史賽克 (SYK) 2015 Q3 法說會逐字稿

Welcome to Stryker's third-quarter 2015 earnings conference call. My name is Anna, and I will be your operator for today's call.

(Operator Instructions)

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.

(technical difficulty) 2015 earnings call. Joining me today are Bill Jellison, our CFO; and Katherine Owen, Vice President of Strategy and Investor Relations. Following my opening comments, Katherine will provide an update on MAKO and Bill will then offer details on our quarterly results, before turning to questions and answers.

Our Q3 results represent the 10th consecutive quarter of delivering a minimum of 5% organic sales growth, which reflects the strength of our diversified model, and our commitment to achieving revenue gains at the high end of med tech. Once again, all three business segments delivered year-over-year sales growth, as continued strong momentum in the US, which represents approximately 70% of our sales, more than offset modest constant currency gains outside the US. This performance was notable, given the tough year-over-year comparisons in MedSurg.

Top line standouts in the US included trauma and extremities and in Neurotechnology, which continue their string of double-digit growth. I am also pleased with our US performance in MAKO, hip, knee, and spine, which are all showing good momentum since the beginning of the year. And despite tough prior-year comparisons, instruments and medical continued to perform well. Katherine will discuss MAKO in more detail, which included another strong quarter of robot sales and FDA approval of the total knee application.

International markets proved more challenging, as softness in China and Latin America offset strong performance in Australia and Europe, the latter, which is benefiting from the launch of our Trans-Atlantic Operating Model at the beginning of this year. Building on our success in Europe with this new structure, we have recently announced changes to our leadership model in other regions of the world. These changes will be effective in 2016, and will drive stronger engagement with the regions and our products divisions. We believe these changes will enable us to accelerate international growth over time, although we do expect the market conditions in emerging markets to remain challenging into 2016.

Turning to the P&L, we drove leverage through improving gross margin, ongoing focus on G&A, and a lower tax rate owing to the establishment of our European regional headquarters. As a result, we have been able to continue to make key investments in R&D and sales and marketing, to help sustain our top line momentum, while ensuring we are achieving our financial targets. Our adjusted EPS for Q3 of $1.25 represents an increase of approximately 9% versus the prior year, which is at the high end of our targeted range of $1.20 to $1.25 a share. With three solid quarters now complete, we are well positioned to meet our full-year sales and revised adjusted earnings guidance. With that, I will now turn the call over to Katherine.

Thanks, Kevin. My comments today will focus on MAKO, with a particular emphasis on our planned rollout of our Triathlon Total Knee on the MAKO robot. Firstly, with respect to the quarter, we sold another record level for Q3 with 17 robots globally in the quarter, bringing the year-to-date total to 41. These robot sales represented a nice mix of existing and competitive accounts, while also reflecting both direct purchases and lease agreements through our Flex Financial Group.

Looking at the Total Knee, recall that we received FDA clearance in August for this key robotic indication, which we believe will drive considerable differentiation in the reconstructive market. Momentum continues to build for the MAKO Total Hip and the [Uni] has gained considerable market share. Beyond these indications, we have a high degree of conviction regarding the opportunity for the robot with the Total Knee, which we anticipate will enable us to drive market share gains following full commercial release.

Against that backdrop, we wanted to provide greater visibility regarding the launch of the Total Knee, as we focus a significant amount of our time and effort on the front end to enable an optimal physician and patient experience. Given the anticipated impact of the Total Knee, we are committed to extensive training with our 1,000-plus sales force, as well as our surgeon partners. We also will look to collect data that will further strengthen the value proposition as we analyze the ability of the robot to positively impact a number of clinical and economic outcomes.

The initial phase of our launch, which will get underway late this year, will target a small group of existing robotic users, who represent the key opinion leaders in the surgeon community. This will help drive a database of outcomes that will allow for a presence at key podium presentations, beginning in 2017. We will also target current non-robotic surgeons who are also KOLs and have extensive experience with our Triathlon Total Knee. By observing outcomes for both groups, we will be able to enhance the training protocols prior to full market launch. A broader market release will get underway in the second half of 2016, setting the stage for full commercialization as we head into 2017.

Note that beyond this critical training and staged release, there is considerable support being provided as we upgrade the existing robots in the field to enable for total knee placement. In sum, we are committed to leveraging our leadership in reconstructive surgery to help ensure that this transformative technology for total knee replacement has an optimal rollout, while setting the stage to collect key data that will further validate its value.

As we have stated previously, our approach to market launch will limit the revenue impact for this indication in 2016. However, we anticipate we will be on a path to demonstrating market share gains in total knees beginning in 2017. With that, I will now turn the call over to Bill.

Thanks, Katherine. Sales growth was 1.3% in the third quarter, including a negative 4.6% impact from foreign translation. Constant currency sales growth was 5.9%, which includes organic growth of 5.3%. EPS on a GAAP basis for the third quarter were $0.79 per share versus $0.16 last year in the third quarter, while adjusted EPS was $1.25 per share for the quarter, versus $1.15 in the third quarter last year.

This quarter's EPS includes negative impacts of roughly $0.06 per share from FX, in line with our guidance. Most foreign exchange rates were again weaker against the dollar than last year in the same period. The weaker euro and Swiss franc, along with our layered hedging program, helped mitigate some of the impact in the quarter, as many of our products are manufactured within Europe, which helped improve our gross margin rate in the period. However, significant currency weakening within the emerging market regions, and general weakness in the Japanese yen, Australian, and Canadian dollar, where we have minimal manufacturing, negatively impacted our gross margins and operating results in those regions.

The most significant non-GAAP adjustments in the quarter relates to a charge of approximately $149 million, associated with the voluntary recalls of Rejuvenate and ABG II. The charges for the Rejuvenate matter may increase or decrease over time as additional facts become available and assumptions more refined. Looking at our sales in the third quarter, our organic growth of 5.3% was comprised of a positive 6.6% from volume and mix, while price negatively impacted sales by 1.3%. Acquisitions added 0.6% while FX had a negative 4.6% impact on sales in the quarter.

Looking at our segments, Orthopaedics represented 42% of our sales in the quarter. Sales of orthopaedic products were up 0.3% as reported, and grew 5.8% constant currency, and increased 5.5% organically. US orthopaedic sales grew 9% in the quarter, despite facing tough comps in all three of our orthopaedic businesses.

Trauma and extremities had another standout quarter, with sales in the US increasing 15%, including foot and ankle organic growth of nearly 20%. US hips continued its strong performance and grew 5.7% in the third quarter, while US knees increased 5%, compared to last year. Internationally, sales were a negative 0.4% in hips in constant currency, and increased 0.2% in knees in constant currency, resulting from tougher macro market issues in China and Brazil.

Next, our MedSurg segment represented approximately 39% of our sales in the quarter. Total MedSurg sales increased 0.6% as reported, with 4.1% in constant currency, and increased 2.8% organically. These results include mid single-digit constant currency growth in our medical and instrument businesses, as we begin to go up against strong double-digit sales growth periods.

Endoscopy grew up by 1.4% in constant currency, as customers await our new camera launch late in the fourth quarter. Our final segment, Neurotechnology and Spine, which represents 19% of our sales in the quarter, increased 5% as reported, and 9.9% organically. Growth in this segment was led by strong double-digit growth in neurovascular and NSE, and CMF increased high single-digit, and spine sales increased low single-digit in the quarter, including mid single-digits in the US.

In looking at our operational performance, gross margins on an adjusted basis in the third quarter of 2015 were 66.9%, compared to 65.7% in the third quarter last year. The increase in the margin rate in the quarter compared to the third quarter of last year, resulted from favorable FX, product mix, and operational efficiencies, partially offset by continued pricing declines.

Research and development expenses were 6.4% of sales in both the third quarter of 2014 and 2015. Selling, general and administrative costs on an adjusted basis were $862 million or 35.6% of sales in the quarter, versus 35.3% in the prior year. The increase was driven in part by our decision to reinvest roughly half of our tax savings, to strengthen our selling and marketing activities, and support our new European regional headquarter. We are confident in our ability to leverage these expenses again in 2016, as we continue to drive a number of key cost initiatives.

Operating margins on an adjusted basis were 24.9% in the third quarter of 2015, compared to 23.9% in the third quarter of 2014. The rate reflects strong gross profit rate, partially offset by the impact of negative price, and our investments to support our European business and sales team. Other expense in the third quarter was approximately $33 million, which includes higher net interest expense and FX transaction losses in the period.

Our reported tax rate for the third quarter was 12.8%, while our adjusted effective tax rate was 16.4%. This compares to a 19.9% adjusted effective tax rate in the third quarter last year. The tax rate this quarter brings our adjusted rate to 17.5% on a year-to-date basis. We still expect the extenders to be approved late in the fourth quarter; however, if not approved, it would negatively impact our full-year per-share earnings guidance by $0.03 to $0.04 per share.

Looking at the balance sheet, we ended the quarter with $3.4 billion of cash and marketable securities, approximately 30% of it held in the US. We also had $3.5 billion of debt on the balance sheet at the end of the quarter. From an asset management standpoint, accounts receivable days ended the third quarter at 56, consistent with last year's third quarter, and days in inventory finished the quarter at 187 days, slightly higher than the 182 days in the third quarter of last year.

Turning to cash flow, our cash from operations in the first nine months of 2015 were $228 million, compared to $1.1 billion last year in the first nine months. Capital expenditures were $191 million in the first nine months of 2015, compared to $172 million in the same period last year. As mentioned last quarter, we did make significant payments this year associated with our Rejuvenate settlement of $1.2 billion, most of which occurred in the third quarter. Approximately 50% of the funding for the Rejuvenate liability is being sourced from the O-US cash.

Also, as we have previously mentioned, we have repatriated approximately $700 million in the first nine months of the year, and expect to repatriate nearly $1 billion more late in the year. We still have approximately $2 billion available for share repurchases under our expanded authorization, as approximately $446 million of share repurchases were made in the first nine months. We continue to evaluate the level and frequency of our share repurchases; however, current plans are to fully utilize the current authorization over the next two to three years.

Our strong third-quarter results give us additional confidence in our ability to deliver improved operating results for the year. Our sales guidance continues to be constant currency growth of 6.5% to 7.5%, with organic sales growth in the range of 5.5% to 6.5%. If foreign currency exchange rates hold near current levels, we expect net sales for the full year of 2015 to be negatively impacted by approximately 4%. Pricing pressure will continue, and prices are currently expected to be down 1.5% to 2% for the Company moving forward, relatively consistent with the pricing environment we have experienced over the last year.

We expect that our adjusted tax rate for all of 2015 and in 2016 will be in the 17% to 18% range. Also, keep in mind that the potential benefit from the renewal of the tax extenders continues to be in our year-end guidance, and represents approximately $0.03 to $0.04 per share for the year. Based on current FX rates, we still expect 2015 to be negatively impacted by approximately $0.25 per share for the year, and again, keep in mind that the full-year negative impact of foreign exchange rate movements is largely driven by the translational component of FX, which we do not hedge.

And finally, we are narrowing our earnings guidance for 2015 to $5.07 to $5.12. Thanks again for your support, and we'd be glad to answer any questions that you may have at this time.

(Operator Instructions)

The first question comes from Kristen Stewart from Deutsche Bank. Please go ahead.

Hey, thanks for taking the question. Just wondering if you could comment a little bit more on the orthopaedic trends that you're seeing in the United States. It was a very good quarter across the board for the business, and particularly within the hip and knee franchise. Wondering if you're seeing early benefits just from MAKO and just being out there and talking through having the system, or if you're seeing any acceleration in the market or just some disruption from some competitors that are out there? Thanks.

Thanks, Kristen. This is Kevin. Look, we're very pleased with the quarter, both in hips, knees, as well as MAKO. I would say that the team has done a terrific job on driving organic growth within hips and knees. Hips you've seen for the last three years, we've been driving terrific performance. We're very pleased with the knee momentum that we're seeing.

I think we got a bit of a shot in the arm with the launch of our cones, our 3D cones for revisions, but it's been momentum building throughout the year. It's just really strong leadership, strong execution. The robot sales, of course, help. I wouldn't say that we've seen much in the way of disruption. So this is really more just driving organic growth, and really building throughout the course of the year.

Okay. Great. And then just in terms of the comments for outside the United States, with some disruption within China and Latin America, any level of visibility in terms of when that would turn around, or I guess, just for now, just expect that to continue into 2016, if that's the take-away?

In my opening remarks I mentioned into 2016. I don't have a crystal ball, so it's really difficult to predict when the macro conditions will improve. We referred to capital equipment being particularly tough last quarter. We did see that spill over into implants, with distributors starting to lower their inventory levels, and we really don't have great visibility into how long it will last. I think it will certainly continue through the fourth quarter and into 2016, but it's something we're going to have to update you on, as each quarter unfolds.

Europe is turning around with the help of the Trans-Atlantic Model?

Europe had a terrific quarter, a really excellent -- we're in the sort of mid single digit growth in Europe, and overall, you know Europe GDP is not growing at that rate, so we are very pleased with our performance in Europe, and expect that to continue.

Our next question comes from David Lewis from Morgan Stanley. Please go ahead.

Kevin, I wanted to come back to SG&A for a second here. I think incrementally across the year I thought the Company has talked about more material opportunities for SG&A reduction. Can you give us a sense of what that opportunity is, perhaps the size of the opportunity, when we could hear more about it? And a related question for Bill. What's a reasonable level of leverage we can expect going forward here at this level of sales. I think last quarter you told us maybe 40 basis points. What's an appropriate level as we think about 2016? And I had a quick follow-up for Katherine.

Okay. All three of us. I'll start. David, we've been working all year on plans around SG&A. We've taken a number of measures already, and we're working on evaluating some more significant measures. We still have significant scope for improvement in SG&A. We've talked before about the fact that we have very little in the way of shared services, we have many IT systems across our disparate organization, so there are significant opportunities.

I'm not yet ready to quantify that, and discuss that with you. Once we reach that stage, we will definitely tell you. We'll be very thoughtful, as we were with GQO. We gave you a five year road map with the amount of savings planned over that five year period. You should expect to hear something like that related to SG&A, but we're just not ready yet, and I don't want to speculate on exactly when we'll be ready to communicate, but work is ongoing, and it will be something you will hear in the not too distant future.

Just as a general comment associated with the leverage expectations, pretty consistent with what we were talking about before. So if you're seeing this mid single digit sales growth, we believe we can grow our broad-based operating margins, in the 20 to 40 basis points, 30 to 40 basis points range on an average basis, over a three or four year period of time. I think that's pretty consistent with our expectations, and if you look at where that should come from, price is a key factor. So as we mentioned in the past, as price is still up close to around the 2% range, we'd expect very little improvement at the gross margin level, and most of that would really be taking place through the SG&A-related leverage.

If price is 1.5% or less, which we don't expect, we expect it to be in the 1.5% to 2% range, but if it was less than that, we would expect to be able to drop some through at the gross margin level. Obviously if the price went above 2%, then we think that could cause some detrimentation to the overall gross margin rate, but the operating margin rate would till be able to provide some level of leverage. Next year on the SG&A side of the equation, as we talked about before, this year, we had heavy investments for both the RHQ structure to support our tax and some of our new sales and marketing-related efforts with the TOM model, but we do expect to get good leverage out of the SG&A category next year to be able to deliver on those results.

Okay. Great.

Our next question comes from Bob Hopkins from Bank of America. Please go ahead.

First question, Kevin, I just wanted to follow up on the emerging markets. Interesting that you see it spill off into implants. I know you don't have a lot of visibility, but what's your best estimate right now from what you're hearing from the field in terms of why is this happening. Is it simply just the economies over there, or just any other color would be appreciated.

Yes, I mean, what we're seeing is certainly in Brazil, it's a market slowdown, complete slowdown in the market, and that's obviously the biggest country we have in Latin America, and so it's both capital equipment as well as implants. In China, we saw capital equipment slowing down earlier in the year. This quarter, we saw implants starting to slow down.

It really, as far as we can tell, is related to macro concerns, and the distributors are just nervous. They're worried about their cash flow, and so it's not something that I think will continue indefinitely, but it's something that we saw, certainly in certain parts of our business, you see it in spine and trauma more acutely than we saw it in hips and knees. It was pretty broad based and something we'll continue to monitor, but I don't have great visibility, honestly, into how long it will last.

Okay. And then the second question, Kevin, I'd love for you to comment on capital allocation. We haven't seen a lot of deals from you. Just talk about the environment there. And then also, if you don't mind, just talk about your confidence as you look at your business going forward into next year, confidence in being able to continue to grow the top line in that 5% to 6% area? Thank you.

Thanks, Bob. First of all, I'll start with the second part of your question. I feel very good without the health of our business overall, with the one exception of the emerging markets, which I think will continue to be difficult. If I look at just across our businesses, the management teams we have in place, our ability to execute. We've had 10 quarters in a row of at least 5%, and I do believe it's sustainable. Like every year, in 2016, we're going to have our share of tailwinds and headwinds, and we'll give our guidance in January, as you know. But I feel very good about our execution, our management teams, and our ability to deliver -- consistently deliver strong sales growth.

Now, related to -- what's the first part of the question on capital allocation. I would tell you know that all of our divisions have BD people that are out looking at targets. I would say there are plenty of targets that are out there. We haven't closed very many deals, at least not as many this year as we have in the past couple of years, but that's not a function of lack of targets. It's just making sure that the valuations work, and that the deals are going to be value-creating for Stryker. As you know, M&A is difficult to predict in terms of timing, but we do feel that there are a significant number of attractive targets out there and our teams continue to work on that, and that does continue to be our first priority in terms of using cash.

Our next question is from Mike Weinstein from JPMorgan. Please go ahead.

I just want to follow up some of the questions that have already been asked. So first question would be, can you peel the onion a little bit more on the O-US performance? You've talked about Brazil really slowing down, and Europe you said was still mid single digits.

Do you have any geographic breakdown, whether it's in developed world versus emerging markets, or Europe versus Latin America versus Asia? Any other insight you could give us to the -- because the US looks great this quarter, obviously with the new business. International barely grew. Some more color there would be great.

And then the second point of follow-up, you talked about the 20 to 40 basis points of expected annual margin expansion. I just want to be clear. Is that what our expectation should be for 2016, or do you think you can do better than that next year based on what you're working on? Thanks.

Hey, Mike, it's Katherine. I'll take the first part of the question. International really was very much driven in terms of the headwinds we were facing by China and Brazil, and it was really an extension of some of the trends that we saw in the second quarter. With China, it was capital has been challenged there, given that's government self-pay, but with some of the pull-back we have seen, that impacted the implant business as well. And then in Brazil with the country in a recession, that has impacted that business.

So really outside the US, it's very much China and Brazil that are pulling down the numbers. Europe with the Trans-Atlantic Operating Model, we're really seeing very good momentum. I think Kevin cited the mid-single digit growth we're seeing there, and stronger performance in other geographies, like Japan and Australia. So really, I would say it's very much isolated to the emerging markets of China and Brazil. Bill, do you want to?

Sure. On the operating margin side of the equation as I mentioned, before we are generally comfortable with kind of that 20 to 40 basis point improvement moving forward. We think our businesses are structured in a good way to deliver that. A key part of that is based on price, and also based on our top line sales growth.

Kevin mentioned or alluded to at least being comfortable with something in the same type of sales growth range, even for next year. If we deliver in that type of a range, we would still expect to get reasonable operating margin leverage off of that. We have not given any guidance obviously for 2016. We'll have to take a look at kind of where FX is as well as the markets are at that point in time, and we'll give better guidance with our next call.

Okay. Bill, just one follow-up to that. Just on FX, do you have a sense at this point, assuming no change in rates what the FX spillover would be to the bottom line next year, what incremental headwind you'd have in 2016 to earnings versus 2015?

I'd say that right now, based on where current rates are at, we would only expect maybe somewhere in the $0.05 range of a negative impact for next year. But again, depends on where rates change over the next quarter on what we would look at and when we give our guidance, but that's probably a reasonable range at this point.

Our next question is from Rick Wise from Stifel. Please go ahead.

Back to MAKO, Katherine, you talked about opening current and new accounts. You came in a couple of systems better than I was looking for. Just in talking about the new accounts, it's early, I know, but can you give us a little perspective? Are these new accounts impacting share? Are you seeing pull-through?

How, when do we start to see that? And I assume that MAKO should have another good fourth quarter. I assume you expect fourth quarters to be typically normally seasonally strong.

With all of our capital businesses, the fourth quarter tends to be the strongest quarter, and MAKO would be no exception on that matter, so we would expect a solid fourth quarter. I think it's just too early. Clearly, the knee indication has sparked a lot of interest in the clinical community, and there's a lot of excitement around it, but I think at this point, how early we are in starting to roll out and the fact that we're in really the training stages and not being in full commercial release until late next year, it's just too early to say. I think what you're seeing on the organic hip and knee performance in the US is a lot of good execution, certainly bolstered by MAKO. But MAKO isn't having the impact, for example, on our knee or hip momentum, that we would expect to see, particularly with the former, as we head into 2017.

And Kevin, maybe my second one for you. Can you talk a little bit more, give us a little more color on some of your comments today? You talked about some of the O-US leadership changes, and some of the -- can you maybe give us a little more detail about some of the specific changes you're making, some of the specific marching orders you're giving your team? Where you've done these things, I think they've had an impact. What are you looking for, and what results should we expect over the next year or so?

So what we've done, and we announced during the quarter, that we are phasing out the role of the Group President of International. So that's a role that Stryker's had for a long time, and we're eliminating that position. As a result, the other regions are going to report directly into our businesses. It's a big change for Stryker. It's going to enable us to be much more closely connected, to have the regions very, very closely connected to our product divisions.

That's what we saw as the key benefit with Europe. I could tell you that the movement in Europe is ahead of our expectations, and so this is a natural evolution of this Trans-Atlantic Model. We knew that we wanted to get Europe done first. We had the biggest opportunity for share gains are in Europe. That did accompany some investment. We don't necessarily feel that we need to make the same degree of investments in other countries, but we saw the benefit of that region to product connection, and we know that will also drive value in other markets of the world.

And our next question is from Matt Taylor from Barclays. Please go ahead.

This is actually Young Li in for Matt. Thanks for taking our questions. I guess, regarding MAKO, a strong system number this quarter. Just wondering what's the breakdown between purchased system, versus financing?

We don't break out the mix, although I would say it's still dominated by purchases, but there's a decent component of leases as well, and that's really aided by our Flex Financial Group that's been around for a number of years now, and exists throughout all our capital businesses within MedSurg as well as Ortho.

Okay. Great. Thanks. On foot and ankle, the growth is strong, nearly 20%. Is that largely market growth, or are you starting to take some share?

I would say that the market continues to be a very attractive segment. We're doing well in the market. We're very pleased with the SBI acquisition we did a year ago, which rounded our portfolio. But you've seen over the past three years, we've been experiencing great growth. I would say it's primarily market driven, but in some cases, we are taking market share. But I would first look at the market as being the major driver.

All right. Great. Thank you.

Our next question is from Matt Miksic from UBS.

A couple follow-ups on some of the topics that folks have hit on already. One, MAKO, you talked about the uptake in hip and Unis. Maybe Katherine, or if you could talk a little bit about what kind of traction maybe, any color you can give on the traction you're seeing with hips? And then I have one follow-up.

I would say just reflected as we continue to place more robots sequentially, you're seeing the impact it's having with our very large sales force out there articulating the benefits of using a hip in both robotics. They've already established a lot of credibility and market share in Uni, so the gains there are less significant. In hips, having our sales force well into the integration now, being able to articulate the benefits, has really helped drive that adoption.

Any impact of new software or new applications? I know you're probably on version 2 or 3 or 4 now, in terms of the system. Anything there that's starting to make things a little easier for folks, or any color?

I think any time we do any improvement, it certainly helps. I think the biggest factor is having our considerable sales force, obviously much, much larger in size out there, aligned and coordinated with their MAKO counterparts going into hospitals. And those are both our own customers as well as competitive accounts, and being able to place a robot and drive the adoption. Obviously with Uni and hips, and then as we go forward, the economic value proposition only improves as you start to layer in the knee.

Got it. And then on spine, appreciate the Q&A and access last week, and going through some of the new products. Business is still obviously, not I wouldn't assume where you want it, in terms of growth perspective. What can we look for there, in terms of catalysts to get that moving? Is it launches? Is it sales force? Is it strategic activity? Any color would be helpful.

We're really pleased with the momentum that we're seeing in the spine business, and that really is several years of increased investment in R&D. We have a terrific R&D leader in there, who I think you saw last week at NASS. We've launched something like 10 new products in the last six months. That's more than we've launched in the last two years collectively, and we have a nice pipeline of new products slated to be launched as we're going forward.

We're going to focus on R&D, driving innovation and optimizing the sales force, and that's all the things that the current leadership is executing on. That will be the focus. There's no magic bullet here. But we're going to continue to look at that, and clearly pleased with the impact some of those products are having.

Certainly you've seen the numbers in the US pick up, and we're encouraged about the US. We have work to do outside the United States. A lot of those products have not yet been registered. We haven't launched many products, including the CoAlign acquisition, which has given us a shot in the arm in US. We're just working through all the manufacturing transition into Stryker.

The product tail does lag a little bit outside the US. We have work to do there. Certainly, O-US is also impacted by the slowdown, both in China and Brazil. So not pleased with the O-US results, but very pleased with the momentum in the US. As we launch those products outside the US, I would expect the O-US business to pick up.

Our next question comes from Joanne Wuensch from BMO Capital Markets.

I have two questions. The first one has to do with cross-selling amongst your portfolio, and what you're seeing in terms of being able to leverage your orthopaedic, as well as the other areas. And then the second question has to do more broadly with any changes at the CMS level for the pilot program for bundled payment, what you think that may or may not impact your business? Thank you.

I'll take the first question. I would say cross-selling is something that we do, wherever we believe that the customer is interested in dealing across our businesses. So the area that we tend to see this the most is in Neurotechnology, where our customers will express an interest for a Neurotechnology offer, and then our divisions will then work together collectively.

It's generally in response to a customer request. It's not something that we do proactively, and that we're pushing from the center. It's really in response to customer needs. But our divisions work extremely well together. Katherine cited an example of Flex Financial which is a unit that sits inside of our MedSurg group that helps MAKO sell robots within our orthopaedic group. So collaboration does work very, very well at Stryker, but it's something that tends to be very based on customer needs, and not pushed from the center.

And then Joanne with respect to your second question, I would say that this is really not new to the industry, you're really more moving over the next few years within Medicare to a mandatory. What you tend to see in a situation is a much bigger focus on the post-acute care, particularly patients that are discharged to rehab, because the dollars there and the opportunities for cost savings are much, much greater, than any of the other areas.

So what we've seen is they tend to focus there is significant disparity around the US in terms of what patients are sent home versus those that go directly to rehab, and we do expect that trend to continue. Doesn't mean pricing pressure isn't going to go away. We just don't believe that's going to be a trigger to change dramatically the pricing backdrop within implants.

Our next question is from Glenn Navarro from RBC Capital Markets.

I had two follow-up questions on spine. Kevin, the US spine number came in better than we thought, and I'm just curious, is that a function of a stronger spine market in the US? In other words, better unit growth, less payer pushback and pricing pressure, or is this market share gains, given your new product rollouts? And then as a follow-up, in the past, Kevin, you've talked about wanting to grow spine organically and inorganically. Given the strength of the current pipeline, should we start to assume that internal development is the way you're going to go, versus M&A? Thanks.

So the first thing I'd say is the spine market's been a pretty stable market over the last couple of years, and so, I don't believe the market is suddenly improving magically. I would say the last two quarters, we've been very pleased with our performance in the US, and we believe that's because of the new products that we're launching, and that we're growing faster than the market. Of course, not everybody has reported yet, so we won't have a full picture on our share gains in this quarter, until everyone else reports.

Related to the organic versus inorganic, we're very pleased with growing our business organically. That's always the best way to drive value in our businesses. And as it relates to inorganic, all of our divisions are constantly looking for acquisitions. I certainly don't feel compelled to do a deal, because you can see we're posting nice growth with our organic performance, but we're always on the lookout for acquisitions, but that's not unique to spine. That applies to all of our divisions.

Okay. Thank you.

Our next question is from Raj Denhoy from Jefferies. Please go ahead.

Wonder if I could ask a bit about MAKO, and you laid out your plans over the next couple of years in terms of collecting data before you go broader with that, with the technology. I'm curious, as you start to think about the data, and where you think the opportunities are to present the compelling case to hospitals to adopt it, is it primarily going to be focused on efficiencies and hospitals running their practices more efficiently, or will it be focused on patient satisfaction, or perhaps both? Anything you can give us on that would be helpful.

Sure, Raj. I think as you think about what we said in terms of the early launch, what they're really looking at observational outcomes, with both existing robotic and non-robotic users, but really focusing on the key opinion leaders who really have a presence at the podium. And we're going to be evaluating everything from implant positioning, adverse events, ligament releases, patient satisfaction. That's going to be a lot of the initial focus. Absolutely over time we'll be developing I'm sure, more robust clinical evaluations or trials. Right now, that's going to be the focus initially.

Less on the cost side it sounds like initially, in terms of hospitals being able to do orthopaedics more efficiently or cheaper?

I think that's something that will come over time as surgeons move up the learning curve and gain greater experience, but given the very limited launch early on as we look to optimize the training protocol, that won't be the focus.

Our next question is from David Roman from Goldman Sachs. Please go ahead.

I wanted to start with a strategic question. Kevin, this does relate to your comments around emerging markets. I think if we look back a few years, those regions represented a significant priority for you, as some of the US businesses were a little bit more sluggish. Maybe in the context of what you're seeing today, could you maybe help us understand where you're prioritizing your investments? As you think about those investments, where should we expect to see the greatest return within your business?

Sure. Right now, emerging markets represent about 8% of Stryker sales. That's clearly below med tech. It's not a bad time to be less exposed to emerging markets. But that doesn't mean we aren't committed for the long term. Our India business is doing well. China will be an important market for the future, so we're certainly not going to -- we're not going to invest at the same rate that we've invested for the last couple years while we weather the current storm, but we are in it for the long term and we do plan to grow in emerging markets.

It's just, we had planned previously to be a little bit more aggressive in areas like Russia and Turkey. That's clearly not a good use of our investment right now, so we'll sort of hit the pause button in those countries. As the market conditions improve, we'll dial up the investments. Very pleased with the investments we have made in Europe. Those are driving terrific returns.

As an overall Company we do want to grow our business outside the United States. Our strong US business continues to perform very well, and we do plan to grow outside the US, and that's why the operating model changes are extending even beyond Europe to include the other countries of the world, because I think that direct connection to our product divisions will drive growth everywhere else outside the United States. And Europe is very instructive. What we've seen in Europe, we know we can replicate in other countries.

Okay. Maybe just a follow-up for maybe a combination of a macro and micro question. As you look at some of the businesses in which you operate, whether it's some of the MedSurg business or procedure volume exposed areas, we have seen a nice pick-up in growth. And while clearly, you have some new product momentum in those areas, how much do you think, of the growth we're seeing, is a catch-up of prior periods of some headwinds versus what might be entering a new normal steady state growth rate for some of those franchises?

I'm not sure what catch-up you're referring to, because if you look at the last year's third quarter, we had knee growth of 6.8%, hip growth of 18.1%, trauma of 15.3%. So we're posting strong growth this quarter on the backs of pretty strong growth in the prior year. So for 10 quarters, consecutive quarters of over 5% organic growth, it's not like we're catching the tail of periods of slow growth. We're posting consistent, steady strong growth.

Now, from quarter to quarter there's some variation between businesses, but overall, this is a very steady growth story that you're seeing at Stryker. I'm not sure I understand the question, or if it was a specific business you're referring to. Because on an overall basis, we're posting growth on top of prior growth quarters that were pretty strong.

Our next question is from Matt Keeler from Credit Suisse. Please go ahead.

Thanks for taking the questions. First, can you help us think about the MAKO Total Knee opportunity? You talked about MAKO's success in Uni and the share gains, I think 17% over four years. Once the Total Knee is launched, starting in 2017, do you see the potential for a similar magnitude of share ramp going forward from there?

We haven't quantified the targeted gains. We have been very clear that we do expect, once it's in full commercial release, to begin to get on a trajectory to gain meaningful market share, and we would expect to be on that trajectory in 2017. I wouldn't be assuming quite that level of share gains but we also want to get some experience under our belt. This is brand-new to the industry, but we're really excited about the impact it will have in terms of driving share gain in 2017. I think as we get closer to that time frame and we think about setting our targets for 2017, we'll be able to have a better sense of what that could possibly mean.

Great, thanks, and I'll stick with MAKO. As you invest in training next year, as we get the launch underway, do you expect that to be a drag at all on margins, ahead of when you're fully launched in 2017?

No, I think you should just assume that will be contemplated within our normal spend.

And our next question is from Larry Biegelsen from Wells Fargo. Please go ahead.

Two from me. One on MedSurg, one on neurovascular. Starting with MedSurg, the growth has slowed a little bit this year. I know you talked about a new camera, I think in Q4, in endoscopy. Could you talk about how long it will take to kind of reaccelerate the growth across MedSurg, and some of the other new product cycles we should be thinking about? And I had one follow-up. Thanks.

The first thing I'd say about our MedSurg businesses is they had an absolutely huge quarter in the third quarter of last year, if you look back at the numbers that we posted, close to 20% growth in a number of those businesses, so very tough comps. We're very pleased with our medical division, and expect them to continue to perform very well. Endoscopy, certainly, we've had a few challenges related to the vertical integration. That's starting to pick up steam, and I'm feeling very optimistic about that. That camera launch is sort of the end of the 1488 camera cycle, we're moving to the 1588 platform that we launched towards the end of this year, and certainly, there was a little bit of a delay in orders as people are anticipating that launch.

The one product area that is later in its cycle is our System 7 power tools within instruments. If you look at the instruments numbers, they continue to post pretty strong results throughout the rest of their portfolio. But that's one area, as you look into 2016, where you can anticipate maybe a little bit of a moderating of growth, as it gets toward the latter part of their cycle. They have another range of products that they can sell, and they're performing very well. I would tell you I'm very pleased with our MedSurg performance. I know the absolute growth in this quarter looks a little smaller, but again, on the back of an outstanding third quarter of last year, it's not like our business is slowing down, or that we're losing momentum or losing share. I feel like we have very, very solid businesses that will continue to perform well.

Thanks, Kevin. And then on neurotech and neurovascular, the growth's obviously been very strong recently. Can you help tease out how much of that growth is from Trevo benefiting from the new stroke data versus your coils and flow diverters also growing, and any update just on how the stroke market is evolving, since all the new positive data earlier this year? Thanks.

I would start by saying when you look at our portfolio, it does address both hemorrhagic and ischemic, but the majority of the revenue is still driven on the hemorrhagic side, which is going to be the coils and related accessories where we're seeing growth. Ischemic growth is certainly outpacing that, but it's a much smaller market at this point in time. And it's certainly benefiting from data, whether it's the MR CLEAN study that showed using stent retrievers, including the majority of the retrievers used in that device was our own, absolutely have a benefit on patients, and this was further enhanced with the AHA guidelines that came out earlier in the year. That data is really underscoring the benefits of these devices. They're the only devices that have clinical data supporting their use in ischemic patients. Growth there is much faster, but obviously off a much smaller base.

Our next question is from Matt O'Brien from Piper Jaffray. Please go ahead.

This is JP in for Matt. I had one on just the competitive landscape that you're seeing in maybe hips and knees, especially with new entrants into the market, and maybe other large integrations with Zimmer Biomet there, if you're seeing any displacements or distractions?

There really haven't been any new entrants into the hip and knee market. The competitive backdrop has been very stable. I think as we think about the merger between Biomet and Zimmer, they're obviously a considerable player in the market. We haven't seen them report Q3 results, so like you, we're at a disadvantage. We feel very pleased with the momentum we're seeing in the business.

We have said it's usually a few quarters in before you really get a sense if any dissynergies are tracking above or below what they anticipate, but we're really focused on our business, we've got a great portfolio of products. Obviously the MAKO and the new indication we see as a huge benefit. We'll see what happens to them, but really the focus right now is gaining traction with our own customers and using MAKO to get into some competitive accounts.

Great. And if I could just ask one on MAKO. If you think about the pipeline of new indications that you're looking at in your R&D, what's next? Should we think about maybe a shoulder, or maybe moving into spine? Just trying to see what you have there.

I would say when you think about it, right now, essentially all of our focus is on the recon market. I can't underscore enough the amount of time and energy that's being put into the Total Knee launch to make sure it is executed as close to flawlessly as possible. We do think that is the biggest indication, and can have considerable impact on the market. I think there will be downstream applications in other areas of joints, whether it's in the shoulder or in the spine, but that is multi years away from where our focus is right now.

And our next question is from Ben Andrew from William Blair. Please go ahead.

Maybe just talk a little about the foot and ankle business. It was up 20% or so in the quarter. How much of that is sustainable over time, given what the current competitive dynamic is, versus maybe the underlying market growth?

New markets are often difficult to predict. So when we created our foot and ankle business unit a few years ago, I really didn't expect that the market would be this big, and that the growth would be this high. So it's been a fantastic business unit for us, performing extremely well, mostly with organic growth. We had obviously the SBI acquisition as well.

The market still seems to be very hot. There's still a lot of surgeons that are increasing their volumes, and more and more surgeons getting trained. So we do believe that this will be a high growth market for the foreseeable future. Whether it stays up at the 20% or starts to moderate, I'm not sure. We're not really concerned about competitive dynamics. We have a great product portfolio, very strong sales force execution. When you're riding market growth, and you've got the products and the sales force, it's a good place to be.

Thank you.

Our next question is from Richard Newitter from Leerink Partners. Please go ahead.

Just two quick ones. Maybe the first one on MAKO, Katherine, I guess. Can you characterize the types of accounts that are purchasing the system right now? Is it possible to do so? Any types of -- certain types of characteristics, academic centers, community hospitals. Also, what percentage of your installed base or new systems over the last few quarters are going to multi-system accounts?

The latter, very small, and it really covers the entire range. We're seeing all sorts of customers out there. I wouldn't be able to characterize it as one specific type of hospitals. We have some hospitals with one robot, some with multi. We have some that were existing customers, some that are competitive customers, some that are buying the robot, some that are leasing the robot. It really is the full range. There's not one specific characteristic that I would point to.

Okay. Thanks. And then Kevin, just going back to M&A, obviously, there's been quite a bit of turmoil in healthcare equity markets. Valuations look like they've been pulling back. To the extent that -- were evaluations in any way potentially something that was slowing down the process for you as you looked around, and does this recent pullback make things more attractive from your seat?

M&A, the timing of M&A is always difficult to predict, and valuations is one factor. It's not always the only factor. We also have issues sometimes around quality, and remediation that's required. Sometimes it's cultural fit. There's always a range of issues that we go through, when we're looking at a target, and as we get under the covers and do due diligence, then we figure out whether we really want to move forward or not.

Valuation clearly is always one of the factors, but I wouldn't say suddenly, just because we have a temporary market pullback that the companies are ready to sell to us at a much lower price. So I think it will take a little time for that to settle in. But clearly, valuations is one of the factors that we look at, and one of the reasons that we won't move forward. It's not the only reason.

And our next question is from Josh Jennings from Cowen & Company. Please go ahead.

I just wanted to -- one question on MAKO first. Can you just talk about the robotic competitive landscape that you're seeing from direct competition, OMNI or Blue Belt and how you see that evolving now with the Total Knee application approved?

Yes, so I tell you that we're not focused at all on the competition. We really don't see Blue Belt as a fully robotic solution. It's really, in our view, it's an enhanced navigation system. It doesn't have the type of features that our system has. We really believe we're alone in the purely true robotic space, and that we have a long runway ahead of us, and we're really not concerned with competition.

Great. Just a follow-up for Bill. You had some discussion about opportunities for operating margin expansion. Any chance you can give us some more details on where you see those opportunities in the different business units? Are there more opportunity in recon versus neuro technology versus MedSurg, any further detail would be great. Thanks a lot.

Sure. So I mean one, we don't break that down externally at all. But I mean, you should expect that any of our businesses that are seeing mid digit plus organic level growth, we would expect to get reasonably good operating margin improvements on that over time.

Based on the market growth dynamics in different geographies and/or in aggregate for a business, if the growth rates are down in the lower single digit range, you probably shouldn't expect really any operating margin improvements. As that goes up, though, we should definitely get operating margin leverage in almost any of our businesses. And I think that in general, that's what we're driving to achieve over a two, three year period of time on average.

And our next question is from William Plovanic from Canaccord Genuity.

Two brief questions. One on MAKO, how long will the cost or time associated with updating those two accommodate the total knee into your current number systems out in the field? Second question for Bill. Just on the gross margin, that was a huge increase, and I know you gave us the reasons, FX, mix, and efficiencies, offset by price. But I was wondering if you could quantify those. And then how much of that, like are we at a new level, we're going to be 50 BPs, 100 BPs higher going forward, or will we drop back down to where we were in the first half of this year and this was a one quarter gain just because we had the big US quarter? Thank you.

Bill, just I want to make sure I'm understanding the question. You're saying how long it takes to physically upgrade an existing account to the new indication, to the new robot, the software and the related hardware components?

Really, just how long will it take for you to update all the units in the field. Is that through 2016, you'll be done by the end of the year?

I would say, at the end of 2016, we feel like we'll be in the very good position to go into a full commercial launch, and we won't be limited by the need to upgrade existing customers. You're always bringing on new customers, but that's part of the reason to have a very measured controlled rollout, is to make sure we're in a position really to put the pedal down, and when we go into full commercial launch.

As far as the gross margin rate question is concerned, so yes, it was a very good quarter. As I mentioned really in the early part of this year, both in the first and second quarter, we talked that our gross margin rates were going to improve as we moved into the third and even into the fourth quarter of this year. Our expectation from a breakdown of some of the categories. So two of the biggest impacts in this quarter are FX and mix, and maybe a little bit on the pricing, since pricing was only 1.3% for us.

But FX and mix were probably, if you look at the total improvement, they're probably each in the 50 basis point plus range, as far as the impacts that they have. Keep in mind that a lot of our products are manufactured in Europe. As the European or the euro currencies have been declining this year, and the US has stayed strong, we've actually continued to get improved gross margin rates from FX, despite the fact that FX on the bottom line at the EPS level has actually been negative for us.

And then same thing on the mix side. I think that you should expect both of those to continue as we move into the fourth quarter, and then you should look more from an anniversary perspective that the improvements that we'd expect next year would be relatively modest at the gross margin level, but we'll get into that as we announce our overall expectations for the year. Generally, if price is at the upper end or in the 1.7%, 1.8%, to 2% range, we'd expect our gross margins to be relatively flat in that kind of an environment.

And 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. Our conference call for the fourth-quarter 2015 results will be held on January 26, 2016. Thank you.

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