Stryker CEO Lobo: “For every POD that goes away a new POD seems to pop up” |

Stryker CEO Lobo: “For every POD that goes away a new POD seems to pop up”

Kevin LoboStryker CEO Lobo: “For every POD that goes away a new POD seems to pop up” (Stryker Earnings Conference Call)

Operator: Welcome to Stryker’s First Quarter 2014 Earnings Conference Call. My name is Eric and I’ll be your operator for today’s call. At this time all participants are in a listen-only mode. Following the conference we will conduct a question-and-answer session. This conference call is being recorded for replay purposes.

Before we begin, I would like to remind you that the discussions during this conference call will include forward-looking statements. Factors that could cause actual results to differ materially are discussed in the company’s most recent filings with the SEC. Also, discussions will include certain non-GAAP financial measures. Reconciliation 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.

Endoscopy had another solid quarter. Medical was steady while Sustainability Solutions was slowed by some product lifecycle challenges. U.S. Neurotechnology had another stellar quarter with 11% growth as all three businesses, neurovascular, neuro powered instruments and CMS registered double-digit gains.

Spine growth was flat aided by double-digit growth in Interventional Spine.

International constant currency growth of 5% was led by strong performances in Australia, Japan, India and China. The latter of which had strong performance in both the premium and low-priced segment of the market.

Europe momentum continues with year-over-year growth in the low single-digits. Most product categories had positive results, although knees were soft due primarily to lingering issues in some emerging market countries which we previously mentioned. We continue to expect this trend to improve beginning in Q2.

Turning to the P&L; the year-over-year decline in gross margin is a function of the negative impact from foreign exchange along with price which was partly offset by the benefit from our GQO initiative. We continue to make significant investments in R&D which increased 17% year-over-year, while maintaining our focus on driving greater SG&A efficiencies.

With our adjusted Q1 EPS of $1.06 we are confirming our full year adjusted EPS guidance of $4.75 to $4.90. With that, I will now turn the call over to Katherine.

Katherine A. Owen – VP, Strategy and IR: My comments on today’s call will focus on providing an update on our recent M&A activity. During Q1 we acquired Pivot Medical which was founded in 2007 with a focus on hip arthroscopy procedures treating FAI syndrome. Pivot provides us with a platform of innovative instrumental implants to efficiently access and restore the mobility of the hip with minimal incision.

Hip arthroscopy is the fastest growing procedure in sports medicine resulting from improved procedural solution and growing demand for less invasive solution. This acquisition complements our existing sports medicine portfolio and provides our customers with a comprehensive offering to address a broader range of procedures.

More recently, we completed the acquisition of Berchtold Holding, which achieved sales in 2013 of approximately $125 million to its product portfolio of surgical infrastructure equipment. Berchtold offering includes surgical table, equipment films and surgical lighting systems geared towards maximizing efficiency and safety in operating rooms and IT use.

Combining these complementary solutions with our endoscopy division’s existing operating room portfolio creates a comprehensive quality focused offering equipped to satisfy a wide range of customers’ needs around the globe.

Also during the quarter we closed on the acquisition of Patient Safety Technologies which we discussed in detail on our prior call. Our Instruments division is excited about this innovative technology which helps prevent the objects in the operating room thereby improving patient safety and reducing healthcare costs.

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

Kevin A. Lobo – President and CEO: Good afternoon, everyone, and welcome to Stryker’s first quarter 2014 earnings call. Joining me today are Bill Jellison, our CFO; and Katherine Owen, Vice President of Strategy & Investor Relations.

Following my opening comments, Katherine will provide an update as it relates to our recent M&A activity and Bill will then offer details on our quarterly results before opening the call up to Q&A.

Our first quarter results reinforce the strength of our diversified mix of businesses which include implants, disposables, capital equipment and services that address a broad spectrum of the medical technology industry.

With this comprehensive offering, we achieved another quarter of solid organic sales growth, up 5% excluding acquisitions and foreign exchange. While we benefited from one extra selling day in the quarter, this was offset by the negative impact from the unusually severe weather, which resulted in a high number of cancelled surgeries.

As these surgeries are being rescheduled over the course of the year, we do not anticipate any discernable impact on our full year growth rates. All three of our key business segments, Reconstructive, MedSurg and Neurotechnology and Spine delivered year-over-year revenue gains in Q1 and growth was well balanced between the U.S. and international.

In the U.S., trauma and extremities posted an impressive growth of 12% off of a tough 26% comparable, which was aided by competitor recall last year. This growth was fueled by continued strength in foot and ankle, up 34%. Hip growth of 6% and knee growth of 4% reflected seasonality and some disruption associated with the MAKO acquisition.

As publicly traded competitors, we were only able to start our integration discussions after the deal closed late last year. With that planning taken place over the course of the first quarter. During this period, we experienced hesitancy by our sales reps as well as some customers to move forward ending visibility around the integration specifics.

Starting in April, we now have the benefit of a unified sales force. With this key step in place, we are well positioned to leverage our considerable sales and distribution capabilities to drive sales growth going forward. U.S. MedSurg was led by robust growth in instruments, up 13% as the team is capitalizing on the late 2013 510(k) clearance of the Neptune Waste Management System.

Finally, as it relates to MAKO, during Q1 we initiated enrollment in a clinical study of a total knee application using MAKO’s Total Knee System. We are excited about this opportunity to further broaden the clinical applications to this technology and anticipate having a Total Knee on the market in 2015.

We are excited about these recent transactions and the opportunity for our divisions to leverage their considerable sales and marketing infrastructure to help drive accelerating revenue growth.

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

William R. Jellison – VP and CFO: Thanks, Katherine. Sales growth was positive by 5.3% in the first quarter, including a negative 1.1% impact from FX translation. Constant currency sales growth was a positive 6.4%, which includes organic growth of 5%.

Earnings per share on a GAAP basis for the first quarter were $0.18 per share versus $0.79 per share last year in the first quarter, while adjusted earnings per share were $1.06 per share for the quarter versus $1.09 in the first quarter last year. This quarter’s EPS includes a negative impact of approximately $0.05 per share from FX, the quarter comparison to last year’s first quarter is also negatively impacted by approximately $0.05 per share both from the tax extenders not being renewed and also from an additional full year benefit for the 2012 tax extenders booked in the first quarter of last year.

The most significant non-GAAP adjustments in the quarter are related to a $340 million increase in the charges associated with the voluntary recalls of Rejuvenate and ABG II. These charges may increase or decrease over time as additional facts become available and assumptions become more refined. No insurance proceeds that may potentially be available to cover some of these costs have been included at this time.

Looking at sales in the first quarter, our organic growth of 5% was comprised of a positive 6.9% from volume and mix with price negatively impacting sales by 1.8%. Acquisitions added 1.4%, while FX had a negative 1.1% impact due to significant weakness in both the Japanese yen and the Australian dollar compared to the same period last year. This impact should lessen considerably as we move through the year if rates fold near current levels.

Looking at our segments, Reconstructive represented 43% of our sales in the quarter. Sales of Reconstructive products were up 4.5% as reported and grew 5.9% constant currency. U.S. Reconstructive sales grew 8% in the quarter; Trauma and Extremities once again had another solid quarter with sales in the U.S. increasing 11.6%, with continued strength in Foot & Ankle as we work to expand that market.

U.S. hips and knees growth in the period were 5.9% and 4.4%, respectively and we believe the strong fourth quarter did pull some activity out of the first quarter. We expect sales growth to accelerate in 2014 and look forward to a Total Knee launch in 2015.

Our International Reconstructive business is up 2.9% in constant currency, and had low single-digit organic growth in the period.

Next, our MedSurg segment represented approximately 39% of our total sales in the quarter. At the beginning of the year we moved all of our Sports Med implants previously reported in our Recon business segment to a newly created sports med unit under common leadership in our endoscopy division. This business is reported up through our MedSurg business segment. 2013 segment information has also been restated to consistently reflect this move.

Total MedSurg sales increased 5.8% as reported and 6.8% on a constant currency basis. These results were led by double-digit growth from our Instruments business and high-single digit growth in endoscopy. Medical had low-single digit growth in the period.

Our Instruments division – keep in mind also now has the Neptune product back on the market after receiving FDA clearance and should ramp up nicely as we move through the year. Remember we were not able to sell Neptune capital last year.

International sales were strong, up 7.1% in constant currency, driven by our larger O-U.S. division endoscopy and instruments.

Our final segment, Neurotechnology and Spine, represented 18% of our sales and delivered another strong quarter. Sales growth increased 5.9% as reported and 7% on a constant currency basis. Growth in this segment was led by our Neurotechnology businesses and IVS, which grew double-digit in constant currency. Spinal implant sales were down low single-digits.

In looking at our operational performance, gross margins on an adjusted basis in the first quarter of 2014 were 66.9% compared to 67.5% in the same period last year. Foreign exchange rates and price had a negative impact on the rate this quarter as we felt the full impact of the weaker Japanese yen and Australian dollar. If rates stay at current level the year-over-year impacts from FX will begin to lessen as we move through at least to the back half of this year.

Research and development expenses increased to 6.5% of sales versus 5.9% of sales last year in the quarter. This is a 16.3% increase in R&D spending over last year and it also reflects our commitment to invest in areas which we believe will help us deliver above market sales growth.

Selling, general and administrative costs represented 52.3% of sales in the first quarter and this included approximately $340 million of cost related to the Rejuvenate and recall matters.

On an adjusted basis, SG&A expenses were $836 million or 36.3% of sales in the first quarter of 2014 versus 37.2% in the prior year’s first quarter. Operating margins on an adjusted basis were 24.1% in the first quarter of 2014 compared to 24.4% in the first quarter of 2013. The rate was negatively impacted primarily by pricing and foreign exchange rates in the quarter, partially offset by operational improvement and also from lower selling, general and administrative expenses as a percent of sales.

Other expense on an adjusted basis in the first quarter was $23.7 million compared to $10.8 million in the first quarter of last year. This increase in expense resulted primarily from higher interest expense and foreign exchange transaction losses in the period. Our reported tax rate for the first quarter was 34.5%, while the adjusted effective tax rate was 24.1% for the first quarter. This compares to a 20.3% adjusted effective tax rate in the first quarter last year.

As we move into 2014, we expect the full year rate will run closer to 23% with a higher rate in the first half. Remember, an extra year of tax benefit resulting from the renewal of tax extenders were included in the first quarter of 2013 and the tax extenders have not yet been approved for 2014, so no benefit for them was included in the first quarter.

While our 2014 guidance anticipates renewal of the tax extenders, they have not yet been approved by Congress and renewal and timing of them is still uncertain and is negatively impacting our tax rate early in the year. We also anticipate tax benefits from the reorganization and move of our European headquarters to the Netherlands. However, this is not expected to be in place until the second half of the year, so no favorable impacts will be included in our tax rate until later this year.

Looking at the balance sheet, we ended the quarter with $4 billion of cash and marketable securities consistent with our 2013 year-end level. We also had $3 billion of debt on the balance sheet at the end of the quarter.

From an asset management standpoint, accounts receivable days ended the first quarter at 56 days or two days better than the end of the first quarter last year. Days in inventory finished the quarter at 175, which was an eight day increase compared to 167 days in the first quarter last year and inventory levels increased in the quarter primarily in support of a Japanese ERP implementation.

Turning to cash flow; our cash from operations were $206 million compared to $236 million in the prior year. First quarter cash flow was lower as inventory increased in the period including amount to support an ERP implementation in Japan and our capital expenditures in the quarter were $70 million compared to $49 million last year in the same period.

We still have nearly $700 million available for share repurchase under a current authorization. However, no shares were purchased in the first quarter as we focused on and closed a few acquisitions in the period.

As Kevin mentioned, our 2014 guidance remains unchanged with organic sales growth in the range of 4.5% to 6% and adjusted net earnings per share in the range of $4.75 to $4.90. To assist you in your modeling, particularly as it relates to the first half, we would note that current foreign exchange rates are resulting in additional headwinds with the total year impact expected to be approximately $0.10 per share with the majority of the impact in the first half of the year.

Also as mentioned previously the renewal of the tax extenders remain in our guidance, however we now do not expect them to be renewed until later this year.

Thanks for your support, and we’d be glad to answer any questions that you may have.

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