Welcome to Stryker's Second Quarter 2015 Earnings Conference Call. My name is Adrienne 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. During that time, participants will have the opportunity to ask one question and one follow-up question.
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 more 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 ks filed today with the SEC. I'll now turn the call over to Mr.
Kevin Lobo, Chairman and Chief Executive Officer. You may proceed, sir.
Good afternoon, everyone, and welcome to Stryker's Q2 2015 earnings call. Joining me today are Bill Jellison, our CFO and Catherine Owen, Vice President of Strategy and Investor Relations. Following my opening comments, Catherine will provide updates on Mako, neurovascular and our transatlantic operating model. The momentum we are seeing across our 3 segments as we leverage strong sales and marketing execution and realize the benefits from both internally developed products and acquisitions. We are focused on growing organic sales at the high end of medtech and this marks our 9th consecutive quarter of achieving organic sales growth of at least 5%.
Our strong U. S. Businesses, which represent about 70 medical, trauma and extremities, neurotechnology and instrument. Medical and trauma continue their excellent performance and neurotechnology has been bolstered by new clinical data that Catherine will discuss. Instruments had a nice recovery from Q1 as much of their product order issues have been resolved.
Our U. S. Spine business was also a bright spot posting 9% growth in the quarter. We are encouraged about the growth of recent product launches such as Acculife from the Coline acquisition and have a robust pipeline of new products that will be launched over the next few years. This product flow when combined with a strengthened management team, positions Spine well for the future.
Outside the U. S, our performance was largely consistent as strength in Europe and a continued improvement in Japan was offset by some softness in other markets, including parts of our China and Latin America businesses. Looking at the P and L, the establishment of our European regional headquarters and related tax benefits are tracking ahead of our expectations. As previously conveyed, we are reinvesting roughly half of our tax savings to support our new structure within Europe, which is reflected in the year over year increase in SG and A. Our strong top line, disciplined expense management and better than expected reduction in tax resulted in adjusted EPS of $1.20 which was the upper end of our $1.15 to 1 $0.20 range that we targeted heading into the quarter.
We expect our first half momentum to continue, including an improved tax rate. And consequently, we 5.06 dollars to $5.12 a share respectively. With that, I will now turn the call over to Catherine.
Thanks, Kevin. The focus of my comments today will be on providing an update on Mako, progress with our transatlantic operating model or TOM as well as some comments related to our neurovascular business. Starting with Mako, we placed 13 robots globally, representing a Q2 record. This follows a Q1 record level of 9 and a Q4 of 2014 record of 20 robot placements. Of the 13 in Q2, we placed 2 in Australia, which represents our first sales in this key market for Stryker, where we command a market leading position in hips and knees.
During the quarter, we initiated robot upgrades, which will enable Stryker hip implants to start being used on the robot in Q3. The upgrades to the installed base will continue throughout 2015 and into next year. As you are aware, our total knee 510 application was submitted to the FDA late last year and we have responded to the agency's questions with no current change to our target for clearance in 2015. Shifting to Tom, with the completion of Q2, we are 6 months into our new transatlantic structure and are pleased with the progress we are making to optimize our European presence. We continue to invest in this initiative through a portion of the tax savings and all of our key leaders in commercial structures are in place.
We continue to see improving top line momentum in Europe and believe we are well positioned for a further acceleration, particularly as we head into 2016. Finally, the European regional headquarters represent the flagship for our presence in Europe as we bring HCPs into the site for training and education. We believe this will be key to strengthening the Stryker brand in Europe and enhancing our relationships with physicians and hospitals. Lastly, I will make some comments relating to our neurovascular business. As Kevin mentioned, we like the momentum in the neurovascular space and the recent update of ASA guidelines are one of the multiple drivers to market expansion.
We expect to see similar guidelines coming from Europe and Japan. Specifically in June for the first time, the recommended that patients should receive endovascular therapy with a stent retriever for the treatment of ischemic stroke, which represents the vast majority of the roughly 800,000 strokes that occur annually in the U. S. Alone. These guidelines represent the 1st new stroke treatment in 2 decades to win the strongest backing.
The usual treatment of an ischemic stroke is to administer a clot dissolving drug known as TPA. However, the drug must be given within 4.5 hours after symptom onset. With stent retrievers, the clots can be quickly removed from the patient to restore blood flow to critical vessels in the brain. Late last year and earlier this year, several major studies, including the MR. CLEAN study, found stent retrievers dramatically cut the risk of death or disability in patients whose clots persisted after treatment with tPA.
The new guidelines recommend patients be treated with a stent retriever if it can be done within 6 hours of symptom onset and if they have a severe stroke caused by a clot in a large artery. Clearly, the mounting clinical data and support from underscore the opportunity for endovascular treatment of stroke. However, it's important to note that much work needs to be done to further develop the market, including the optimization of EMS transport and inter hospital transfers, protocols in hospital infrastructure and investment in new human and physical capital to absorb the patient volume. Stryker remains committed to continuing its investment in stroke innovation with the recent launches of Trevo 6 millimeter, 3 millimeter and 40x30 or a long Trevo. This combined with further clinical studies such as the DAWN trial for late and wake up stroke patients.
With that, I'll now turn the call over
to Bill. Thanks, Catherine. Sales growth was 2.9% in the second quarter, including a negative 4.7% impact from FX translation. Constant currency sales growth was 7.6%, which includes organic growth of 6.9%. EPS on a GAAP basis for the 2nd quarter were $1.03 per share versus $0.33 per share last year in the 2nd quarter, while adjusted EPS were $1.20 per share for the quarter versus $1.08 per share in the Q2 of last year.
This quarter's EPS includes negative impacts of roughly $0.07 per share from FX in line with our original 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. The most significant non GAAP adjustments in the quarter relate to a charge of approximately $112,000,000 associated with the voluntary recalls of REJUVENATE and ABG2, offset somewhat by a favorable legal settlement with Zimmer Biomet. The charges for the REJUVENATE matter may increase or decrease over time as additional facts become available and assumptions become more refined.
Looking at sales in the 2nd quarter, our organic growth of 6.9% was comprised of a positive 8.7 percent from volume and mix, while price negatively impacted sales by 1.8 percentage points. Acquisitions added 0.7%, while FX had a negative 4.7% impact on the sales in the quarter. Looking at our segments, Orthopedics represented 42% of our sales in the quarter. Sales of orthopedic products were up 0.6% as reported and grew 6.2% constant currency and increased 5.3% organically. U.
S. Orthopedic sales grew 8 point 3% in the quarter. Trauma and Extremities had another standout quarter with sales in the U. S. Increasing 18%, reflecting approximately 30% growth in our U.
S. Foot and ankle business including strong double digit organic growth. U. S. Hips continued its strong performance and grew 5.7% in the 2nd quarter, while U.
S. Knees increased point 8 percent against a tough 7% comp last year. Internationally, sales were positive 1.1% in hips in constant currency and increased 5.3% in knees in constant currency. Next, our MedSurg segment represented approximately 39% of our sales in the quarter. Total MedSurg sales increased 3.9% as reported with 7% organically.
These results were led once again by double digit organic and constant currency growth in our Medical business as our sales force as
we
restored shipments from as we restored shipments from a supply issue, which negatively impacted the Q1. Endoscopy grew by 3.2% Our final segment, Neurotechnology and Spine, which represents 19% of our sales in the quarter, increased 6.4% as reported and 11.5% organically. Growth in this segment was led by strong double digit growth in each of our neurotechnology businesses, including neurovascular, CMF and NFE. Spinal implant sales increased mid single digit in the quarter and high single digits in the U. S.
As new products energize the business. And looking at our operational performance, gross margins on an adjusted basis in the Q2 of 20 15 were 66.3% compared to 65.9% in the Q2 last year. The increase in the margin rate in the quarter compared to the Q2 of last year resulted from negative pricing pressures, which were more than offset by favorable mix, FX and operational efficiencies. Pricing declined 1.8 percent in the quarter, in line with our expectations of approximately 2 percentage point declines. Research and development expenses were 6.3% of sales, slightly lower than last year in the quarter.
Selling, general and administrative costs on an adjusted basis were $879,000,000 or 36.1 percent of sales in the quarter versus 35.3% in the prior year period. The cost increases were driven in part by our decision to reinvest roughly half of our tax savings to strengthen our European selling and marketing activities and support our new European regional headquarter. We also incurred higher compensation costs, including commissions Adjusting for these items on a year to date basis, we would be delivering leverage of 30 to 40 basis to 40 basis points and we are confident in our ability to deliver at least this level of expense leverage in 2016 as we continue to drive a number of key initiatives in this area. Operating margins on an adjusted basis were 23.8% in the Q2 of 20 15, nearly flat with the Q2 of 2014. Operating margins on an adjusted basis were 23.8% in the Q2 of 2015, nearly flat with the Q2 of 2014.
The rate reflects solid operational improvements, coupled with favorable mix, largely offset by our investments to support our European business, negative price and compensation costs tied to our strong sales performance. Other expense in the second quarter was approximately $30,000,000 which is flat with last year in the Q2. Our reported tax rate for the 2nd quarter was 2.2 percentage points, while our adjusted effective tax rate was 16.8%. This compares to a 22.4% adjusted effective tax rate in the Q2 last year. Looking at the balance sheet, we ended the quarter with 4 point $3,000,000,000 of cash and marketable securities, approximately a third of it held in the U.
S. We also had $3,500,000,000 of debt on the balance sheet the end of the quarter. From an asset management standpoint, accounts receivable days ended in the 2nd quarter at 55 days, slightly below last year's Q2. And days in inventory finished the quarter at 173, just a little better than the 170 7 days in the Q2 last year. Turning to cash flow.
Our cash from operations in the first half of twenty fifteen were $737,000,000 compared to $579,000,000 last year in the first half. Capital expenditures were $114,000,000 in the first half of twenty fifteen compared to $124,000,000 in the same period last year. However, capital expenditures are expected to run higher than last year as we move through 2015. We expect significant cash outflows associated with our REJUVENATE settlement in the second half of this year with a major portion of the funding occurring in the Q3. So far in the Q3, we have paid out $786,000,000 and we expect to fund a total of approximately $1,200,000,000 this quarter.
Approximately 50% of the funding for the REJUVENIQ liability is expected to be sourced from OUS cash. Also as we previously mentioned, we have repatriated approximately $700,000,000 in the first half of the year and expect to repatriate nearly $1,000,000,000 more late in this year. We still have over $2,000,000,000 available for share repurchase under our recently expanded authorization as approximately $324,000,000 of share repurchases were made by the end of the second quarter. We will continue to evaluate the level and frequency of our share repurchases. However, current plans are to fully utilize the current authorization over the next 2 to 3 years.
Our strong second quarter results give us additional confidence in our ability to deliver improved operating results for the year. We are increasing our guidance for both sales and earnings for 2015. Our sales guidance now includes constant currency growth of 6.5 percent to 7.5 percent with organic sales growth in the range of 5.5% to 6.5%. If foreign currency exchange rates hold near current levels, we expect the net sales for the full year of 2015 to be negatively impacted by approximately 3.5% to 4%. Pricing pressure will continue and prices currently expected to be nearly 2% declines for the company moving forward, consistent with the pricing environment we experienced over the last year.
The benefit from the renewal of the tax extenders continues to be in our year end earnings guidance and represents approximately $0.05 per share for the year. We continue to expect that they will once again be approved. However, we do not expect them to be renewed until late in the year. As such, we do not have any benefit from them in our actual results or our planned earnings guidance until the Q4 of this year. We also expect that our adjusted tax rate will run at or below the level achieved in the first half of the year and will be noticeably better in the period the tax extenders are approved.
Based on current FX rates, we expect 2015 to be negatively impacted by approximately $0.25 per share for the full year. Keep in mind that the full year negative impact of foreign exchange rate movement is largely driven by the translational component of FX, which we do not hedge. And finally, we are also increasing our earnings guidance for 20 15. Our adjusted net earnings per share is now $5.06 to $5.12 with adjusted net earnings per share in the range of $1.20 to 1 $0.25 for the Q3 of 2015. Thanks again for your support and we'd be glad to answer any questions that you may have at this time.
Thank you. We'll now begin the question and answer session.
Hi, Bob. You bet. Hi, Bob.
Hey, terrific. Good afternoon and congrats on a really good quarter. So I have just two things I want to touch on, one for Bill and then one for Kevin. First Bill, one of the questions that we've gotten pretty consistently from investors relates to your ability to drop through operating margin leverage. And I noticed you made the comment about 30 to 40 basis points of drop through.
So was that an SG and A or an operating margin comment? And is that the kind of leverage you want us to expect you to be able to deliver as we look forward?
Sure. That comment Bob was specifically on our SG and A component and we wanted to just make that clear because we're making some nice reductions within that area currently. However, as you can tell that's obviously being masked by a couple of things this year and we wanted to highlight that. I think also as we relate to the 2016 comment, we're highly confident in our ability to create that leverage. But again, that's just at the expense level and we'll talk more broadly about our operating income levels as we give our regular guidance.
But you should expect and you're seeing our gross profit margin improvement currently show up. And as I mentioned earlier this year, we should have better comparables against gross margin as we move through this year. And so if we're getting any level of gross margin improvement, which we believe should be flat to a slight positive in a more neutral FX related environment along with some of the SG and A related leverage that we just talked about, you should expect leverage at the operating income line as well moving forward.
Great. Thank you. And then for Kevin and Catherine, obviously, you're seeing some clear strengths across your businesses. And as you think about capital allocation, does the strength of your business change at all? How you think about capital allocation priorities?
Does M and A remain the top priority? Just if you could just speak to that how this clear strength in your business might be impacting your thought process there that would be helpful.
Sure. Thanks Bob. Our capital allocation strategy is unchanged. We still have M and A as our first priority in use of cash. And you can see based on the actions we've done over the past couple of years, they are contributing to our sustained organic growth performance because after the anniversary of the 1st year then they become part of our organic business.
And we still see significant scope for acquisitions within the 3 segments that we play in today. So that continues to remain number 1. And as we've mentioned previously, dividends we intend to have steady increases at least as fast as our earnings growth potentially a little bit faster than that. And then share repurchase is the more fungible one which really varies depending on the timing and the flow of deals which as you know is inherently uncertain. But no change to our strategy.
The strength of our business frankly reinforces the strategy that we've been deploying over the past few years.
And the next question comes from David Lewis from Morgan Stanley. Please go ahead.
Good afternoon. Kevin, what I find interesting about this particular quarter, if we look at various segments that you were enthusiastic about at AAOS, namely spine, neuro and Mako, they've all come through. And frankly, I think most would agree have come through faster than most were expecting. So I think it would be helpful based on your earlier year enthusiasm, what's sort of your conviction on the continuation of the trends you're seeing here in the Q2 in those key businesses spine, neuro and Mako?
Yes. So I feel very good about all three of those businesses. Neuro has been a trend we've seen frankly for multiple quarters. And it's now being accelerated because of the ischemic stroke segment that Catherine mentioned which will be a multiyear journey. And that was based on the Concentrix acquisition, which we did in October of 2012.
So neuro has been really a continuation of a multiple quarter experience. On Mako, we turned the corner really about the midpoint of last year and you've seen sustained improvement and expect that to continue. We're of course very anxious for the total knee approval, which we believe will be another catalyst for enhanced growth. But our organization really has embraced this. The sales force integration is now really humming.
So we're feeling very, very good momentum and excited. We got over our back order issue that plagued us a little bit in the Q1. We were able to get through that on Mako in the Q2. So feel good about that. Spine really is the one business that's turned the most and the most recently.
And I'm really encouraged because it's based on a combination of product launches and numerous product If you look over the past 2 years, we've launched more than we did in the past 4 years. If you looked in the first half of this year, we've launched more in any 6 month period than we've launched probably in the last 3, 4, 5 years. So we've really gained momentum. We have new R and D leadership that has an exciting flow of products. And of course, we've added some acquisitions as well with Co align with the BioPhor Biologics.
So we have a number of products and the product flow going forward I feel very good about. And as you've seen in spine innovation is rewarded and you grow through innovation and new products and that's a tourism across large and small players in spine. So the innovation is alive and well in spine and our management team has been strengthened over the past year or 2. So I feel very good about our prospects of spine going forward.
Okay. Very clear. Thanks, Kevin. And maybe just a deeper dive, Catherine, on Mako. I think what's interesting is that business has basically gone up every quarter last 4 to 5 quarters.
This particular quarter you doubled Mako installs or systems year on year. We still haven't seen a significant impact from either product approvals on hip or potentially obviously the knee in the latter half of the year. So what is driving the momentum to make it? Was this simply sales reorganization focus? Or are we starting to see the enthusiasm for existing approvals and the approvals coming obviously in a few months?
I would say David it's more the former as we've got the integration challenges that we had early on last year behind us and the team is really working together and leveraging the considerable breadth and depth we bring along with the Mako expertise. We are in the process as I mentioned around doing the necessary software upgrade that will enable us to start to put our hip implants on the Mako. We have the clearance, but we have to do that work. And that will continue through this year and into next year as well. And then the knee indication, we are looking to get that clearance hopefully sometime in 2015.
It's in the hands of the FDA. But keep in mind, it is going to be 3, 4 quarters before we've gone through the necessary training and upgrades and work that's going to be needed to be done to make sure that that launch is truly optimized. So I would make sure to just consider that it will not be a light switch when we get that indication. It clearly enhances the value proposition of having a robot, but it is going to take some time to make sure we really optimize that launch.
And our next question comes from David Roman from Goldman Sachs. Please go ahead.
Thank you. Good evening, everybody. I was hoping we could come back to the neurovascular business. Understandably, Catherine, in your comments, you talked about the need for training and development and educating the market around the new guidelines. But if we look at the numbers that your key competitor put up in their most recent quarter as well as the step that we saw in your business today, it does look like the market was sort of ready to get moving here.
So maybe you could just help us think about how we should size this opportunity on a go forward basis and whether the growth rates we're seeing now are waiting for clinical data and new guidelines? I think waiting for clinical data and new guidelines?
I think that there are some well established in the minority stroke centers that were well prepared for this clinical data that were expecting it to be positive, but they had done a lot of that market development and had the patient into your hospital transfers and the various work that needed to be done completed. So they were good to go, but that does not represent the majority of places where patients would need to go. So I think you're seeing an early benefit, but there really is going to need to be a lot of market enhancement work done between us and others as well as additional clinical data. So we feel really excited. The data is truly compelling and the impact that this can have on patients is just it's clear that these devices have a very clear role to play.
But it will take time for this to be broadly applicable with all stroke centers, which is what we're trying to signal. I think it's too early for us to size the market up. We just have to see how this plays out on paper with roughly 80% of the 800,000 patients who have a stroke being ischemic and get to some very big numbers. But I don't think we want to get too far ahead right now until we've got some more time to see how the neurovascular community embraces the data and the market development work.
Okay. And maybe just secondarily, another question on Mako. I think Kevin one of the things you talked about at AAOS was sort of different ways to sort of get the capital out there and target of the Biomed accounts. Could you just maybe talk about how any of sort of the changed commercial strategy may be impacting the business today and any opportunities that may arise out of the Zimmer Biomet transaction and some of the divestitures that were required for completion there around Unis?
I'm not exactly sure I follow your question there. Just so in terms of relating the Unis, the Zimmer Biomet to Mako? Is that your question?
Well, I think as one of the divestitures required for FTC clearance was some of the Zimmer Uni products. So are you seeing any disruption in the market thus far that would provide an incremental opportunity for Mako associated with that transaction?
Yes. I would say it's really too early. I mean this deal is just closing right now. We haven't seen much of an impact there. Mako already had a very sizable portion of the uni market as it was.
And certainly every time there's a change any type of acquisition whether we're doing an acquisition or whether someone else is doing an acquisition as the companies integrate there usually is opportunity. So we'll see how that plays out. But right now it's too early to say. It really didn't impact this quarter that's for sure.
And our next question comes from Kristen Stewart from Deutsche Bank. Please go ahead.
Hi. Thanks for taking the question. I was just wondering if you can just reconcile the change in guidance just in terms of the EPS. I know that looks like FX is a little less negative relative to where you were guiding previously. I think in the Q1 you'd said it was going to be a $0.25 to $0.30 headwind.
I think the tax rate went down and the organic growth went up and you're reinvesting a little bit. So maybe just help me understand some of the moving parts just How much of it's underlying How much of it's the underlying organic moving versus reinvestment and so forth?
Sure. Kristen, this is Bill. And I think that as far as our overall guidance is concerned, we've obviously had some positives on a number of fronts. I mean, our sales and operations are doing very well. We've increased our top line sales guidance obviously.
Tax is obviously also a little bit better than our quite a bit better as well than we've been talking about earlier at least to The Street. And then as far as FX is concerned that might be a penny or 2 better for the whole year than what was there. But I think that there's also on an ongoing basis, there's a lot of other dynamics that are in the marketplace as well that we need to make sure that we're taking into account. And it's really the culmination of all those positives and negatives that we're looking at. Also keep in mind on the tax side that we have stated all year long that we've been expecting to reinvest about half of that, which is what you're seeing in kind of the SG and A side.
We have been expecting that investment upfront in the year. And so that's also reflected in the numbers that you're hearing.
Okay. And then so I guess the best way to think about it is, if not for the reinvestment you guys would have clearly I guess what would have been the underlying operational EPS growth if not for the reinvestment?
Yes. Keep in mind on the reinvestment, a chunk of the reinvestment is actually to support that overall project, which is running through the SG and A. Another part of it is what we've talked about upfront with our transatlantic operating model and some of the additional support that we want to be putting in our sales and marketing efforts, especially within Europe. And I think we're also already seeing some at least positive motivation and activities around that move at this point and we expect that that's got a multi year benefit for us. And as we talk about kind of the leverage that we've got with our underlying operating expenses, we believe that we're actually delivering that already this year and that's why we're also committing to some level of that at least externally as I mentioned on the call earlier.
Yes. I think Kristen this is Kevin. Just wanted to underscore what Bill said. So a good portion of the reinvestment is establishing that European structure and there's costs related to that. So the tax benefits, it's not like a one time event that's a windfall.
This is by remapping our transactions, creating a structure, creating this headquarters, there was a significant amount of cost involved in creating that. Of course, it's driving significant financial benefits through the tax line and those benefits will be there for years to come. So this for us is an investment that is clearly paying off, but it is directly related to each other. And it's not that the tax area is just a windfall and comes for free. There was a cost associated.
It appears on 2 different lines of the P and L, but net it's a huge positive for us and one of the contributors to our raised guidance.
And our next question comes from Mike Weinstein from JPMorgan. Please go ahead.
Hi. Can you hear me okay?
Yes, we can.
Hey, great. Hi, guys. So let me start off. I'll pick up actually and maybe push a little bit on the guidance as well. If I went back to so really the tax discussion goes back to the Analyst Meeting right last year and that's when you disclosed that there would be a couple of 100 basis point benefit from the European setup and that you were going to invest half of that.
But since the start of the year, the tax rate guidance has come down by what would basically imply today about 3.50 basis points. So that's like $0.20 And initially the FX headwind was $0.30 and now it's $0.25 So that's $0.25 of kind of incremental, call it, less headwind or call it incremental tailwind for you guys. And you've only you've raised the bottom end of the range by $0.16 since the start of the year, but you've only raised the top end by $0.02 Are you putting earnings away at this point for a rainy day? Tell us just reconcile the math I just walked through versus how much you've raised guidance so far this year?
Sure. Mike, I think one point to make is really around the tax rate side of the equation. And we and taking a look at kind of the expectation Street, we wanted to give guidance to say, From a directional perspective to The Street, we wanted to give guidance to say that it was a meaningful improvement, but we really didn't fully like identify that until we saw that run through our numbers. We wanted to commit to it. And just like with our investments that we were doing within that area, same thing.
We were spending a certain amount of money upfront that we knew we were comfortable with, but we also were holding some back and making sure that we wanted to see that realized through our earnings statements before we really are releasing that. So but our total expectation for the project is in line and which was the commitment for us to reinvest half of that total savings back into the business both to support that structure, which was pretty significant to support the change in the structure that we have within Europe, but then also to really ramp up some of our sales and marketing activities there.
Okay.
So the answer is you're not putting earnings away for a rainy day. I'll ask one follow-up so the operator doesn't cut me off. But just talk for a minute about U. S. Spine because obviously this is the best quarter in a while and just would love to hear your thoughts on it.
Yeah. Mike, just getting back. So for our guidance, obviously the guidance is really for our operational performance. And so things that when we give our Q3 guidance that's where we believe our operational range will be for the Q3. Of course, if FX changes, we've now after 6 months of our regional headquarters, we've now got a very good view of our tax rate.
So you're not going to see as much volatility in our tax rate in 3rd Q4. You can be much more reliable. As you enter a new structure like this, there's a lot of unknowns. We worked through those unknowns in the first half of the year. So now we're feeling a lot better about that.
So
you won't see as much volatility as we saw in the 1st 6 months.
And we do try to guide around what's going to happen operationally. And then of course things like FX and unknown things happen over the quarter that can move us up or down within the range. On Spine, so this has been it's been a while in the works, right? So we hired I mentioned I think at Academy a year ago, not this year, but the prior year that we had hired a new spine R and D leader and reestablished a real focus on innovation, which had been lacking in our spine business. And we've launched a lot of products in the first half of this year and we have a really robust pipeline.
So product flow is I would say number 1 issue. We also have enhanced some of our management team in spine, stabilized the sales force. And so we really have a good offense. We were running a very profitable business before, but we weren't growing very fast. And we've now turned on the engine of growth really behind new products.
And it's not something that I see as a one hit wonder. Of course, each quarter is dynamic. This is one good quarter. But I do see a sustained path for good results for multiple quarters going forward.
Our next question comes from Matt Taylor from Barclays. Please go ahead.
Hi. Thanks for taking the question. I had a couple of questions. I guess one was just if I look at the pricing in recon, it actually got a little bit better this quarter. It was the best it had been in, I guess, 6 quarters.
So I wondered if there was any real change there, if that's just within the range of normal variability?
I would put that in the range of normal variability. It can bounce around in the tens of basis points. Obviously, it's better when it improves or is less negative, but I wouldn't point to any change or difference in what's going on in the market.
Thanks. And have you seen any disruption from the ongoing combinations at your different ortho competitors? And maybe just comment on how you're seeing such strong growth in trauma and foot and ankle?
So we haven't really seen any impact from the Biomed Zimmer merger recognizing that it has just recently closed. So we'll see how that plays out. We're certainly not going to underestimate them as a competitor. They're 2 formidable organizations, but we're also very focused on continuing to drive growth and execute on Mako. And then on Trauma and Extremities?
Yes. I'd add on Trauma and Extremities this has been a multi year story, right? So if you look at 2012, 2013, 2014, each of those years in the U. S. We grew at least 15%.
And based on the first half of this year, it's safe to say it looks like we're going to deliver another 15% or more growth. So that's 4 years in a row. So we've just seen sustained performance. It's foot and ankle is large has been a huge contributor to that. That continues to grow extremely well.
And it's a market it's a little bit like the stroke market Catherine was talking about. It's been a market development story. So kind of hard to predict. It's frankly exceeded our expectations when we created the Foot and Ankle business unit. But that's a team that knows how to perform.
It's been performing consistently year after year. So we're excited. We still have a lot of room for growth in upper extremities. So while we're very pleased with our performance, it's not that we've reached the end of the growth opportunity. We're still actually a smaller player in upper extremities and we see that as a potentially exciting area for the future.
And our next question comes from Glenn Novarro from RBC Capital Markets. Please go ahead.
Hi, good afternoon. I wanted to just follow-up on pricing in light of what CMS announced with respect to this pilot program on bundling, we've been getting a lot of incoming questions about does this put pressure on price longer term? So my first question Kevin is what are your thoughts on this whole bundling project? Thanks.
Yeah. So what we saw with the initial pilots on the bundled payments is we really didn't see any different dynamic in pricing. So price pressure we expect will continue as it is currently. Once they start to focus on the total episode of care in a bundled payment, they tend to make much more focus on post acute costs, which frankly outpaced the cost of an implant. So we see this as a trend that really doesn't disrupt the implant pricing.
We'll have the same pressures we had before. If anything, it might start to drive them to rationalize towards less suppliers of implants. And in that world, we like that. Vendor consolidation to us is an environment where we feel we're well positioned to win. So to us this is a dynamic that we've seen in pockets and we haven't seen our business adversely affected by a move to bundled payments.
Because like I say, the post acute costs are very significant. And once they shine a spotlight that's where I believe more of the focus will be placed than on the implant costs. That's not to say the implant costs are not immune from price pressure, but I don't see it as a new catalyst.
Got it. And then just on medicals, another it was a very good strong medical quarter. And I just wonder if that's a function of the favorable CapEx environment that we're in today? Or is it a function of your new product cadence or maybe both?
I would attribute it to both. The Medical Group is doing a great job executing on product launches, some of which you may have seen at our product fair in June. The environment is stable. It's inherently volatile as we've seen over the years, but the outlook is very stable right now is how we characterize CapEx particularly for Medical.
And our next question comes from Richard Newitter from Leerink. Please go ahead.
Hi. Thanks for taking the questions. First question for Bill. You mentioned the 30 to 40 basis points of SG and A leverage in 2016 and you said flat to positive gross margin leverage in an FX neutral situation. Can you just flat to negative?
Sure. So on the flat to negative?
Sure. So that obviously relates to the gross profit margin piece of it. And from that perspective, we still are expecting about a 2 percentage point price decline level. As we've talked about before, as you're in that kind of 2% level, we believe we can in a normal kind of FX related environment, we believe we can still keep margins flat and actually hopefully still improve them slightly based on kind of all the cost initiatives that we have in that area. If pricing 40 basis points of improvement level.
And obviously, if it goes north of 2%, that also has a more negative related impact. But again, we see prices pretty much in line with where we are this year, which is right in that 2% range.
Okay. That's helpful. And then for that when you do in fact get approval there, even though we might not see it in the actual kind of implant numbers for knees and growth rates there, should we expect some sort of step up in your ability to play systems? Are there customers for whom the value proposition will become that much more apparent?
Without a doubt those customers who are going to see greater value in the robot with more applications and the total knee is the biggest one. So I have no doubt there's some who have waited. And I'm not sure I would necessarily model some step function change or bolus. This is a tough business to model, but it clearly strengthens the value proposition. But really the real driver will be a few quarters out once we start to do the upgrades and see more and more traction.
So I think in theory it makes sense. I think we'd be a little bit hesitant to get too aggressive in modeling any type of step function change.
Our next question comes from Raj Denhoy from Jefferies. Please go ahead.
Hi. Just I wanted to ask a question on the spine business. When that business was not performing well, there was a lot of questions about whether you would want to do an acquisition there to perhaps jump start the performance. And I guess my question is as you've now seen a resumption in performance and you've described it as kind of being longer term or at least having some durability, Does that change your view on that business and really how much how long you'll wait for it to grow, if that makes sense? I apologize.
I think the way we continue to view it is clearly M and A is a primary use of our cash as we've talked about. We have dedicated BD people in all of our divisions who are actively looking at targets and that's the reason why we were able to identify co align and seeing the benefit of that product from that acquisition. So they're always going to be out looking at ways to augment the portfolio, but first and foremost, we look to invest in the business and build it organically. And so we're never going to rule out acquisition targets in any area and they're going to vary in size. As you know, most of ours tend to be relatively small to midsize targets, but those BD people will continue to look at market opportunities.
But I guess as that business performs better, do you have more patience in a sense for it? Or do you still feel like you need to do something to because I guess you described wanting to be bigger in that business longer term?
Yes. I don't want to speak to any specific division. We've said we're focused on our core and key adjacent markets and spine is one of them. But we also do a lot of relatively smaller deals and I'm not going to rule out continuing to augment our portfolio. We do that when businesses are performing well and we continue to invest in them.
So there's no deviation or change in the overall strategy. Each deal will stand on its own merits, but I wouldn't want to single out any one division and say they're off the BD market for any period of time.
And our next question comes from Jason Waddes from Beren Capital. Please go ahead.
Hi, thank you. Just a couple of follow ups. First, the reinvestment that you're doing in Europe, can we assume that that's a finite period? I mean, basically just through the end of this year? Or how long will that reinvestment period run through?
So the investments that we're actually making there would be investments that would occur on an ongoing basis, but off of the same level, right? So we're investing about half of that tax savings this year, but you should think that that's just a normal step up for what we're doing within the European side. But as we're moving forward, we would expect to grow that new base level and leverage it as well against our sales growth as we would anything else. And that's why we wanted to reiterate that you should expect to see at least that 30 to 40 basis point of improvement in SG and A line category for next year.
Okay. That sounds
like a one time investment. This is an investment that supports the business moving forward.
I think okay. That's helpful. And then just another follow-up on Trivo. I think, Catherine, based on your comments, it sounds like the large stroke centers have pretty quickly picked up on the data and have changed their practices. But if you start going to more regional or smaller centers, it's unclear whether they're moving in that direction just yet.
Is that the right way to think about what's going
on in the marketplace? Yes, it's very well tablet stroke centers that are very sophisticated and we're ready to go. I think a lot of those other stroke centers were waiting for data to be a catalyst to say we have to start to do this work. And this data that's come in like Mr. Clean and will be coming in is certainly that catalyst.
But it takes time as you think about that laundry list of market development items I mentioned. Those are not something that will happen in a quarter or 2. It will be a few years, but it's clearly supported by the data that I think will prompt many of those to start to make those changes and investments.
And our next question comes from Mike Matson from Needham. Please go ahead.
Hi. Thanks for taking my question. I guess, first of all, I just wanted to see if the selling days this quarter were the same as the year ago quarter?
Yes. There's no change in selling days.
Okay. Thanks. And then I know it's a smaller deal, but I was just wondering if you could comment on this Mukha Medical acquisition that you did?
Yes. We're excited about that. The medical group is clearly excited about it. We've had a relationship with them, a distribution agreement going back to 2012. Company has been around for nearly 50 years, a private company based out of Turkey.
And they've done a great job. They specialize in the design and manufacture of hospital beds and stretchers. And they've been primarily serving the Turkish market and surrounding countries. So it's a great opportunity for us to build a presence in that segment with a premium value product. We know them well, so we're comfortable with where they're located in their manufacturing facilities.
And it really helps to further strengthen our portfolio longer term. So it's a small deal and there'll be some very modest not material incremental sales, but clearly a great product franchise for to further bolster what medical is doing.
And are those products intended to be sold globally? Or is it more for the European markets or emerging markets?
It's primarily for the Turkish and surrounding countries as well as some in Latin America. Longer term, we'll wait and see what direction we go in with this, but you should not be thinking about that as a near term U. S. Product offering.
And our next question comes Larry Biegelsen from Wells Fargo. Please go ahead.
Hey, guys. Thanks for taking the question. So just starting with neurotech. So we understand that a lot of physicians prefer to use an aspiration device with the Stentriever. Do you guys have any plans to introduce your own aspiration device?
And if so, what's the timing? And I have a follow-up. Thanks.
Sure. Thanks for the question. One of the great things about neurovascular, both the hemorrhagic and ischemic side is there's so much opportunity for innovation and you've seen that over the last few years with technologies coming out and we have a very robust pipeline on the R and D side. I'm not going to get into specifics at this time around, which products and the timing of them, but I will say we're very comfortable as one of the market leaders here and with the talent in our R and D team that we are well positioned both with our current portfolio and future generations of products that we'll be introducing. But I'm not going to get any more specific at this time around timelines.
I understand. And then Kevin, I think you mentioned some softness in China. Can you talk about what you're seeing there? Just very quickly, Bill, on the tax rate, I'm a little confused what tax rate to use this year. I mean, last quarter you said less than 20 percent, but it's like trying to get about 18% in the first half without the R and D tax credit?
Thanks a lot guys. Okay. I'll start with the China question. So we saw good really good performance with our implant business. Where we saw the slowdown was in capital equipment.
We saw that hit quite sluggish in China in the Q2. And we even saw in Latin America also the issues that we had were more pronounced in capital equipment than in our implant business.
And associated with the tax rate question that you asked, our year to date operating tax rate is about 18.1%. And as I mentioned in the call script, we're comfortable with a rate for the full year at or slightly below that. Keep in mind, as you mentioned, the tax extenders are not in that number yet. So when the tax extenders are ultimately approved hopefully by the Q4 of this year in that period you'll actually see the tax rate dip down again that one period obviously, but because that would be a full year benefit of those extenders being picked up in the Q4. But for an average rate for this year, we would expect to be a little bit below what our average trend rate is right now.
And I think that that's relatively a consistent tax rate that you could project for next year as well.
And our next question comes from Matthew O'Brien from Piper Jaffray. Please go ahead.
Afternoon. Thanks for taking the questions. Kevin, as I look across the businesses, it looks like the performance is quite strong across the platform,
but it seems like
it's more volume driven than anything that we've seen to
function of benefiting from things like ACA, the deferrals and CapEx that are now kind of coming through and then guidelines in neuro? And is that something that you feel comfortable being able to smoothly transition through or lap as we get into next year, some of those benefits not being as much of a tailwind?
So it's hard to generalize, right, because every division has its own story. So if you look at Trauma and Extremities and the performance there that's a lot of it was innovation creating a new business unit for foot and ankle. So I think each division has its own story. The overall tailwind around capital equipment is undeniable and I think it's you see that in the marketplace. So that's been a real positive.
But if you look at our instruments division as an example, even before the tailwind, they were really performing at a very, very high level and double digit growth kind of performer and getting Neptune back on the market and growth there. So I feel really strongly about all of our divisions' leadership, their innovation pipeline, looking at the way they look at acquisitions. I get a chance to go around and visit with every division. And we've strengthened a lot of leadership in many areas and we have very, very strong positions. And so we were growing faster than the market when the markets were a little bit down.
Now the market is certainly moving up in the capital equipment side and we're taking full advantage. But you could see even in an area like medical that's done 2 deals just in the past year, they're smaller deals, but they're adding to the innovation that they're doing organically and innovation wins. And so when the market is good, you can see the numbers are buoyed. But I'm not worried about as we get into comparatives that are a little bit higher that we can sustain strong growth.
Okay. Very helpful. And then as a follow-up question, just looking at the environment that we're in right now with extremely low interest rates and robust equity markets, I'm just curious on the asset side of things. You've done a couple of smaller deals recently, but are the valuations that are out in the market place right now for some of the larger acquisitions, even midsize acquisitions targets getting to the point where it just doesn't make sense? Are you unable to meet your internal hurdle rates with some of those assets?
And if that's the case, are you willing to given the environment adjust your internal hurdle rates?
I would say clearly valuations have moved up. We're always confronted with challenges around valuation, sellers' expectations even in an environment that hasn't been quite as strong as recently. So it's always going to be a factor that we've got to consider. It hasn't changed our priority around M and A, but it certainly does become an issue on some deals that doesn't impact the numbers we look at. And the next question At this time, there's no change in terms of as you sorry, the second part of your question when you talk about our hurdle rates and returns.
We're pretty disciplined in the approach we take there. We think that makes sense.
And our next question comes from Joanne Wuensch from BMO Capital Markets. Please go ahead.
Thank you very much. Most of my questions have been asked
and answered. But briefly in China, you've made a
number of investments there over
the years. I remember Charleston very well. Do you have a footprint there that you want to have?
Well, overall, we still have a long way to go in China. I would say the Charleston acquisition was a great deal for Trauma and Spine and we're expanding in China. We are still about to launch in India. So we don't sell TROSIM yet in India. We're launching that in the second half of this year.
We're still waiting for approvals in Brazil. We will launch that next year. So I think TROSIM has a lot of room to grow outside China. Inside China, I'm very pleased with that. But we don't yet have a lower priced hip and knee offering.
That's something that you could see in the foreseeable future. That's something we'd want to pursue. We're not still covering all of the territories in China. So we're continuing to grow our sales force in some of the more remote areas where we still don't have access. So we've been growing our China business very strongly over the past 5, 6 years in both the premium segment as well as the lower priced or mid tier segment.
But we still have a long way to go. I would say that the market potential in China is still very significant. Right now, obviously, you're hearing a lot about a China slowdown. But I think within Healthcare, we still believe we have a lot of room to grow. And certainly on the MedSurg side, that's been an area the endoscopy business has been a very strong business.
But our other MedSurg businesses don't yet have a very, very strong footprint in China. So we still see a lot of opportunity. We're learning a lot about the mid tier segment. And TROSTON was our first foray into that segment And figuring out how to win in that marketplace with other products is something that I see maybe not in the next year, but in the next 5 years as very important for Stryker. So we still have a long way to go.
I appreciate that. As a follow-up, one of the areas or one of the ways that Spine has grown is investment in the sales force. Is there a way to qualitatively talk about how much larger that sales force looks like to In
which country, sorry?
In which country sorry? She got cut. I'm sorry. I wasn't sure. The question was in China.
So we obviously use a distributor network in China and we for the mid for the mid tier segment. And what I mentioned to you is we've got very good coverage in the big cities and in some of the surrounding areas. But pushing to the western part of China, we still have room to grow and that will largely be through expanding the distributor network. So it's not so much about direct sales force. It's more about making sure we have the right distributors to cover the rest of the country.
And our next question comes from Josh Jennings from Cowen and Company. Please go ahead.
Hi, good evening. Thanks a lot. I just wanted to start with on Mako. Catherine, you mentioned 2 systems placed in Australia. And maybe if you could just give us an update on the plans for OUS launches in other countries?
Or are we getting ahead of ourselves?
Yes. I think it's going to continue to be dominated by the U. S. Robot placements. Australia is a market where as I mentioned we have very strong market positions in both hips and knees.
So it was a market that made a lot of sense. But I think as you go forward I would really focus on the U. S. Is going to be the primary driver of the placements.
Great. And just in on the emerging markets business, pardon me if I missed this in your prepared remarks, but can you just talk about including you talked a lot about China, but just other avenues within emerging markets where you are in terms of your trajectory this year actually in the first half of twenty fifteen? And any initiatives you can to accelerate your emerging market growth? Thanks a lot.
Yes. So I would say after China, which has been a really strong market, our strongest emerging market is China at Stryker. After that I would say I'm really pleased with our progress in India where we're growing very, very well from a small base admittedly, but we're having very good performance starting from last year in India and it seems to be very sustained growth. The other priority market is Brazil and Brazil obviously is going through a pretty tough recession right now. We also had some issues where we had to change one of our spine dealers in Sao Paulo and that caused a bit of an issue in our spine business.
And so we have that from time to time in Brazil, which represents roughly half of Latin America. So that's so Latin America is the future very important for us and we're quite a small player. But I would say this year because of the recession in Brazil, it's not going quite as well as it has in the past couple of years, but certainly an important market for the long term. Areas like Russia and Turkey are actually doing quite well, but you can imagine those are not exactly the most attractive markets at least at the moment. But those are the other 2 emerging market countries that are going to be a top priority for us.
But we're measuring our investments. We had planned if you look back maybe 2 years ago, we were planning to really invest more vigorously in Russia and Turkey. And given the macroeconomic conditions there, we've tempered our investments in those two countries. But clearly, we it represents about 8% of our sales Stryker Emerging Markets and we would like that number to be much higher. But the conditions have to be right and we want to make sure we get a good return on our investment.
But there's a couple of markets that are doing very well and there's other ones that I think we're going to be a little bit more measured in the pace of our investments.
And our next question comes from Bill Polivaniks. Please go ahead.
Great. Thanks. Good evening. Thanks for taking my questions. First on the foot and ankle, that's grown really well for you.
Would you say that that you're creating the market with procedural kitting or do you think that's more taking share from existing players in the foot and
ankle piece? Well, with the kind of growth we've had over the past few years, I would say the bulk of it is market development. But you can't grow at this kind of rate without taking some share. So I'm sure we've taken some share along the way. But this has been a is really more about a new market story where we're getting people that weren't using implants to start to use implants.
That's been the biggest engine of growth within foot and ankle.
Okay. And then on Mako, as you place these systems and that's reaccelerated, is this based more on an alternative financing method or are these kind of direct sales?
Yes. I would say we have a flex financial unit within Stryker that provides various options to make capital easier to acquire. And we have used that to for some of the sales of the robot. But frankly, the vast majority have been direct purchases thus far. So the hospitals are finding capital and they are pointing it up.
But we do have an arsenal of a range of options for them to choose from. And we I think going forward certainly in Europe as an example as we start to expand Mako in Europe I think using financing will be much more prevalent than it is here in the U. S. But in the U. S.
They've been the vast majority have been direct purchases.
There are no further questions at this time. I'll now turn the call over to Mr. Kevin Lobo for any closing remarks.
So thank you all for joining our call. Our conference call for the Q2 of 2015 results will be held on October 22, 20 15. Thank you.
Thank you, ladies and gentlemen. This concludes today's conference. Thank you for participating and you may now disconnect.