedure volumes have returned to normal in Europe, Australia, and Japan, but we faced challenges in China due to the VBP affecting both our neurovascular and Spine businesses. Despite this, we witnessed strong international growth, particularly with Mako gaining momentum in Asia Pacific. Our presence in Europe is solid, but there is still more progress to be made. For example, we expect to lead in the cameras segment this year, and while our power tools share has increased, we still haven't reached our U.S. or Australian levels. International growth has been consistent over the past five years and we see significant potential in emerging markets, where we are still small but growing well from a modest base.
Operator, Operator
We’ll take our next question from Travis Steed with Bank of America.
Travis Steed, Analyst
Hey, thanks for taking the question. I’ll ask both of mine up upfront. Some of the payers and providers have talked about a slower July. I was just curious if you could kind of frame some of the summer seasonality, if you’re seeing more normal seasonality or how it kind of compares given some of those payer comments? And then a margin question for you, Glenn. Just curious if we should use the second half operating margin this year as kind of a new jumping off point since this is the more normal cost environment in the second half?
Kevin Lobo, CEO
I’m sorry, the sound quality was a bit challenging. I believe you’re inquiring about whether we observed anything unusual in July. Typically, we don’t comment on individual months. However, you can see from our raised guidance that we are anticipating a strong second half of the year. I prefer not to focus on just one month. Occasionally, certain dynamics can occur, but there’s nothing significant to highlight for July. As for your second question regarding margins.
Glenn Boehnlein, CFO
Yes. Travis, can you repeat that in terms of the operating margin question?
Travis Steed, Analyst
Yes, sorry. I’m just curious if the second half of this year is kind of the new jumping off point for margins going forward, just given that this is a more normalized cost environment in the second half?
Glenn Boehnlein, CFO
Yes. No, I would say a couple of things. First of all, Q4 is always seasonally higher. It’s our highest operating margin performing quarter. So, I wouldn’t necessarily say that should be the jumping off. I think if you back up from where our guidance is, you could sort of figure out kind of where we’re angling to end the year at, and that would be the good jumping off point.
Operator, Operator
We’ll take our next question from Danielle Antalffy with UBS.
Unidentified Analyst, Analyst
This is Simon Hagan on behalf of Danielle. Congratulations on a strong quarter. Can you discuss the factors affecting the growth of the ortho market, including pricing, innovation, and the trend towards treating both much younger and much older patients? I have one follow-up question.
Kevin Lobo, CEO
Yes. The trends are consistent with what we have observed in the past. There is a backlog of surgical demand from surgeons, particularly from older patients who are eager to have procedures done. Additionally, there are more active individuals seeking to undergo these procedures. Innovation is key for us, especially with robotics, which continues to perform well, and we are seeing an increase in usage. The percentage of Mako procedures and cementless procedures continues to rise, as does the number of hip surgeries performed using Mako. These are not new trends but rather a continuation of what we have seen before. There isn’t a new dynamic; it’s primarily the pent-up demand from patients who have been waiting to receive care, and they are starting to come in, with this trend expected to continue for some time. Furthermore, with the aging population—around 10,000 people turning 65 every day—demographics are favorable for us, alongside the lasting effects of COVID. At Stryker, we are excited about our portfolio, especially with our Insignia stem addressing the Direct Anterior approach, which has been critical for us and is driving substantial growth in hip procedures.
Unidentified Analyst, Analyst
And just one follow-up, really off of what you were just talking about. Looking at the competitive position in large joints in the United States, how do you expect to continue driving share gains, and where do you see yourself given continued innovation?
Kevin Lobo, CEO
We are very optimistic about our prospects. The demand for Mako remains strong. We believe we have the best system available, and we are thrilled about it. We have addressed our gaps with Insignia in the hip segment, and we offer an impressive 3D-printed hip cup with Trident II. Our cementless product line is well ahead of competitors, and we have outstanding publications featuring excellent five-year cementless data, which will enhance surgeons' confidence in the future. Additionally, our team is exploring other exciting developments, including a hinge product set to launch later this year for revision procedures. We also have plans to introduce revision capabilities for Mako in the near future. We are not resting on our laurels; we are making incremental improvements. Recently, we launched the 2.0 software to enhance user experience and training for residents. We believe we have a strong position, and we will continue to advance our initiatives.
Operator, Operator
We’ll take our next question from Mike Matson with Needham & Company.
Mike Matson, Analyst
I want to ask one about the Q Guidance System in spine. It sounds like it’s doing well. I’m just wondering if you could maybe give us sort of an overview of it. I know you’ve had navigation systems time before. Is this something kind of different, or is it more just the latest version? And then how does it kind of fit in when you do bring Mako into spine?
Kevin Lobo, CEO
What I can tell you is that this has the fastest camera available. It was developed in-house without any third-party involvement. It operates at lightning speed, and this camera will eventually be incorporated into the Mako as well, allowing that model to feature the same excellent camera. The user experience is exceptional, especially when it comes to visualizing and executing procedures. The feedback we've received has been outstanding. We have always excelled in navigation, but this really showcases our capabilities. The user experience with Q will also be applied to the Mako spine, and we are very excited about that connection. Even before the Mako launch, Q is already making a significant impact. We believe that once Mako is launched, it will address a crucial market need for a robotic application. Additionally, we are introducing another product in enabling technology that will be utilized by the Spine group, but it's too early to provide specific details. We will share more information at the right time. Together with Mako, this will create a very strong enabling technology platform for Spine.
Operator, Operator
We’ll take our next question from Richard Newitter with Truist Securities.
Richard Newitter, Analyst
Congrats on the quarter. Kevin, I think a few months back in the first quarter, you were asked a question at an investor conference about what areas could be of interest to you? There’s so much going, right, across your existing businesses. So obviously, M&A, though, is still top of mind. So I’m just curious kind of where are the holes? And where do you think the investment could be most incremental for you?
Kevin Lobo, CEO
That's a great question. I've mentioned the areas we're focusing on before. We see a strong demand for smaller acquisitions. Each of our businesses is identifying their goals and assessing different targets. The immediate priority is to find these smaller acquisitions, as they tend to yield significant financial returns for Stryker. While they may not substantially impact overall growth, they greatly enhance our financial position. Our existing sales force is well-equipped to sell these products effectively. Regarding the adjacent markets we've discussed previously, there haven't been any changes in our interests. Neuromodulation remains a key area for us, which includes spinal cord stimulation, deep brain stimulation, peripheral nerve stimulation, and therapies for sleep apnea. I do believe that electrical treatments will play a major role in the future. Currently, we're somewhat cautious about spinal cord stimulation due to market challenges, so that's a slight shift in my previous comments. However, all the other adjacencies I mentioned in the first quarter are still very much on our radar. As we free up cash, especially moving into next year, if the smaller acquisitions don't require substantial investments and our cash reserves grow along with a better debt situation, we hope to pursue opportunities in one of those areas I previously mentioned.
Richard Newitter, Analyst
Thanks. And then maybe just a follow-up on Spine. It’s one of the few businesses that’s not back in the high single digits or better yet but you obviously have pretty good line of sight to seemingly transformative technologies and product rollouts with Mako, but that’s 1 year, 1.5 years away. So I guess, do we just kind of think of spine as a grind from here higher or stabilization and then look out when ‘25 comes around?
Kevin Lobo, CEO
Yes, I would prefer to describe it as stabilization rather than grind, but it’s likely a bit of both. The Spine market is challenging, that’s for sure. However, with the guidance for the upcoming quarter, we’re feeling optimistic. We’ve made some improvements to our expandable portfolio. There are still a couple of areas we’re looking to address, and we aim to fill those gaps. What really excites us is the enabling technology. We believe that the robotic platform will at least put us on par with our competitors, and the upcoming launch related to instruments, which we’ve presented to some surgeons, will position us ahead in enabling technology. Unfortunately, we still need to wait for that to be ready. The instrument launch is expected to happen before the Mako and will be compatible with our Q Guidance. You’ll likely hear about that sooner than the Mako. For now, we plan to align with market growth and maintain our position until we reach a point where we can begin to grow in a more typical manner for Stryker.
Operator, Operator
Thank you. At this time, I would like to turn the call back over to Kevin Lobo for closing remarks.
Kevin Lobo, CEO
Thank you all for joining our call. We look forward to sharing our Q3 results with you in early November.
Operator, Operator
This does conclude today’s Stryker’s second quarter earnings call. We thank you for your participation. You may disconnect at any time.