Stryker Corporation (NYSE:SYK) 6th Annual Evercore ISI HealthCONx Conference November 29, 2023 1:20 PM ET
Company Participants
Glenn Boehnlein – CFO
Jason Beach – Head, IR
Conference Call Participants
Vijay Kumar – Evercore ISI
Vijay Kumar
Stryker this afternoon. We have Glenn Boehnlein, CFO; and Jason Beach, who heads Investor Relations. I’m Vijay Kumar, I cover Medtech and Life Sciences at Evercore. Glenn, Jason, thanks for taking the time.
Question-and-Answer Session
Q – Vijay Kumar
So you guys had a pretty bullish Analyst Day, year-to-date trends have been really strong. We have to start with the customary macro utilization question. So far, macro utilization trends, have they been playing out as per plan? Any changes in the macro environment?
Glenn Boehnlein
Yes. I think — and thanks for that. You’re right. We were very excited about getting to tell our story at Analyst Day, at least for those of you that might have been able to attend. Exiting Q3, moving into Q4 and thinking about 2024 as we look at some of the macro trends that we’re seeing. First of all, we really are feeling that procedural tailwind in Orthopedics. We don’t anticipate that slowing down. We fully expect it to continue into 2024. Both on the Hip and Knee side.
I would also say that for Stryker, we’re also feeling the uplift that we’re getting, say, from just our Mako footprint now that’s out of the market, as well as our new hip stem. And so Insignia, both of those have been real lifts for both those sides of the businesses.
Flipping to our MedSurg side in terms of macro trends, if you think about backlog is a good barometer for us of what are — is the customer order situation that we have. And I would tell you that we basically are at the same level of backlog that we’ve been at all year, which means that as we ship product in any one given month, we’re taking in the same amount or even greater number of orders.
And so that — first of all, it gives us really good insight into what are the buying patterns of our customers. How are our customers thinking about 2024, because a lot of that backlog goes into 2024, and all those things look positive. I mean, I think on the — the couple sort of — if I’m sort of picking apart knits at the edge here, there are still supply chain, just hotspots. I feel like we’re through most of that. But there are flare-ups that happened here and there.
I think staffing has stabilized for our customers. So they are operating in sort of their new given staffing levels and are maximizing their procedures based on those staffing levels. So overall, we feel really good heading into next year.
Vijay Kumar
Fantastic. You did bring up backlog on the MedSurg side, I think CapEx comes up, Glenn. And it’s been a little confusing because some of your peers have cited challenges by customers, signing great environment. Is Stryker gaining share? Is that what Stryker is seeing? Or have you heard anything from your customers about the capital environment as they’re contemplating fiscal ’24?
Glenn Boehnlein
Yes. I mean, first of all, don’t let me give you the wrong impression. It’s not that it’s not competitive, and it’s not that our customers aren’t being mindful about how they spend their capital and these capital analysis committees and things like that still all exist. And so I think those procedures are still there. I think a couple of things.
First of all, we have two kinds of capital. We have sort of big capital beds, structures, booms, lights tables, and we have smaller OR related capital that really ties directly to revenue streams for the hospitals.
And on the big capital side, those processes are largely the way they have been. There are trials. Bigger capital can often be tied to OR remodels or even ASC newbuilds. We still see that fairly robust. We have a good backlog there.
I would tell you that the timelines are more elongated there maybe than they usually have been, but we still have a very healthy backlog. I would say on the smaller capital, think about Endo cameras, System 9. For that type of capital, it’s still a very robust order environment. And I think to the extent, customers need that capital because they’ve either put off purchases during the pandemic, and this is capital that depreciates fairly rapidly because it’s utilized so heavily. They’re on replacement cycles.
And then you combine that with the new releases that we’ve had of those products and I think we’re in a good position to certainly capture market share and drive really good growth.
Vijay Kumar
Got you. And just looking at some near-term numbers, Glenn, you have Q4 guidance, I think, implies maybe keen sort of sequential step up from third quarter levels. Historically, you guys have done mid- to high teens. So wondering if there was something that got pulled forward into 3Q, any seasonality impact here when you look at Q4?
Glenn Boehnlein
Yes. First of all, we don’t necessarily guide quarter-to-quarter, but I assume you’re very pleased with our full year guide. And so yes, you can back into what the quarter needs [technical difficulty] to be. I think part of that is we’re up against a very tough comparable in the fourth quarter last year, and that maybe drives — still a very, very healthy number and a healthy volume increase, but maybe somewhat of a suppressed gross number just because of that comparable. I mean, I don’t see any indicators say, quarter-over-quarter where there’s any deacceleration across any of our businesses.
Vijay Kumar
Got you. Fantastic. And then maybe sticking on to this macro theme, with war, any impact from geopolitical tensions here for Stryker business?
Glenn Boehnlein
Fortunately, the two areas that are sort of hotspots, we did not have business in Ukraine to begin with. So that necessarily hasn’t been an issue for us. We do have manufacturing in Israel, but it’s well north of where everything is happening, and we don’t foresee a disruption in that area as well. And then beyond that, we really haven’t seen too much. Obviously, we’re complying with some of the restrictions, relative to what you can sell in Russia. But none of those businesses also are of a magnitude where they’re going to be meaningful to our overall results.
Vijay Kumar
Got you. And then sticking on the international regions here, Glenn, China VBP is another one that comes up. What was the impact to Stryker in fiscal ’23? Any impact for fiscal ’24 from new VBPs?
Glenn Boehnlein
Yes. I mean, keep in mind, China is roughly 2% of Stryker sales. So again, not a very meaningful number in the totality. We did have an impact from VBP, especially on the Orthopedic side of our businesses, but that is largely absorbed now and behind us.
So year-over-year comparables are sitting with the VBP impact in. There continues to be Neurovascular VBP, tender issues that are coming up. And so there probably will be some impact to Neurovascular next year. But again, just given the magnitude of the overall materiality of China for overall Stryker, I don’t think it will be something that would hit your radar screen.
Vijay Kumar
Got you. And I’m assuming within in the 2% Neurovascular in China is very, very miniscule. The majority is recon?
Glenn Boehnlein
No, I would say Neurovascular. I don’t know that we probably haven’t disclosed this, but Neurovascular is bigger than recon in China.
Vijay Kumar
Okay. That’s helpful.
Glenn Boehnlein
Even post VBP.
Vijay Kumar
And the — I guess the elongation of timelines for large capital, Glenn, reminder, large capital, I think, was 8%, 9% of Stryker revenues. This elongation, is that new projects, new wing build-outs of new facilities? Is that where the delay is happening or…
Glenn Boehnlein
A lot of it is on the customer side. So if it is new facilities, there still is sort of supply disruptions in the construction industry. And so we’re beholden to timeframes that our customers have, relative to when they want to take our equipment. I mean the good news is they’re coming to us with the order, we’re taking that order off the street. So the question is, just becomes when do we deliver on it. And it’s more on their time schedule than ours.
Vijay Kumar
Got you. And then one more big picture macro question before we into the good part on new products. GLP-1, obviously, at the Analyst Day, you did highlight, you had a panel. That was helpful. But it also looks like you guys did some internal analysis. Anything that you would like to share on what kind of analysis you guys did? Or why Stryker feels so confident that shouldn’t be an issue?
Glenn Boehnlein
Yes. We — for our part, we haven’t done anything formal that we’ve published, but we will talk about, we essentially went to almost all of our KOLs to get their opinion on how is this going to impact their business? What were they seeing sort of in their own practices or even hearing from customers? And that really helped us form our opinion that first of all, in the short term, these drugs actually bring more patients into the funnel. There are a lot of patients that are not qualified for hip or knee procedures because of weight issues.
So if they can lose 20 or 30 pounds, that actually brings them into the funnel that they can be future patients. I think over the longer term, the opinion is osteoarthritis is much more impacted by activity than weight. And so if you make these patients more active, we think that it probably at least is at a neutral place in terms of what might be the long-term impact for our business.
And there are lots of other factors relative to side effects of these drugs, the cost of these drugs, there’s a lot of things that play into this. So right now, for short term, we actually think it’s a little bit of a slight tailwind.
Vijay Kumar
Got you. But just to be clear, at the Analyst Day, sort of the framework you laid out, that’s not assuming any tailwind from GLP-1, right?
Glenn Boehnlein
No.
Vijay Kumar
Yes. And I think at the Analyst Day, you said large joint end markets should CAGR at mid-singles. I think that’s slightly above sort of the general perception, recon being like low single CAGR. What changed? Why is that mid-singles? Is that because of robotics? Is that because of backlog?
Glenn Boehnlein
Yes. I think — so our timeframe is through 2026 as we look at that in the report that we put out. And we’ll take a couple of things. This procedural backlog is going to drive sort of higher than historical normal growth. We also think that robotics is going to start to have an impact, just given the magnitude of the footprint. And then honestly, just demographics. If you just look at populations as a whole, you’re going to see a lot more people getting of the age that they’re going to start sort of looking at these procedures. And then the last thing that’s happening in demographics is that we’re seeing younger patients come into these procedures a lot sooner than they had in the past decade.
Vijay Kumar
Got you. And I know in the past, you’ve given an installed base. Any update on how large that installed base? It looks like Mako is going to be more significant, and that seems to be tighter utilization in your installed base. Has something changed?
Glenn Boehnlein
I’ll let Jason do this one because he’ll…
Jason Beach
Yes. So for competitive reasons, we don’t disclose a number of robots. We’ll certainly give you a better update in January in terms of utilization and those types of things to give you a sense of how Mako is performing.
But even if you use Q3 as an example, both in the U.S. and outside of the U.S., installs were quite good in the third quarter. If you look outside of the U.S., obviously, Mako outside of the U.S. got a little bit of a later start as you think about regulatory timelines and some of those things. But great momentum outside of the U.S. as well. So like I said, we’ll give you a little bit more color in January, but we will kind of steer away from installed base.
Vijay Kumar
Got you. And any sense on what the utilization growth on Mako’s been, Jason, over the past few years?
Jason Beach
Well, I mean, you probably heard us disclose at Investor Day, right? We’ve got, call it, 60% of our knees done on a Mako and 30% on Hips. So that continues to grow. And we think that’s a really good indicator of kind of Mako momentum. So while we haven’t necessarily disclosed every year in terms of that, it certainly trend positively over the last several years.
Vijay Kumar
Got you.
Glenn Boehnlein
Yes. And the one thing I would just add to what Jason said is we’ve — we initially had this heavily focused on getting placements out in the market to customers. Our focus now is not only on placements, but also driving utilization. And that utilization just — once we can get a group of doctors that want to do the procedures on the robot, they typically want to repeat that over and over and over again.
And so as you think about robots and some of the factors that might be important, placements are important, but more and more as the market matures, it’s utilization. Are they actually using the robot?
Vijay Kumar
And do you have a way to track that in real time, Glenn, on utilization and has the system…
Glenn Boehnlein
We do press a button, then I can see this comes up on my computer. Yes. No. I don’t. But we do track it, and it’s compiled monthly.
Vijay Kumar
Got you. Got you. I — the only reason I bring that up is, you mentioned 60% of your Knees are done robotic, and I’m assuming the market is sub-20%, right? Being robotic. And as you hit that 60%, is this now where we’re looking at incremental share gains from the market? Like why can’t the market be a 60% robotic?
Jason Beach
Yes. Look, I think we’ve said, right, as you think about where percentage Knees done on Mako could go, I mean there’s still plenty of room here, right? As you think about robotics, I think more and more, it’s becoming kind of the price of admission, right? Not just in the U.S., but as you start to go outside of the U.S. So we think there’s plenty of runway here for both Hips and Knees, actually.
Vijay Kumar
Got you. And you did give us a cumulative number or robotic procedures at over 1 million being done in Mako. Do we have a sense like how many of those were Knees versus Hip?
Jason Beach
Yes, we did not split that out or disclose it. But just if you think about the initial momentum with Knees versus Hip, I mean, obviously, it’s going to be significantly more from a knee standpoint. But yes, we didn’t break it out between the two. .
Vijay Kumar
And when I use a knee analogy of A), when a robotic penetration of knee took off, Stryker Knees outgrew the market, I think, almost like 2x. Should we expect something similar like that for Hips, just given the traction early momentum we’re seeing here?
Glenn Boehnlein
Yes, I think you probably won’t see that exact mirror. I mean Knees was right, right? Because Knees were inconsistent. Not everybody could do a Knee the same way. And this gave you a platform that really drove operational consistency and a more sort of data-driven procedure. I think with Hips, there’s a lot of satisfied patients that have had manual hips. So there still is a lot of doctors who feel like, hey, I can accomplish this procedure.
I do think, to the extent we have placed a robot, what we’re finding is that a lot of these docs that do Knees are like, well, I’m going to give it a try doing Hips. And if you look at the complement with our new Insignia Hip and sort of the software that we have on Mako, it works really well. So I do think we will drive more Hip utilization, but I don’t think it will reach the point where Knees is.
Vijay Kumar
Got you. Then maybe perhaps pivoting away from a recon when you look at what’s exciting, what’s in the pipeline. Clearly, Spine, shoulder, that seems pretty exciting. I think it seems like your language around the Spine application has changed recently. And certainly at the Analyst Day, did feel like us, it seems like you certainly feel like your offering will be differentiated. Maybe just highlight on what does — why Stryker won’t be a me-too follower. What is differentiated about your Spine offering?
Glenn Boehnlein
Yes. I think the big thing for us is maybe not just the end effector for Spine that will be added to a Mako robot, but it’s also the ecosystem that we’re setting up. And Kevin has alluded to it, there are other products that are under development that will launch with that application, that just between those sort of front-end products, the spine product, navigation and all of those together, will just create a differentiating factor for the procedure. So we’re super excited about it end of next year.
Vijay Kumar
And what is your expectation for adoption within Spine, right? Should this be more similar to the Knees? Or should this look more like Hips?
Glenn Boehnlein
That’s a good question. Here’s — well, here are my expectations. I think it puts us on a level playing field from a competitive market standpoint, which is something we need.
Secondly, I think we have a slight leg up, because we are talking about an end effector that can be attached to an existing Mako installation. So the barriers for a customer to maybe want to trial this are pretty low, especially for the ones that already have Mako.
So using that as a platform to launch I think will give us a lot of tailwind in terms of when we do go out. Am I going to go on record with quoting? Will it be a nip or a — Knee or a Hip thing? I don’t think I’m going to ready to say that yet.
Vijay Kumar
But the value proposition here is — it’s pretty clear, right? In a navigation, I think in Spine tends to be challenging. So there clearly should be some advantages.
Glenn Boehnlein
Yes. and we’re very excited about it. We’ve also previewed it at NASH with some select surgeons. And so there is a lot of energy around it.
Vijay Kumar
And on the shoulder side, like what’s the value proposition in shoulder, Glenn?
Glenn Boehnlein
Yes. I mean, first of all, shoulder is a really complex procedure. There’s lots of soft tissue. There’s a lot of customers that have a shoulder procedure that are not necessarily satisfied. The recovery period is very long, sometimes up to nine months to recover from a shoulder operation.
I think what robotics will bring to the shoulder procedure, again, a little bit more precision about how cuts are made. Robotics can also avoid certain soft tissue anatomy in a way that manual just can’t, and allow sort of this precisement of cuts preservation of soft tissue. And all of those things, if you look at even other joint procedures or even manual shoulder procedures, those contribute to a better experience for the patient and a better outcome for the patient.
So I do think shoulder — and the other thing I would just add to that is it’s a complex procedure. Anyone who’s getting a shoulder should absolutely go to someone who is just doing shoulders nonstop because of that. So then if you look at like community hospitals or smaller hospitals that offer the procedure, it may be level the playing field a little bit for how they can execute that procedure for docs that aren’t necessarily doing it day in and day out.
Vijay Kumar
Got you. Clearly, it feels like shoulder should also be right in the Mako wheelhouse, just given it’s complex and there is a clear value proposition.
Glenn Boehnlein
Yes. We’re — it’s — when we bought Mako, it clearly was something that was on the roadmap, then you fold in right medical and given our upper-extremity position now, it makes a lot of sense for us.
Vijay Kumar
Got you. Once you have these applications, fair to assume like those growth within Spine and shoulder should be about markets about end market, Stryker should be gaining share in those markets?
Glenn Boehnlein
Yes. I mean I would argue in shoulder, we’re already gaining share currently. But as I said, in Spine, it levels the playing field. And yes, the expectation would be that we can gain market share.
Vijay Kumar
Fantastic. Then switching over to the big three new products, 1788, System 9 and LIFEPAK. 1788, let’s start with that, and it’s already been launched. It looks like it’s been off to a pretty robust start. Where are we in the adoption cycle? I think in the past, you’ve said it’s a two-year cycle. Just given the robustness of the cycle, is that now getting pulled forward into one year? Or is that still a two-year cycle?
Glenn Boehnlein
No. There’s lots of runway to go on 1788. I would say, starting when we did for 1788 really allows us to jump in and perfect our trialing. It also helps us designate which customers we want to go to first. Believe me, customers have been in the order pipeline for probably six months now, relative to wanting to trial and see the 1788. For those customers that are on calendar year ends, it helps them put it into their budget for next year, which is helpful.
So I do think 1788 also is maybe a step-up in terms of technology, and that’s differentiated from, say, a 1688 launch. So I do think that there’s a lot of excitement from customers in terms of what 1788 brings to market. And with that, we’ll — with really big technology like that, we’ll gain price, we’ll gain market share, and there’ll be really good momentum.
And then same thing with System 9. It’s been out already, but really with System 9, the sweet spot is year two and year three. And so same thing. The numbers for System 9 look really good so far. They should be very good next year and the year beyond that.
And frankly, if you think about these products, the more market adoption we see and the more they get out in the market, then we get a little bit of a halo and a buzz because docs talk, nurses talk, clinicians talk and it just drives really good momentum for those products.
So LIFEPAK is a bit of a different launch for us. First of all, we haven’t had a new LIFEPAK in 15 years. So this will be a big deal. I think Kevin talked about at the analyst meeting. This is sort of the professional-grade LIFEPAK. It’s the one that’s in the back of ambulance. It’s the one that in emergency rooms.
There’s a big need for this. Customers have been eagerly anticipating sort of some of the feature sets that we’re going to put out there. And so I think that — and competitively, we’re in a good position for LIFEPAK, just given where some of our competitors are in the market right now, too. So there is a lot of anticipation for LIFEPAK and I think, again, there, it will give a lot of momentum to our medical and emergency care businesses.
Vijay Kumar
The — on 1788, you said opportunity gain share. Have you disclosed what your current market share in within endoscopy is?
Jason Beach
I don’t believe we have, Vijay.
Vijay Kumar
And these market share gauge, would — should that be in line with historical product cycle launches when we had like the prior cycle launch?
Jason Beach
Yes. I think, look, to Glenn’s point, as we think about the 1788 launch, I mean it is differentiated, right? So is there maybe incremental opportunity in terms of size of price here potentially? But yes, we’re super excited about it. And to Glenn’s point, early days, right? We launched in September, and so we’ll ramp through the end of this year and into next year and then into 2025 really being kind of that second year of the launch.
Vijay Kumar
And these should all be incremental growth drivers, right, from a growth perspective for ’24?
Jason Beach
Sure.
Vijay Kumar
And you did bring up pricing, Glenn, what’s the general average price uplift when you think about these new products?
Glenn Boehnlein
Look at it, Jason. The — it really ranges, but yes, do we get 10% to 15% more than price for sure, on new products like this, especially ones that bring new technologies. And there’s not a lot of pushback. And to the extent there is pushback, we can offer older generations of product to sort of meet the requirements of that customer.
But that’s the — that’s been vetted after years of, say, launching some of these products. We know in the marketplace that especially the earlier adopters, teaching universities, places that want to have the latest technology, will pay more to gain that technology. And so on the MedSurg side, we are still fairly bullish about what we can gain in price for next year.
Vijay Kumar
Got you. And so when you think about that mix improvement, should pricing be positive next year, Glenn?
Glenn Boehnlein
All right. Well, I’m not going to guide you on price for next year. But what I would say, to my previous comments, is we have really good momentum on price. We feel good about that. I think on the Orthopedics side, it’s just less negative.
And we have good process in place now and know how to have these conversations with customers in ways that we weren’t doing before. And so I think we’ll hold our ground on the Orthopedics side. So I do think that pricing won’t be as negative as it’s been in the past is what I would say.
Vijay Kumar
I think the term you used Glenn at the Analyst Day was muscle memory, if you will. I think there’s a new organization, which is going after pricing at an enterprise level, maybe elaborate on what this new division is and what is it that they’re doing different?
Glenn Boehnlein
Yes. I mean it’s called customer solutions. And what we did is we took sort of our contract negotiation teams that existed within divisions and put them in a center-led organization. And if you think about how they negotiate. So on the Orthopedic side, those contracts are — it’s much more centralized.
It’s big systems and GPOs pitting orthopedic companies against each other to figure out pricing. Although I will say that Mako provides a little bit of differentiation because it’s a closed system, they have to buy Stryker joints.
And then on the MedSurg side, the way it really works is you basically — your product gets qualified within pricing bands and it becomes more of a hunting license for your reps.
So I would say that all of that expertise now is combined. We drive really good process in doing it. We’ve recruited in some of our best salespeople to really lead those efforts. And we’re seeing a really positive response and positive process.
The other thing that we’ve done is we’ve wrapped way more data around what they’re doing. So we have a lot more reporting by contract. We can go to our customers and demonstrate where we have saved them money or where they actually haven’t been compliant with their purchase commitments. And so that triggers different pricing. So all of that sort of information and process has really led us to be a lot more confident about how we’re managing that process.
And then the final leg on that stool is at the field level, incentives have been put in place as part of commission programs within all of our businesses that speak to pricing. So what that does, at least psychologically, the rep doesn’t go to the bottom of the pricing sheet right at the get go, because they know it will impact their commission.
Vijay Kumar
Fantastic. I think we’ve spent a lot of time on these big 3, right? You get a fair amount of retention from sheath. But I feel like there’s a lot more going on, on and off, you talk about Neptune, smoke evacuation. What else do you have in the pipeline that excites you?
Glenn Boehnlein
Well, you certainly hit the big ease. Launching those robotic applications will be giantly exciting. There’s a lot of smaller products that we’ll launch that I know individually aren’t as exciting, but there are products that will have fast growth and accretive growth. And so those actually make a big difference. I don’t know, is there anything we should be highlighting?
Jason Beach
Maybe just the other one I’d highlight would be one we talked about on the Q3 call, which was Pangea in the Trauma division, right? It’s — we’ve often been known as kind of nailing, right? This brings the plating portfolio and kind of into a complete set here. So super excited about that in the Trauma division, which we’ll launch early next year.
Vijay Kumar
Was that a product gap, Jason, when you — like the nailing and now you have a complete suite?
Jason Beach
Yes, I think you could say that. Again, we were probably known more for the nailing less than the — less plating. This does bring it together and more of a total solution when you show up at a customer.
Glenn Boehnlein
Yes. I think — we just — we weren’t in step with our competitor on plating, to Jason’s point, we were ahead on nailing. So actually, we’ve been looking at our plating for quite a while. It’s been under development, bringing a very competitive offering to the market. And I think Pangea is kind of the answer to that. And so we’re very bullish on what we’re going to be able to do with Pangea.
Vijay Kumar
How — any way to sort of quantify or size the market? What is your share within that market? And what this new product could do for that segment?
Jason Beach
Yes. We’ve got the market research paper out on the — on our website. What I would say though, specific to Pangea, and I think we’ve said this on the Q3 call, largest launch in trauma history. So it will be meaningful to that division on the revenue side.
Glenn Boehnlein
Yes. And as you look at that trauma market, it’s basically a subset of that. It’s nailing and plating that are both included in there.
Vijay Kumar
Got you. And Glenn, at this Analyst Day, clearly, you were to highlight, right, what the margin target.
Jason Beach
Just stole the show.
Vijay Kumar
I did, and it’s not easy to outdo Kevin, but you did. I think you did.
Glenn Boehnlein
Is this being recorded?
Vijay Kumar
Gross margins are still 200 basis points below pre-pandemic level. So when you think about the back to pre-pandemic operating margins, how much of that is coming from gross margin step up?
Glenn Boehnlein
Yes. That’s a question we’ve decidedly are not going to guide to. What I will say is that as we look at how do we get to 200 basis points and what opportunities are identified and where do they sort of fit within the geography, the income statement. There are lots of things to go after in gross margin.
We talked about price. Price is certainly one of those things. I would say the operating environment for supply has stabilized and maybe is more normalizing. So we think about getting back to our direct purchasing negotiations and volume discounts that we used to get.
If we also think about — one of the things we learned in the pandemic is that, hey, maybe we should insource some component manufacturing that previously we were outsourcing, just have better control and honestly, to do it cheaper. Then we also looked at product transfers and where should we be making some products in geographies where we can get labor arbitrage or sort of cheaper outcomes.
And then finally, I would say that distribution and logistics continues to be an opportunity for Stryker. We are sort of finally migrating away from putting everything on an airplane and utilizing ocean freight again, which is significantly cheaper.
And then the other thing we are is we’re looking at strategically what should our distribution network look like, and where can we use some of our bigger distribution facilities for even more product and so leveraging that.
And so I do think as we look at opportunities, they’re fairly balanced between OpEx and gross margin. The other thing, frankly, as long as we can keep growing at high single digits or even low double digits, there’s the opportunity to really drive leverage over fixed costs, and that just naturally comes.
Vijay Kumar
Got you. And I think at the Analyst Day, you mentioned some of the variables for the margin targets, FX in a price. FX, it is where it is. What are you assuming for pricing? Are you expecting like pricing to be similar to current environment? Is that what’s being assumed?
Glenn Boehnlein
Yes. I mean we — beyond some of the upsides we’ve talked about on pricing. I think pricing will remain fairly level. We’re not expecting giant movements, one way or the other.
Vijay Kumar
Got you. And I think a lot of investors and the Street was focused on the cadence rate, 200 basis points over the next two years. Should we straight-line that? Should we front-load that? Or is it like back end loaded?
Glenn Boehnlein
Yes. I don’t know that we’re going to tell you that at this point in time, you can send your model to Jason, and he’ll plug in the right cadence. But yes, we’ll provide more details in January.
Vijay Kumar
What should the levers be when you think of what the cadence for maybe the variables we should be thinking of, which should drive those cadence on the margins?
Glenn Boehnlein
Well, some of the things that I just mention on gross margins certainly are variables and levers. I think some of the other things down in operating expenses, we basically are kind of back to what I would call our 2019 travel meeting and sort of customer promotion budgets. So that will remain stable now, whereas before, it was growing at a rate that was not helpful to op margin.
I also think, too, that as you look at what we’re doing with shared services, you look at what we’re doing with our IT footprint, we’re well underway in a lot of those efforts. And so we’ll start to see really good payback and performance and ability to leverage those things as we move forward to.
Vijay Kumar
Got you. Maybe the last minute here, Glenn, free cash, I think you said the goal is 70% to 80% free cash conversion. Why is 80% sort of a theoretical limit for the industry? Why can we aspire to be more than 80%?
Glenn Boehnlein
Yes. Is that for the industry? I think — a couple of things for us. When you’re growing at 200 or 300 basis points above market, you’ve got to feed a lot of things to keep that going. And that would include working capital. That includes CapEx to expand capacity so that you can make enough product to do that.
And then also the other factor is if you look at our M&A activity and our appetite for M&A, that has a lot of operating cash impact as well in any given year where we do M&A. And so those things, I think, are generally some of the limiters that sort of make 80% sort of the upper range of that number.
Vijay Kumar
Understood. And then maybe the last one here. Leverage levels at 2.5x. How does it impact your appetite for deals or deal size in the current rate environment?
Glenn Boehnlein
Yes. I mean, it’s funny, if you look at our divisions, believe me, their appetite is still there. So that hasn’t really impacted them. I think we’ve been working with the companies that are on our target list for a while now. I think that they have sort of realized more moderate valuations. So two things. We’re seeing valuations come down.
The other thing, too, is that we’re holding firm on what our return requirements are relative to ROIC into WACC. And so if the deal can’t meet those hurdles, then we’re essentially not going to do it.
Vijay Kumar
Fantastic. I think with that we’re out of time. Glenn, Jason, thanks for the time this afternoon.
Glenn Boehnlein
Thank you.
Jason Beach
Thanks for having us.
