史賽克 (SYK) 2018 Q3 法說會逐字稿

Welcome to the Third Quarter 2018 Stryker Earnings Call. My name is Tiffany, 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 in exhibit to Stryker's current report on Form 8-K filed today with the SEC.

I will now turn the call over to Mr. Kevin Lobo, Chairman and Chief Executive Officer. You may proceed, sir.

Welcome to Stryker's third quarter earnings call. Joining me today are Glenn Boehnlein, Stryker's CFO; and Katherine Owen, VP of Strategy and Investor Relations.

For today's call, I'll provide opening comments followed by Katherine with an update on MAKO and K2M. Glenn will then provide additional details regarding our quarterly results before we open the call to Q&A.

With organic sales growth of approximately 8%, our strong top line momentum continued in Q3, reflecting the strength of our diversified revenue model.

Neurotechnology and Spine was once again the standout, delivering 12% organic growth in the quarter as Neurotechnology grew 17%.

MedSurg posted a 9% gain with Instruments leading the way.

Orthopaedics increased approximately 5% powered by over 8% growth in knees as MAKO continues to gain traction. We are now approaching 600 robots globally and continue to feel bullish about the future of robotic-assisted surgery.

On a geographic basis, sales were well balanced in the developed markets, and we grew double digits in emerging markets. With cost transformation for growth initiatives continuing, operating margin increased roughly 50 basis points in the quarter despite significant acquisition-related dilution.

With R&D at 6.7% of sales in Q3, we continue to focus on internal innovation, which is driving a steady cadence of new product launches. With the strong organic sales growth and operating margin expansion, we delivered adjusted per share earnings of $1.69 towards the high end of our targeted range of $1.65 to $1.70 for the quarter. Given our solid performance through the first 3 quarters of the year and our conviction in our Q4 outlook, we are raising our full year guidance for organic sales growth and adjusted EPS.

With that, I will now turn the call over to Katherine.

Thanks, Kevin. My comments today will focus on MAKO with updates on the key metrics we have shared in recent quarters, along with an update on our recently announced plans to acquire K2M.

In the third quarter, we installed a total of 37 robots globally with 26 in the U.S. compared to a total of 33 in the year-ago quarter, of which, 23 were in the U.S. As expected, upgrades of robots in the field to the total knee application were largely completed in the third quarter. Over 50% of the robots installed in Q3 were in competitive accounts with Stryker either has no market share or show well below our average number.

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

Looking at U.S. procedures, in Q3, MAKO Total Knee procedures approximated at 11,300, bringing the year-to-date total to over 30,000. With all MAKO procedures topping 18,700 in the quarter, total knees represent the majority of roughly 60%. Utilization rates also continue to increase, up about 40% year-over-year.

We are also pleased with the increasing MAKO Total Knee data, supporting both the clinical and economic benefits. Specifically, a prospective study was recently published in The Ball & Joint Journal, which compared early postoperative functional outcomes and time to discharge between conventional jig-based total knee arthroplasty and MAKO-assisted TKA. The study included 40 consecutive patients in each arm with all surgeries performed by a single surgeon. Overall, the study concluded that the MAKO treated patients achieved statistically significant improvement with respect to decreased pain, improved early functional recovery and reduced time to hospital discharge compared with conventional knee surgery.

And as it relates to hospital stay, patients treated with the MAKO robot were discharged over 1 full day earlier than traditional knee surgery patients.

Additionally, just this week, the Hip and Knee Society, published a paper comparing 90-day episode of care cost with patients receiving a MAKO Total Knee replacement versus conventional knee surgery. Overall, the study determined that MAKO Total Knee patients' episode of care cost were $2,391 less than conventional knee replacement. Additionally, index facility cost and length of stay were also less with MAKO. And the MAKO patients were discharged less the skilled nursing facilities and had a 90-day readmission reduction of 33%. All outcomes measured in the study were statistically significantly favorable to MAKO-assisted knee replacement.

Overall, we are pleased with the continued adoption of the MAKO robot, and it's clearly enabling us to drive meaningful knee market share. The early clinical data is encouraging and underscores the unique features and capabilities of the MAKO robot that are enabling differentiated outcomes.

Turning to K2M. In late August, we announced plans to acquire K2M for approximately $1.4 billion. K2M provides Stryker Spine with a highly complementary and innovative product portfolio, which includes an attractive minimally invasive offering. The combined business will have a competitive portfolio across Stryker Spine product categories and leverage a powerful commercial engine.

With the addition of K2M's proven product portfolio, consistent track record of execution and robust pipeline, Stryker Spine business will be well positioned to sustain innovation and provide our customers and employees with proven product. We are excited Eric Major, Chairman and CEO of K2M, will be joining Stryker as President of our Spine Division. Eric's long-standing relationships with thought leading surgeon as well as his history of driving a strong sales execution culture is expected to optimize the integration and execution of the combined group.

With that, I'll now turn the call over to Glenn.

Thanks, Katherine. Today, I'll focus my comments on our third quarter financial results and the related drivers. We have provided our detailed financial results in today's press release.

Our organic sales growth was 7.9% in the quarter. As a reminder, this quarter included the same number of selling days as Q3 2017. Additionally, it is anticipated that selling days will have no meaningful impact on the fourth quarter or full year growth.

Pricing in the quarter was unfavorable 1.6% from the prior year, while foreign currency had an unfavorable 1% impact on sales. U.S. organic sales growth was 8.3% and international organic sales growth was 7%. Both geographies have the same number of selling days. In the U.S., there were strong performances across all segments.

International sales growth was led by emerging markets, Europe, Australia and Japan.

Our adjusted quarterly EPS of $1.69 increased 11.2% from the prior year, reflecting strong drop through on sales growth combined with operating expense control. Consistent with our expectations, third quarter EPS had no significant impact from exchange rates.

Now I'll provide some highlights around our segment performance. Orthopaedics delivered constant currency and organic growth of 5%, including organic growth of 4.4% in the U.S. This performance was highlighted by strong performances in knees of 8.4%. With the knee business, we continue to see our high demand for our MAKO TKA Knee platform and 3D-printed products. Our Trauma and Extremities business had moderate growth and was impacted by softness in the market and product supply issues.

We anticipate that the product issues will not impact Q4, and we expect sales acceleration in 2019 as we launch a number of new products in Trauma.

Internationally, Orthopaedics delivered organic growth of 6.2%, which reflects solid performances in Europe, emerging markets and Australia.

MedSurg continue to have strong growth across all businesses in the quarter with constant currency growth of 10.4% and organic gains of 8.8%, which included a 10.1% increase in the U.S.

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

Endoscopy delivered U.S. organic sales growth of 6.2%. Endoscopy had strong performances across its general surgery products and its sports medicine communications and pro-care businesses.

In September, Endoscopy's NOVADAQ acquisition anniversaried and became part of organic growth.

The Medical division had U.S. organic growth of 12.4%, reflecting solid performances at its Sage, patient care and physio businesses. As expected, Medical Sage business drove a significant amount of growth as Q3 2017 included Sage's product hold and the comps were very low. Medical did face tough comps in the core capital businesses as that segment had exceptionally strong mid-teens growth in the year-ago quarter, helping to offset the impact of the Sage recall. For the third quarter, Sage had a 7% impact on Medical's organic sales growth and a 1% impact on overall Stryker's organic growth.

Overall, Medical's core capital businesses have a solid pipeline, which is expected to drive strong Q4 sales.

Internationally, MedSurg had organic sales growth of 4% with good performance in emerging markets, Australia and Japan. Neurotechnology and Spine had constant currency growth of 18.3% and organic growth of 11.9%. This growth reflects double-digit performances across all of our Neurotech businesses and less of a market headwind in core Spine.

Our U.S. Neurotech business posted organic growth of 16.7% for the quarter, driven by strong demand for our hemorrhagic, ischemic stroke, CMF and our Neuro Powered Instruments. Additionally, we continue to be pleased with the progress of our Entellus acquisition integration.

Our Spine business reflects double-digit growth of our IVS business and our Tritanium implant products.

Internationally, Neurotechnology and Spine had organic growth of 13.4%. This performance was driven by continued high demand across most geographies for our Neurotech products.

Now I will focus on operating highlights in the third quarter. As noted in the press release and discussed in our Q1 earnings call, the adoption of ASC 606 primarily had the impact of reclassifying certain expenses from SG&A to sales. As such, all references to basis point improvements are net of this impact.

Our adjusted gross margin of 66.3% was up approximately 50 basis points from the prior year quarter. Compared to the prior year quarter, gross margin expansion was favorably impacted by comps, including impacts from prior year mid weather, productivity and efficiently -- efficiency, partially offset by price, foreign exchange and business mix.

R&D spending was 6.8% of sales, which was slightly higher than prior year quarter.

Our adjusted SG&A was 34.6% of sales, which was in line with the prior year quarter. This reflects the continued focus on operating expense improvements through our cost transformation for growth, CTG program, including key projects focused on indirect purchasing and shared services as well as some favorability arising from prior year quarter comps as it relates to Sage and weather disruptions.

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

In summary, our adjusted operating margin was 24.9% of sales or approximately 40 basis points favorable for the prior year quarter. Our operating margin primarily reflects good leverage and continued operational savings, offset by CTG investments, the onetime write-off and acquisitions, the latter of which had an approximately 50-basis-point negative impact in the quarter.

We remain highly confident in our ability to deliver on our full year commitment of driving a minimum of 30 to 50 basis points improvement in our operating margin.

Next, I will provide some highlights on other income and expense. Other expenses decreased from the prior year quarter, primarily due to favorable interest income.

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

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

Turning to cash flow. Our year-to-date cash from operations was approximately $1.6 billion. This reflects increased earnings and lower recall-related payments, which were somewhat offset by increases in working capital, including higher tax payments as a result of tax reform and specifically required payments related to the toll tax on previously untaxed foreign profits.

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

Given our year-to-date performance and continued momentum, we now expect that our adjusted net earnings per diluted share will be in the range of $7.25 to $7.30 for the full year. For the fourth quarter, we anticipate adjusted net earnings per diluted share to be in the range of $2.13 to $2.18. This guidance, full year and quarter, includes anticipated impacts from the aforementioned business investments, the previously announced $0.04 of dilution related to Entellus and potential dilution from acquisitions that may close in the fourth quarter.

Additionally, as highlighted in our Q2 earnings call, it also includes full year foreign currency favorability of approximately $0.05.

And now, I will open the call up for Q&A.

(Operator Instructions) Your first call comes from the line of Robbie Marcus with JPMorgan.

One, I want to ask you on the operating margins. And if we back out the 50 bps of M&A, we're at 90 bps of operating margin expansion for the quarter for the business. Maybe you could just give us your thoughts on where you see the business now. Following the changes in compensation, it's clear that the businesses is growing fast on the operating margin line. So help us understand what you think Stryker is on a go-forward basis in terms of operating margin grower?

Yes, I think as you look at operating margin, we're not backing off of our guidance at all in terms of minimal 30 to 50 basis points of margin expansion. We still believe that, that is one of the things that we can hold true to even given the sort of negative dilution that we'll get through our M&A or even potential M&A. I mean, keep in mind, we also delivered fairly good gross margin performance this quarter. That includes sort of the impacts of mix, price and productivity and efficiency. I also think that we're starting to see some savings from some of our sort of shorter-term CTG programs, which include indirect spend efforts and shared services efforts. So overall, I feel very committed and strong it will make our minimum of 30 to 50 basis points, and we'll hold firm on that guidance.

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

Rob, are you saying specifically for Trauma or for total company for the quarter?

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

Really, it's going to be very reflective of this quarter. There's a lot of our businesses that have some really strong tailwinds right now, whether it's in Neuro, whether it's in Ortho or MedSurg. And those getting later in this life cycle with its 1588 camera and they're gearing up to launch the 1688, which will happen in the first half of next year, but they have strength in other parts of the business in the quarter. So I wouldn't say there's any one stand out, but there's a lot of our businesses that have very strong momentum heading into Q4, which is historically, as you know, our strongest quarter.

Now the only thing I'd like to add, Robbie, is since you look as to how we've done the whole year, our year-to-date sales growth organically is roughly in that 7.5%, 7.6%, 7.7% range. So we're basically expecting more of the same in the fourth quarter. We had a very good fourth quarter last year, but we're really firing on a lot of cylinders right now and feeling pretty healthy about our businesses. From quarter-to-quarter, of course, you will see a little bit more bounce. Maybe in Neurotech we saw a really big bounce this quarter. Will it stay up in the 17% range, that might moderate just a hair. But overall, we're at a very stable position right now across our businesses and feeling very good about our growth outlook.

And your next call comes from the line of Bob Hopkins with Bank of America.

So 2 quick questions. The first one, just, Kevin, from a big picture perspective. I know we're not finished with '18 yet, but it is shaping up to be, as you said, an exceptional year from a revenue growth perspective given your new guidance at 7.5% at the high end. So just how confident are you that you can continue that growth? What are the things in the pipeline that we should be focused on for the next year versus things that might slow? So just trying to check your confidence for next year relative to the superstrong year this year.

Sure. Thanks, Bob. And as you noticed, it's been, I guess, 5 years now we've increased our organic growth year after year. It's been rising. Obviously, med tech markets are also been pretty good, but we've been continuing to outpace the market pretty significantly. As I sit here today, I feel like going into '19 is going to be more of the same. And we have a healthy balance of headwinds and tailwinds, very similar to what we had going into this year. We have a good cadence of new products launched. Katherine mentioned a big launch coming within our MedSurg business. We also have a lot of Trauma products that we'll be launching. I look at MAKO and we're just continuing to ramp MAKO. I think that will continue and especially internationally where we're only just starting to receive approvals for -- we have the hip approved, but we don't yet have the knees approved in big markets like Japan and China. That will happen next year. So if you look at Physio-Control, we have a number of new launches coming. So I'm feeling very good about the cadence of new products. And fortunately, we'll have some other products later in the cycle. System 8 probably won't be as strong next year as it this year. But overall, feel very good balance and feel like we're in very good position to continue the strong organic sales growth momentum that we have for the last few years.

And then one last follow-up on MAKO. Obviously, thanks for giving us the numbers, it sounds like things are going really well there. And you've mentioned every quarter how you're placing MAKO in competitive accounts. And now one of those competitors, Zimmer Biomet, is going to be launching their own version of a robot over the next couple of months, at least in theory. So can you talk to us a little bit about the stickiness of the competitive business that you've won as you look out over the course of the next 12 and 24 months?

Yes. Thanks, Bob. I think it's safe to say, given the investment, not just the cost of the capital and $1 million robot, but the investment of a surgeon to be a champion, to get trained on the robot, to have its OR staff trained on what is a shift in how you do the procedure and then get familiar when it's a competitive account with new products. It's very sticky. And so that's why we believe that competitive advantage we have, not just in what our robot is capable of doing and that's where the definition of a robot is really critical, but also having a multiyear lead head start in getting robots out there. We've got close to 600 globally and continuing to sell new robots with a healthy pipeline. And now you're starting to see the clinical data, the early clinical data come in with a clinical and economic benefit that is specific to our robot. So obviously, competition is coming. You don't grow ahead of the market at the rate we are without people thinking that maybe they needed the robot, but this is a very sticky business once we get a robot in there.

Yes, Bob, the one thing I'd like to add is what I found very encouraging with the early studies is that is pointing to a specific benefit related to our haptic -- the haptic feature of our robot. And that you don't use jigs. And by not using jigs, you really protect the soft tissue envelop. And really so that less invasive nature of the procedure is a massive advantage. And many surgeons will pick up on that. They are anecdotally seeing that with their patients, and I know that the competitive offering will still have a jig and ours is a jigless offering. So I do believe our features are going to win out, at least in the short term. Will that have interest? Sure. Some surgeons will be interested and will have to obviously compete in the market, but we like our chances.

And your next call comes from the line of David Lewis with Morgan Stanley.

So 2 questions on revenue for me. Kevin, I just wanted to come back to Trauma for a couple of reasons. One, obviously, it's the softest quarters in years, given all the strength you've had here. I think you cost the corporation 50 bps of growth in the quarter, so I think it's a single biggest disconnect for vs our models quarter. You talked about some market softness. One of your competitors talked about market softness, but you also mentioned some supply issues. If you could just sort of flush out what's happening in Trauma this particular quarter. And what underpins your confidence that this business reaccelerates here over the immediate term. And then I have a quick follow-up.

Sure. Thanks, David. We were, obviously, we're a little disappointed with Trauma performance this quarter. We've had about 5 years of phenomenal growth. If you look at the comps, we had a big quarter in the third quarter last year. Very strong double-digit growth. So comps has a little bit to do with it, but we did have some supply disruption. We expect to resolve that, and that really did affect our overall business. Our Extremities business grew a little less than 10%, which hasn't happened for a long time, but we expected that, that's going to pick up as you move forward. We also have a number of new products that we're launching. So we have a very strong Trauma team. There's -- it's still a very healthy business overall. The market did slow down a little bit. We saw that frankly since June. That has happened in the past. It's been transitory, but we still feel very good about that business. And we are optimistic, especially behind new product launches. We have a number of new products that we'll be launching going into next year. That business will pick back up again. And even at this level, we are still outperforming the market leader.

And Kevin, the supply issues resolved on the fourth quarter or they don't fully resolve until early part of '19?

I would say largely resolved in the fourth quarter. And so you'll see some pickup in the fourth quarter will be even more noticeable in '19.

And your next call comes from Rick Wise with Stifel.

Maybe I'll start with MAKO again as well. With the steel upgrades completed, maybe with the resources freed up, does this suggest that you have resources to more aggressively go at new accounts? And maybe talk about the MAKO penetration theoretical ceiling. I think you are like 15% of the potential 4,000 accounts or so. Any thoughts on the realistic ceiling for MAKO?

It's tough to say, Rick. There's clearly a lot of runway because it's not only placing a robot in the thousands of hospitals in just the U.S. let alone globally. But also as more and more surgeons practice want to use the robot, then you start to see what is clearly the minority right now, it's purchase multiple robots. And we have some hospitals that are further along in their robotic programs that are doing that or have done that. So we see a lot of runway for robot placements. You are correct with the upgrades complete. That sales force will be focused now on placing new robots. So again, we feel like we've got a strong ability to continue to drive some meaningful market share gains. We still have to train and hire the service side. But overall, we think we've got a very healthy pipeline of demand here and ability to continue to place pretty significant new robots.

And just as a follow-up. Kevin, in the Invuity acquisition, the company we thought have always felt the technology is outstanding. Maybe if you could talk to us a little about the acquisition rational? And maybe just in a larger sense, how does this fit into your long-term strategy or vision about at least one of your -- one of the strategies in terms of where you might be taking Stryker's portfolio going forward?

So thanks, Rick. We absolutely love the bladed retractors. They are very novel, very innovative. Provides tremendous benefits to the clinician. In addition, they have entered the advanced energy space with a very novel product. Our Instruments business has, as you know, has been a very strong performer for a very long period of time. They are now actually focused on waste management as well as they have a Surgical procedure. And now this product fits very well with that call point. We call it Surgical Technologies. It's one of the business units. And then you have the focus on power tools and Steri-Shield, and so it really does fit very well with the existing call point of those Instruments salespeople. And so we believe it's a really novel technology that's in a high-growth space. And our call point, our reps are actually in that area. And so it really plugs really into that existing sales force. And most of the deals we do when we have existing products, existing sales forces that we can plug products into, those are the ones that we tend to really grow very, very quickly. So we're excited about it. It's not wildly outside of our call point but it will enable us to enter into even more surgical procedures than we do today.

And your next call comes from Chris Pasqual with Guggenheim.

Katherine, the initial trickle of MAKO data has been pretty compellingly, albeit with some relatively small patient numbers. Can you talk about what's in the pipeline from a data perspective? Are there big studies that you guys have circled as being key to making the case with physicians that might still be on the fence about the clinical value there? And when can we expect to see those?

So I think you're going to see a steady cadence on the clinical side. And what you're seeing right now given where we are on the launch are the early outcomes, those 90-day outcomes. But we're also with the KOLs who were initiated studies as part of the launch, we are collecting data and then eventually there will be 2-year data. So I think what you should expect to see is a steady cadence here. We were really thrilled, particularly with the first study, I noted that, that was just 40 patients in each arm and it still hits statistical significance on all the endpoints favorable to MAKO. So I think we're just going to continue to build on this. And then as we get further, obviously, into the launch and have 2-year clinical data, possibly by August of next year, that's really what you need to have to get published in the peer-reviewed journals.

Okay. And then you called out the easy comp for Sage this quarter. The contribution to growth that represented. My recollection is that 4Q should also be a pretty easy comp there. Can you just remind us of the timing of when that normalizes?

Yes, the fourth quarter will be an easier comp. It won't be as easy as the third quarter, so the biggest impact was the third quarter last year. And then there were some more recover in the fourth quarter, but yes, there will be a benefit to us of an easier comp in the fourth quarter. And then normalization would really agree sort of sometime in the middle of next year.

And your next call comes from the line of Vijay Kumar with Evercore ISI.

So maybe one question on MAKO and I had a follow-up. So it looks like sequentially system placements were down. And it looks -- it seems to be U.S. was down maybe in national lows are. I'm just curious on is it safe now if your -- or how should we be thinking of system placements?

I think we really need to look year-over-year. Q3 is always the seasonally softest quarter for reconstructive that there's a long history of that. There's just simply fewer hip and knee procedures done during the summer months and correspondingly, Q4 is typically see a very meaningful step-up, given the strong capital quarter as hospital use up the yearly budget and it's strong quarter for hip and knee procedures.

Yes, we're feeling pretty good. The interest's level is very high, and we expect to continue to be able to have very robust sales of our MAKO robot.

That's helpful, Kevin. And then maybe one on margin. So Glenn, you were mentioning on the commitment of 30 to 50 bps of margin expansion. As you think about where rates are right now and when we look at '19 and the deals that you've done, are we still on track for 30 to 50 bps? I think there's been some confusion on the Street about the commitment of 30 to 50 bps for '19?

Yes, we're not. Based on where we are to date and what we know what's in the pipeline, we have not changed the long-term guidance of 30 to 50 bps for '19.

And your next call comes from Glenn Novarro with RBC Capital Markets.

Kevin, I had a question on K2M. You're doubling down on Spine with the K2 acquisition. Is this a signal that you feel more optimistic about the outlook for the Spine market and now was the right time to do the deal? Or was this more signal that Spine is strategic synergistic with orthopaedic and neuro, and you just needed to get bigger. So that's my question and I had a quick follow-up.

Sure. Thanks for the question. I think we've -- I've been for pretty consistent with the past 3 or 4 years in how important and committed Stryker was to the Spine market. It is very synergistic with both the Neurotechnology and as well as orthopaedic, and we're seeing that with a terrific performance of our Tritanium product, which is 3D-printed technology that we also use in Orthopaedics. And so this has been a market we are very committed to. The timing just worked very well for us right now. We've got our Spine business starting to perform better. K2M has really developed stronger and stronger performance with their new product launches. So the timing just came together right now. Deals vary from when you start to get interested in the company, you get to know the company. We've obviously gotten to know Eric very well, and we're bringing him on to be the CEO of the combined organization based on sort of what he's built there, his culture, the way he runs his operations. So culturally, very similar to how Stryker operates. And we're doing a large integration we're you're bringing together 2 organizations of size or you're going to be using the same types of technologies. Culture really does matter a lot. And so it took us time to make sure that we have a cultural fit. And so I'm very optimistic about the 2 organizations merging very well and performing very well. But there really hasn't been a change strategically. It's always been important. I think I've said that over and over again. The market, it's nice to see that the market is stabilizing and hopefully will start to improve. But this is a deal that makes sense for us. It will really improve our growth trajectory in our Spine business. And it just felt like a good time to do it, and we're very excited about it.

And just as a follow-up, both K2M and Stryker are very big into 3D printing. Are there any FTC issues there?

No, we don't anticipate any.

And your next call comes from Isaac Ro with Goldman Sachs.

First question on MAKO and then a follow-up on the neuro tech. On the MAKO side, can you maybe give us an update as to the mix of sort of leased versus outright purchases that you are using for the incremental users? At the reason I ask is I'm interested in how you think that will evolve as the market gets a little more crowded in the coming months.

Yes, so one of the benefits besides the fact that we have a capital sales force and the and implant sales force, we also have our Flex Financial Group, which has existed for years to work with customers, making big capital purchases. Not just the robot, but a number of MedSurg offerings and they can work depending on the needs of the customer between outright purchases and leases. So some of the robots the majority are sold, but we have different arrangements. We're not going to get into breakdown of that primarily for competitive reasons but the ability of our Flex Financial Group to work with the customers is a big part of the strategy that we have.

Okay, helpful. And then just a follow-up. You have a new product cycle in Neurotech that's I'm assuming part of the growth toward the correct me if I'm on this quarter said pretty good about 17% in the U.S. part of the business. But I'm interested in what's going on in terms of the new stroke devices you have is obviously very strong incumbent there. So give a little color as to the nature of market share or overall acceleration of the product category. What you're seeing there would be interesting.

Yes. So the neurovascular group is just having a tremendous year. I would tell you both hemorrhagic and ischemic had very solid double-digit growth, and it's across the board. Broadly speaking, ischemic is more about market expansion. If you look at hemorrhagic, probably one of the standout products is the Atlas-adjusted stent that we launched in the first quarter, early part of the first quarter. We did get to surpass for the Florida state stent approved. That will launch and rerun to product and start to work with the early users late this year, early part of next year. So you do know really impact from that in the U.S. in the quarter. And then we're just in the very early stages of launching our aspiration product, and that's really meant to target customers that really want to use aspiration first. And we still believe the most effective, given the clinical data, is to use the Stentriever in combination. But there is a subset of patients or customers that want aspiration alone, but we're just too early in that launch. So that wasn't a driver. Certainly as we look ahead to '19, given the continued momentum we are seeing, market expansion in ischemic and then the recent new launches we feel really good about Neuro heading into next year despite what will be some pretty impressive comparisons.

And your next call comes from Larry Biegelsen with Wells Fargo.

Glenn, could you give us a little bit of color, please, on FX in 2019? We estimate it's about a 70 basis point headwind. Any color on the EPS impact at this point and the tax rate in 2019, I heard your comment about 18% underlying year-to-date, but the reported has been better. Any color on that for 2019? And then, Katherine, just my second question now, preview of the Analyst Meeting on November 8, just will you give some color on 2019 and beyond from a financial perspective?

Sure, Larry. So if you look at FX and sort of based on the foreign currency exchange rates, we expect a slight negative impact on sales due to foreign currency translation, which will have a negligible impact on EPS in the fourth quarter. And what we're seeing really at the EPS line is we're seeing negative translational effects but is being offset by a positive transactional FX from our hedging program. And these impacts have all been included in the fourth quarter guidance that I referred to. Flipping to taxes. As we look at the full year guidance that we provided at the beginning of this year of 16.5% to 17.5% for our effective tax rate, we expect that our effective rate you will end the year at the lower end of that range. And really, what we're seeing is compared to 2017, we're seeing sort of a slightly higher effective tax rate that's really just driven by the new tax legislation.

And for the Analyst Meeting, we wont be giving guidance, formal guidance for '19. That will be, as always is, on our earnings call in January.

And your next call comes from Joanne Wuensch with BMO Capital Markets.

We spent a lot of time talking about knees and the impact of MAKO on that business. Can you give us a little bit of an update on how you're thinking about your Hip franchise?

Yes, we launched our Trident II, our new hip cup in the second quarter. It really started to ramp in the third quarter. When I say ramp, these launches do take time because you have to get the sets of instruments out. We now about 1,000 in the field. You saw a slight tick up in our hip number in the third quarter, and I do expect that, that will continue to perform very well. The feedback that we're getting on the comp is terrific. We already have a very good stent portfolio, which, as you know, drove us to have outperformance in the market for a number of years. And then we sort of grew in line with the market for the last couple of years. But this cup is being very well received. We now are fully -- the field is fully stocked with their sets, and we started to see a little bit of impact from the third quarter and I think you'll continue to see us tick up in our Hip business. Of course, the same sales force also focuses on Knees. And Knees is obviously, a lot of action is, but we do expect continued moderate sequential uptick for our Hip since.

In terms of M&A, it's not secret you guys have been pretty active with what I would call sort of tuck-ins along the lines of K2M. And then I think some sort of outside your core businesses, such as Invuity, how are you thinking about acquisitions on a go-forward basis?

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

Yes, and I would say with Invuity, it is a slightly different technology, but it is a call point. We already have a sales force calling that area. And so it's not wildly different we allowed to bring technologies into existing sales forces. That has been a real key formula for success for Stryker for a long time. So it's not really as adjacent as a Physio-Control or a Sage business. We're actually tucking this within our Instruments sales force.

And your next call comes from the line of Larry Keusch with Raymond James.

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

So within Spine, innovation always wins. And if you look our Tritanium products, even the Serrato, new product that's soon to be launched. Innovations were awarded in Spine. You have seen that across -- you can look across the Spine companies. If you provide a good cadence of innovation, you will win in the Spine business. There's still a huge amount of unmet needs. It's the biggest market in Orthopaedics, and that's why we like K2. It obviously gives us a bit more market share. They are stronger in certain parts of the country where we are weaker. And so that, obviously, you have a sales force that can sell a broader range of products, that is exciting and should increase our growth. But also they have a really good R&D engine that produces consistent flow of new products. And that's going to be the formula for success. It's not unique to Stryker. I think if you look across the Spine market, innovation is really what gets rewarded. And we're committed to continuing to drive innovation within the Spine business. But on a combined basis, we're going to have a lot more impact as a combined organization then we would have separately.

Okay, very good. And then Katherine, I'm just wondering there's certainly been enough experience now with the MAKO robot are being placed. What's your -- I guess what I am trying to understand is sort of what's the right way to think about how dogs ramp-up on the procedure? Certainly, you give the utilization rates, so we get that. But do they tend to do a couple of cases and then wait and then start to grow their cases more? Just trying to get a feel for how that's kind of working in the field.

Yes, what you see is, clearly, they have an interest because they are going to be the surgeon champion to get the robot purchase. But they don't get trained and then suddenly show up Monday morning, and they are doing all of their knee procedures on the robot. It's a gradual process they might do 5 the old way and 1 that day as I slowly get more and more comfortable with it. So it varies, but it could take anywhere from 12 to 18 months for them to really be fully flipped over to using it exclusively for all their procedures. And then the challenge also becomes maybe the way the surgeon champion and he could get the robot whenever he wanted, but then slowly his colleagues start to close in and want to use it. And so sometimes they are limited in how many cases they can do on a robot because they don't have enough robot time, and that's usually the precursor to the hospital bringing in another robot.

And your next call comes from Kristen Stewart with Barclays.

Just wanted to go back to just clarify a couple of things. On the tax rate, Glenn, I think you were saying that you're expecting to come in at the low end of the range, but you're seeing a higher tax rate. Is the difference -- I don't know if I understood that correctly, is the difference just the stock compensation impact on the tax line? Or how do we kind of think about that on a go-forward basis?

Yes, the real -- the largest difference between sort of our effective tax rate, which is what I guide to and that I mentioned the operating tax rate, is really the impact of stock compensation, the differences there. That's by far one of the largest item.

Okay. And what's the delta expected to be this year between the 2 again?

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

And your next call comes from Richard Newitter with Leerink.

Wanted to circle back to the Trauma, Extremities. Can you parse out with it between Trauma versus Extremities, both where the slowdown is most pronounced. Because it's kind of 2 sets of product categories? And then also, where the supply issue was more pronounced as well, again between Trauma or product lines within Trauma and Extremities?

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

Okay. And just with respect to the market slowdown, any additional color that you can kind of give there with respect to timing? Or what happened with that?

Yes, we're struggling a little bit, too. I think we referenced its expense in June. The market just feels so slowed down. And this has happened over the years where we have these periods wherever -- whatever the reason may be, the market growth seems to slow a bit. So there's nothing that we could really point to right now, but as the results come in, it does seem to support the view that the market did slow down in the quarter.

And your next call comes from Craig Bijou with Cantor Fitzgerald.

Just wanted to start with the HyperBranch acquisition. You guys didn't really talk about it and I recognize its relatively small in comparison to the entire company. But maybe just strategy there and how that fits into your portfolio?

Yes, sure. So that fits within our CMF business, our Craniomaxillofacial business, which is a business that we report within our Neurotechnology segment. We've had fantastic growth within that business unit over the past 5 years, double-digit growth, pretty much every single year, and this was just a product gap. So we did not have a dural sealant product. There's only one other product on the market for dural sealant, so we're -- we've known this company HyperBranch for many years. We've been following them. And we're very excited to add that -- our product. It's absolute tuck-in to our existing CMF business and our CMF sales force.

Okay, that's helpful. Maybe just as a follow-up. Pricing, it look like you got -- it did get a little bit worse during the quarter. So anything to call out there? Or any changes to your expectations going forward on price?

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

And our next question comes from Mike Matson with Needham & Company.

Just want to ask a couple about the K2 deal. I guess, first, what we're seeing with spine deal is there tend to be a lot of dyssynergies. So I just wonder if you could shed any light of kind of what your assumptions there are around what that business is going to look like in the first 12 to 24 months when you integrate the 2 companies. How much the commodities sales you expect to lose? And then I noticed in the press release, you commented on some dilution for this year, but you didn't really comment on whether you expected the deal to be accretive or dilutive beyond 2018. So is that just because there's just too much uncertainty around these dyssynergies and things like that?

So a couple of points. So we did a formal long-term guidance inclusive of K2M next year of 30 to 50 basis points of operating margin expansion. In terms of -- we're not going to break out the assumptions around sales to synergies. There's always something to integrate. What was really attractive about this target is we have very minimal customer overlap, which really helps. And that's we're also have a model where we're used to having both agents and direct sales reps who are comfortable working in that model, it's how our own spine business works. And I think that will help us we look to integrate the sales force. And then lastly, bringing Eric in to run the business. He obviously has a very sales execution-driven culture. We have something very similar but a sales force that is really thrilled to have a refresh to their product portfolio and then broader footing in the degenerative deformity segment of the market that really drives a lot of the thought leaders. So when you add that altogether, along with our experience in doing deals and integrating deals, we think that will help to limit the dyssynergies and ensure that the integration goes well and we get back to above-market growth.

Okay. And then just one follow-up on Robotics and MAKO. So what I understand kind a single-minded focus here on recon specifically on the Total Knee, but we're seeing other companies, there's a few spine robots out there. There's about to be another one. So I've got to imagine you're working on bringing MAKO, particularly in the Spine, maybe in other areas. Can you just comment on your strategy there?

Yes, you are right. We are very focused right now in optimizing the launch of the Knee given the enormity of the market, our head start and the advantages of our robot. But we also have previously stated we have R&D projects actively underway, looking at applications for the robot in both Spine as well as shoulder. We are not in a position to talk about the timing of that, but this robot had a number of applications and we're going to be continuing to expand it. But right now, the focus really is on the Total Knee.

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

And your next call comes from the line of Josh Jennings with Cowan.

I was hoping to just ask quickly about Total Knees moving off the inpatient only list by Medicare this year. Have you seen any type of impact? The market clearly has an impact on Stryker's Knee business, but has there been any impact in the marketplace over the first 3 quarters of this year? And do you see it as a risk to the total knee market going forward? Is there anything to add American Hospital Association can do to help improve that HOPD reimbursement level. And then my follow-up question is that there have been concerns that one of your competitors is on a path to recovery. And just wanted to hear from you if you've seen an incremental competitive headwinds in the orthopaedic franchise from that competitor. Thanks for taking the questions.

So maybe I'll start with your last question. I would say if you look at our numbers and look at our performance, we really just our focus on our own offense. We are focused on driving MAKO. We're focused on 3D printing. And as long as we that, we keep growing and we're growing very well. And so I would say that's where we're going to continue to focus on our offense. And it's really irrespective of what's going on around us. We haven't seen anything, any material change as we approach our customers. There was a first question, sorry?

Total knees.

Inpatient. So no, we haven't seen any major dynamic change because it's really hospital inpatient only. Medicare still doesn't, as you know, cover procedures in the surgery centers. If that change were to occur, I think that would create a more meaningful shift. But we are already starting to place MAKO in surgery centers, and that's the space we know fairly well from our sports medicine franchise. And so that would be the bigger change if that was to occur. We don't see that sort of in the short-term happening. Overall, the market is actually fairly healthy, fairly stable.

And your next call comes from the line of Matthew O'Brien with Piper Jaffray.

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

Sure. Within our Instruments business, we have a couple of terrific products. Our neuro power drills are doing extremely well. We have our sonic light product for tumor ablation, which is also doing extremely well. We have the Malis product, which we have picked up through an acquisition a little while ago, which is called the Malis forceps. So really, a suite of products that we have for the neurosurgeon, which we -- most of it has been through internal innovation, but we've also done some small tuck-ins. That's really driving explosive growth, very strong double-digit growth and I would say the neurosurgical tools, the power tools are growing roughly as fast as our Neurovascular business. So then you have our Craniomaxillofacial business growing in the 10%, 11% quarter after quarter, very steady double-digit growth. So it's really healthy across our portfolio. And our business are performing very well.

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

Yes, so we have a strategic alliance with them to really provide imaging. So there's -- we don't have, as you know, we don't have a C arm ourselves. And so that really allows us, if we're thinking about competing with the Medtronic that has their arm and try to bundle their offering with that type of imaging, this provides a very competitive counter to them. So it runs on our portfolio and we use that -- we enjoy that partnership. They have a very, very good product and make sure that we have a complete and competitive offering for those accounts that are looking for a bundled offering.

And your next call comes from Steven Lichtman with Oppenheimer & Co.

So you highlighted emerging markets as a positive driver in the quarter. I know EM is still not a big portion of total sales for you guys. But would you say overall the environment remains healthy despite some of the broader market concerns?

Yes. So, I mean, emerging markets for us, this is 3 quarters in a row where we had double-digit growth. But as you've seen in the past, it has varied for us. Our performance was been a little bit up and down over the past 4 or 5 years. I feel very good about our business in China. I feel good about our business in Latin America. We've really strengthened it. Turkey and Russia, there's a number of markets where I think we've really improved our position, and in that bodes well for the future. India, we just hired a new Managing Director recently. We still have some more work to do there to get back on a strong footing. They actually had a pretty decent quarter this quarter, first good quarter in about a year or so in India. But so the outlook is still positive. It's going to take us some time. We really haven't made the same degree of investments as other large med tech players, but the market conditions themselves are quite good. And we like our chances to continue to improve our performance in the emerging markets.

Great. And then just on Sage, obviously, a lot of volatility in the last few quarters that you are now coming out from under. How should we think about this sustainable growth of that business now with some of the issues behind you guys?

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

And your next call comes from Kyle Rose of Canaccord.

Just wanted to ask another follow-up on the MAKO's guide. A competitor in the spine side of robotics recently talked about leveraging the robot as a means to drive share. I mean, obviously, when you talked about goal of taking hundreds of share points with MAKO, but the competitor talked about being open to different business models rather than outright capital sale. I know you touched on the Flex Financial, but it sounded like they were more approaching it from a volume-based agreement, give us X% of procedural share over the course of the next several years and we'll place the robot. Are you seeing those types of requests? Have they changed at all? And how do you view that as a business model moving forward when the market gets a little more competitive with new entrants?

Yes, I think first and foremost, it all starts not with the financing options. It starts with what is your robot capable of doing and what value does it bring. And then increasingly, what kind of clinical data do you have. So -- and we're not going to get into other people's business models. It will be -- the burden will be on them to demonstrate first what the robot can do. Secondly, when will they start to have clinical data. We have Flex Financial. We have that for years. It's been a tremendous benefit to us as well as knowing how to sell capital and having a dedicated capital sales force. And that flexibility to meet the needs of our customers, I think with roughly 600 or close to 600 robots globally and what we have in the pipeline. Our model is working for us, and that's what we're going to stay focused on.

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

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

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