Stryker Corp

NYSE:SYK

Earnings Call Transcript 2022-Q1

[Operator]

Welcome to the First Quarter 2022 Stryker's Earnings Conference Call. My name is Brika, and I'll be your operator for today. [Operator Instructions]. This conference call is being recorded for replay purposes.

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

Also, the discussions will include certain non-GAAP financial measures. Reconciliations to the most directly comparable GAAP financial measures can be found in today's press release that is an exhibit to Stryker's current report on Form 8-K filed today with the SEC.

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

[Kevin Lobo, Chairman, CEO & President]

Thank you. Welcome to Stryker's first quarter earnings call. Joining me today are Glenn Boehnlein, Stryker's CFO; and Preston Wells, Vice President of Investor Relations. For today's call, I will provide opening comments, followed by Preston with an update on the trends we saw during the quarter as well as recent acquisitions. Glenn will then provide additional details regarding our quarterly results before opening the call to Q&A.

For the quarter, organic sales growth exceeded 9% with double-digit growth from our MedSurg and Neurotechnology businesses, led by Endoscopy, Instruments and Neurocranial. Our Orthopedics and Spine businesses delivered high single-digit growth, highlighting procedural recovery throughout the quarter. Internationally, we posted mid-single-digit organic growth, highlighted by double-digit organic growth in Europe and emerging markets.

During the quarter, we continue to have robust demand for our capital products. However, we had meaningful shipment delays as a result of ongoing product supply challenges, mostly affecting our large capital businesses.

For the quarter, we delivered adjusted EPS of $1.97, reflecting growth compared to the first quarter of 2021 despite the ongoing impacts from inflationary pressures and significant premiums on inventory spot buys. We expect these supply chain pressures to persist throughout the year, although they will moderate with less reliance on spot buys in the second half of the year. In addition, we continue to invest in R&D at a healthy rate of 7.2% of sales, demonstrating our continued focus on our new product pipelines.

Despite the ongoing supply chain pressures and the continued COVID volatility in certain regions of the world, we remain confident in the outlook of our business, and we expect to continue to deliver sales growth at the high end of med tech. However, as previously mentioned, despite continued discipline with our spending, the pressure on our supply chain will impact our ability to deliver earnings leverage in 2022.

With one quarter behind us, a very strong order book and these macroeconomic dynamics, we now expect full year organic sales growth towards the high end of our guidance range of 6% to 8% and expect adjusted earnings per share at the lower end of our guidance range of $9.60 to $10 a share.

During the quarter, we also closed the acquisition of Vocera, and I'm excited about the highly complementary and innovative portfolio that Vocera brings to our Medical division. We believe that this deal will drive strong value creation in the years ahead.

Finally, I am pleased about our ongoing commitment to our talent and culture, which is reflected in the recognition of Stryker for the 12th year in a row as one of Fortune's 100 Best Companies to Work For. Over this time, our employee base has moved from 20,000 to 46,000, and I would like to thank our leaders for maintaining our positive culture as we have grown.

In addition, we also published our second annual comprehensive report during the quarter, which captures our environmental, social and governance strategy and details our commitments and disclosures on our 3 pillars of corporate responsibility: stronger people, healthier planet and good business.

Overall, I am pleased with our start to the year despite the challenging macroeconomic environment and believe we are well positioned for the future.

I will now turn the call over to Preston.

[Preston Wells, VP, IR]

Thanks, Kevin. My comments today will focus on providing an update on the current environment, including the procedural and geographic trends during the quarter. In addition, I will provide an update on the continued integration of Wright Medical and the initial integration progress of the Vocera business.

After being impacted in January by the Omicron variant, procedural volumes recovered sequentially throughout the quarter as COVID-related delays and restrictions eased. While we see -- while we're seeing volumes recover towards more normal levels, there continues to be some overhang from hospital staffing shortages, which is causing scheduling disruptions around the world. This improvement in procedural volumes is primarily impacting our implant-related businesses, including Hips, Knees, Spine and Extremities. In addition to the procedural recovery, our double-digit growth in Knees continues to benefit from the growing Mako install base. We also grew high single digits in Foot & Ankle, Upper Extremities and Hips, driven by continued new product penetration. Within our Hips business, the launch of the new Insignia Hip Stem, along with the Mako 4.1 software, which also incorporates Insignia into the Mako robotic platform, continues to proceed well and should be a tailwind to our Hips business throughout the year.

Geographically, procedures recovered during the quarter in the United States, Europe and Latin America, which resulted in strong double-digit growth in those regions. Procedural trends in Asia have been more volatile due to the ongoing COVID-related impacts. With Japan and Australia beginning to see improvements towards the end of the quarter, while other parts of the region saw COVID rates peak in March. In China, COVID-related impacts were more widely seen beginning in March, and we expect to see negative impact on procedural volumes in China during the second quarter as a result of strict lockdown restrictions across major cities in the country.

Demand for our capital products remained strong in the quarter, including double-digit growth in orders, which bolstered the strong order book for capital products that we carried over from 2021. As a reminder, our capital business makes up less than 25% of our total sales with under 10% coming from large capital items like beds, robotics, booms and lights, and the remainder coming from small capital products like power tools and cameras, which facilitate surgical procedures. The strong demand in the quarter is occurring across our portfolio, including our small capital products within Instruments, Endoscopy and Neurocranial that support the recovery of procedural volumes.

While we experienced solid growth from our capital businesses in the quarter, the growth was limited as a result of ongoing headwinds, including raw material shortages, primarily related to electronic components and installation delays because of hospital staffing challenges. The raw material shortages have had the largest impact in our medical business, both within our acute care and emergency care business units. These macro challenges will continue to be pronounced in the second quarter. We continue to partner closely with our customers to ensure we are meeting their more immediate and longer-term capital requirements.

Turning to our key integration activities. The integration of Vocera is in its early stages, and we are pleased with how the teams are working together to maximize the opportunity. On a pro forma basis, the Vocera business continued its strong double-digit momentum during the quarter. And finally, the Wright Medical integration continues to progress well across all regions, which is reflected in the double-digit growth of our U.S. Trauma & Extremities business during the quarter, which was led by excellent performances in both U.S. Foot & Ankle and U.S. Upper Extremities.

In summary, while the macro environment remains volatile, procedural volumes are improving and the underlying demand for our products remains strong, which gives us confidence in our ability to continue to drive market-leading growth.

With that, I will turn the call over to Glenn.

[Glenn Boehnlein, VP & CFO]

Thanks, Preston. Today, I will focus my comments on our first quarter financial results and the related drivers. Similar to last quarter, sales comments will be provided based on our new reporting structure. Our detailed financial results have been provided in today's press release.

Our organic sales growth was 9.2% in the quarter. The first quarter's average selling days were in line with Q1 2021. The impact from pricing in the quarter was unfavorable 1%. Foreign currency had an unfavorable 1.8% impact on sales.

During the quarter, we saw a recovery of surgical procedures and accelerated sales momentum as the impact of the COVID-19 pandemic has eased in the U.S. and Europe. However, our sales growth has been constrained by continuing supply chain challenges and electronic component shortages, especially impacting the capital products in our MedSurg businesses and primarily our Medical business.

Our capital order book has continued to be very robust as demand from our customers has continued to be strong. For the quarter, U.S. organic sales increased by 10.5%, reflecting strong double-digit growth in many of our businesses. International organic sales showed growth of 6%, impacted by positive sales momentum in Europe and emerging markets, somewhat offset by lingering COVID impacts in Australia, Canada and China. Our adjusted quarterly EPS of $1.97 increased 2.1%, reflecting sales growth, partially offset by a higher tax rate and gross margin inflationary pressures. Our first quarter EPS was negatively impacted from foreign currency by $0.02 versus 2021.

Now I will provide some highlights around our segment performance. In the quarter, MedSurg and Neurotechnology had constant currency sales growth of 12.1%, with organic sales growth of 10.8%, which included 12.2% of U.S. organic growth.

Instruments had U.S. organic sales growth of 16.3%, led by strong growth in their orthopedic instruments and Surgical Technologies businesses, highlighted by growth in SurgiCount, waste management, smoke evacuation and Steri-Shield products.

Endoscopy had U.S. organic sales growth of 17.7%, reflecting strong performances across their portfolio, including video products and double-digit growth of their communications and Sports Medicine businesses.

The Medical business, which includes our recently acquired Vocera business, which closed in February, had U.S. organic sales growth of 6.2%, reflecting solid performances in their stage and acute care businesses, somewhat offset by the aforementioned supply chain challenges primarily impacting our emergency care products.

During the quarter, we also saw significant growth in orders for our acute care and emergency care businesses, driven by very strong demand. Assuming normalization of the customer environment and certain reduction of certain supply constraints, we expect these orders to contribute to another strong year for Medical in 2022.

Our U.S. Neurovascular business posted an organic decline of 1.4% versus a very strong comparable growth of approximately 20% in 2021. The U.S. Neurocranial business posted organic sales growth of 16.6%, which included solid growth in our max space, NSE drills and bioreabsorbable products.

Internationally, MedSurg and Neurotechnology had organic sales growth of 7%, reflecting double-digit growth in the Endoscopy and Neurovascular businesses. Geographically, this included strong performances in China and Australia.

Orthopaedics & Spine had constant currency and organic sales growth of 7.2%, which included 8.2% of organic growth in the U.S. This reflects the impact of the ramp-up in surgical procedures during the quarter.

Our Hips business grew 8.5% organically in the U.S., reflecting strong primary hip growth fueled by the launch of our Insignia Hip Stem and improved underlying market dynamics. Our Knee business grew 17.5% organically in the U.S., reflecting the previously mentioned strong recovery of procedures and our market-leading position in robotic knee procedures. Our U.S. Trauma & Extremities business grew 10.6% organically, reflecting double-digit growth in Foot & Ankle, Upper Extremities and Biologics. Our U.S. Spine business grew 3.7% organically, led by the performance of our enabling technology products. Other ortho declined organically in the U.S. as the impact of hospital operational staffing challenges and lengthening purchasing cycles limited our ability to place Makos during the quarter. Comparatively, in Q1 2021, other ortho had growth of 49%. Assuming normalization of the customer environment, we expect another strong year for Mako in 2022.

Internationally, Orthopaedics & Spine grew 4.8% organically, which reflects the strong momentum in Europe as surgical procedures ramped up as well as a strong performance in Hips and Knees in Japan, somewhat offset by lingering COVID challenges in Australia, Canada and China.

Now I will focus on operating highlights in the first quarter. Our adjusted gross margin of 64.1% was unfavorable approximately 130 basis points from the first quarter of 2021. Compared to prior year, our gross margin was adversely impacted by purchases of electronic components at premium prices on the spot market and other inflationary pressures primarily related to labor, electronic components, steel and transportation costs as well as operational inefficiencies due to the aforementioned raw material shortages. We expect these adverse impacts to continue throughout 2022 and to be more pronounced in the first half of this year.

Adjusted R&D spending was 7.2% of sales, which represents a 35 basis point increase versus first quarter of 2021, and this reflects our continued commitment to innovation funding and the related future growth it will provide. Our SG&A was 35.1% of sales, which was 5 basis points lower compared to the first quarter of 2021. This reflects continued cost discipline and fixed cost leverage, offset by the ramping of certain expenses and hiring to support future growth.

In summary, for the quarter, our adjusted operating margin was 21.8% of sales, which is approximately 160 basis points unfavorable to the first quarter of 2021. This performance is primarily driven by inflationary impacts resulting in gross margin challenges and other continued investments in innovation, somewhat offset by our sales momentum and cost discipline.

Other income and expense decreased as compared to the first quarter in 2021, primarily resulting from an equity investment gain as well as lower interest expense. Our first quarter had an adjusted effective tax rate of 13.9%, reflecting the impact of geographic mix and certain discrete tax items. For the full year, we continue to expect an adjusted effective tax rate of 15% to 16%.

Focusing on the balance sheet, we ended the first quarter with $1.5 billion of cash and marketable securities and total debt of $13.9 billion, which includes the additional $1.5 billion of debt raised to fund the Vocera acquisition. During the quarter, our long-term credit rating at S&P was downgraded from A- to BBB+, and our long-term rating at Moody's was reaffirmed at Baa1.

Turning to cash flow. Our Q1 cash from operations was $203 million. This performance reflects the results of net earnings and continued focus on working capital management, partially offset by the impact of prebuying certain electronic component inventory and approximately $130 million of charges related to the stock compensation payments for the Vocera acquisition that are accounted for in operating cash flow.

Given the dynamic supply chain pressures, COVID uncertainty, strong order book for capital equipment and considering our first quarter results, we now expect full year 2022 organic sales growth towards the high end of our previously guided range of 6% to 8%. This performance assumes that the recovery environment experienced in Q1 continues to improve throughout the rest of the year with a normal procedure environment, returning during the second half of the year. If foreign currency exchange rates hold near current levels, we expect net sales in the full year to be adversely impacted by approximately 1.2%.

Adjusted net earnings per diluted share to be reversely impacted by approximately $0.10 to $0.15 in the full year, and this is included in our guidance range. Based on our performance in the first quarter and including consideration of the continued supply chain challenges, the inflationary environment and the anticipated impact related to foreign currency. We expect adjusted net earnings -- adjusted earnings per share towards the lower end of our previous guidance range of $9.60 to $10 per share. The low end of the guidance range assumes the continued macro environmental volatility persists, including inflationary pressures that could impact costs, particularly our cost of sales and includes more transient spot buying and longer-term supply chain challenges.

We will continue to evaluate the changing environment, and we'll provide updates to our guidance as necessary. And now I will open the call up for Q&A.

[Operator]

[Operator Instructions]. The first question we have comes from Vijay Kumar of Evercore ISI.

[Vijay Kumar, Evercore ISI]

Congrats on a strong [indiscernible]here. Maybe one on the capital environment, Kevin. There's been a lot of questions on the hospital capital budget cycle. Maybe talk about your order book, how it's perhaps different? And I couldn't help but observe the other line item, which includes Mako was down year-on-year. I understand it's a tough comp, was it just comps? Or anything to do with the capital cycle here?

[Kevin Lobo, Chairman, CEO & President]

Yes. Sure, Vijay. First, I'd tell you that hospital liquidity is still very strong. And as a result, our orders have actually grown in the quarter. We had a strong order book coming into the year, and we added to that very significantly with strong double-digit growth in orders in the first quarter.

And as we mentioned in our opening remarks, large capital has been disrupted partially because of shortages of primarily electronics, but also hospital's ability to actually receive the capital either because of short staffing or because some of their construction projects were delayed.

I'm not concerned about the shortage in other ortho for the first quarter. Our order book for Mako is very, very strong. We had a lot of delays in actually installations, and they're going to have a strong year overall. And certainly, we did have a big comp from the prior year. But the order book for Mako is very strong. The order book for all of our capital is very strong. You saw the actual sales results in Instruments, Endoscopy, Neurocranial.

The small capital, in fact, is -- we're able to largely meet those orders that were growing our challenges is meeting the orders of larger capital, primarily Medical, but also to a lesser degree to Mako. But overall, no concerns, strong demand for Mako and you saw the results in the Hip and Knee business that really benefits from the strong performance we had in Mako throughout the pandemic.

[Vijay Kumar, Evercore ISI]

That's helpful, Kevin. And maybe one on guidance here. To one off of a really strong start here, 9% organic, guide 6% to 8% now looks like you guys are pointing towards the high end, is there perhaps some conservatism baked in when you look at the back half? Certainly, your comps are 7% average for the back half. If the recovery trends do persist, perhaps it seems like the top line is a little conservative, maybe walk us through the assumptions for the back half.

[Kevin Lobo, Chairman, CEO & President]

Well, we're not going to give guidance by quarter, Vijay. But what I would tell you is the second quarter, we have very difficult comps. If you remember, the second quarter of last year was extremely strong. And yes, you're right that Q3 and Q4, the comps do get a lot easier.

I would say that we are still a little bit nervous about our ability to meet the demand for these orders and capital because of the supply chain pressure. So there is a little bit of conservatism based into that just because the environment is pretty uncertain. We do assume an improvement -- continued improvement in procedural volumes. If that continues to play out well, and certainly, there is the potential for us to do even better than what we've guided.

But based on what we know today, that we feel pretty good about sales at the high end of the original range given the strong start to the year and the strong order book.

[Operator]

We now have the next question from Matt Miksic from Credit Suisse.

[Matthew Miksic, Crédit Suisse]

Congrats on a really strong quarter. Kevin, I'll ask the question because I'm sure folks are wondering, and then I have 1 quick follow-up, if that's all right. But just to follow-up on Vijay's question about the robot trends, is this a -- would you say this is a -- these are challenges that all competitors across large capital robots and otherwise are having -- putting systems into hospitals at the moment? Or in other words, would you expect that these aren't things that are going to put you at a disadvantage competitively over the next several quarters? And I have just one quick follow-up.

[Preston Wells, VP, IR]

Hey, Matt, it's Preston. You're right. It's something that we're seeing across the board. As Kevin said, it's really more of the macro elements around the ability for hospitals to be able to put the equipment in and get it installed that's driving it. And so that's something that everybody is facing heard that from several folks as well. So it's not something that puts us at a disadvantage at all. As Kevin mentioned, we feel very strong about where we're headed for Mako and what we're expecting to deliver for Mako this year.

[Matthew Miksic, Crédit Suisse]

Great. And then a follow-up on Hips, just to give us some perspective. It was a really nice bump up here on the back of these launches that you described. I'm just wondering if you could give us some sense of how confident we should be about that going forward? Or is there some trialing? Or there's a couple of quarters here that we should sort of need to digest the interest in the hips? Or do you really feel like you've turned the corner?

[Preston Wells, VP, IR]

Yes. I would say that we certainly are very pleased with the initial launch of Insignia as we recently just launched at AAOS. So it's certainly an indication as we think about going forward and what we expect to drive from our Hips. So we're happy with the initial phases of the launch. We expect Insignia will continue to provide a tailwind along with Mako, along with the recovery of procedural volumes.

[Operator]

We now have a question from Robbie Marcus of JPMorgan.

[Robert Marcus, JPMorgan Chase & Co.]

Congrats on a nice quarter. I wanted to ask on down the P&L, and you mentioned cost headwinds a couple of times during the presentation, and you were able to still hold the guidance range, albeit at the lower end. I was just hoping maybe you could walk us through sizing some of these impacts and the cadence as it flows into and out of the P&L as we start thinking about building second, third and fourth quarter?

[Glenn Boehnlein, VP & CFO]

Yes. Robbie, I would tell you that when we gave guidance back in January, we discussed pressure of 50 to 100 basis points on our gross margin. And I would tell you that, that is looking like it is trending to the upper end for the full year. And if I think about where we're going to feel most of that pronounced increase, it's probably Q1 and Q2 here with some easing in Q3 and Q4.

If you think about the types of costs, obviously, there are these spot buys where we're paying pretty exorbitant prices for chips and the related electronic components. But there are also increases in labor or supplier labor, warehouse and distribution costs are going up.

And then related to that, just because of supply shortages, we're also feeling a little bit of the inefficiencies that, that might be driving in our own manufacturing facilities. So all of those are obviously putting pressure on our gross margin.

Then the last thing I'll mention, and I know this has probably come up in other calls is just freight is another place where we're seeing real increases. And a lot of that is just because of the tight supply chain and even the tightness of our ability to deliver products to our customers, we're seeing a lot of overnight deliveries. We're seeing a lot more air freight when normally we would use a more economical mode for freight. So all of that is kind of compounding in terms of what we're implying as inflationary pressures.

I do see some of that easing up, but I would tell you for the longer term, these labor costs, these transportation costs are probably a little more permanent than some of the other costs as we think about it.

And then moving down the P&L, if you think about what we're spending in R&D, we just -- we're not backing off of that innovation spend. We really honestly think it's very important to keep that product pipeline going and keep it robust. Launches like our Insignia Hip, we're going to be able to fuel growth as long as we continue to fund that R&D.

On the -- further down in SG&A, we have tried to moderate some of the more discretionary SG&A costs. But the single biggest cost there is sales commissions. And as long as our sales force are out there selling, we're going to continue to pay them and pay them well because it's important to us. Beyond that, we have some moderation in other income and expense, and I gave you the guidance on tax. So I think we're trending pretty much in line with all of that.

[Robert Marcus, JPMorgan Chase & Co.]

Great. I appreciate that. If I could sneak one quick follow-up in, we heard from Baxter this morning, they have a growing order book like you, and they're hoping to be able to shorten it and sell-through throughout 2022. Is that your expectation as well that the chip supply should improve, and you'll be able to clear a lot of the order book within 2022?

[Preston Wells, VP, IR]

Yes, Robbie. I think that we certainly believe that we're going to work through that backlog. It's still early days as we're confronted with the supply challenges. And we're certainly working actively with those chip suppliers and trying to get through. And as Kevin mentioned, certainly, second quarter will be a little bit more disrupted than we think about the later part of the year. So we'll work through it throughout the year.

We're not -- as we think about our overall guidance and certainly getting to that upper end or exceeding that upper end, would be working all the way through the entirety of that backlog. So right now, what we're doing is really focused on just getting the supply and working through it for the remainder of the year.

[Operator]

We now have Larry Biegelsen of Wells Fargo.

[Lawrence Biegelsen, Wells Fargo Securities]

Just -- I wanted to start with the inflation and pricing. So just how are you guys kind of managing the rising cost? And what's your ability to offset it? And where are you guys able to take price? It looks like price got a little better, if I'm looking at Q1 versus Q4, if I'm looking at that correctly. And I have 1 follow-up.

[Preston Wells, VP, IR]

Yes, Larry, thanks for the question. So we're looking at it a few different ways. So obviously, we continue to focus on some of the internal projects that we had going with CTG 2.0 that are really looking at how we change our cost structure. But beyond that, we are looking at areas around price.

And just as a reminder, we do have some businesses that historically we've been able to gain some price in particularly on our MedSurg and Neurotechnology businesses. But as we look at all of our businesses in the future, as we have contracts that are coming up on our orthopedic side, we will be looking at whatever price actions that are appropriate at that point in time.

And along the MedSurg business, again, same thing, we'll be looking at price actions as appropriate going forward. So we are looking at that as a way to continue to help with the rise in inflation.

[Lawrence Biegelsen, Wells Fargo Securities]

That's helpful. And then I know China is small for you guys, but a little more color on what you're seeing on the ground there from the lockdowns and your expectations for the VBP for Recon, which it seems like it's delayed to the second quarter? And then Trauma and Neurovascular, if there's anything on the horizon there?

[Preston Wells, VP, IR]

Yes. So Larry, on China, as you mentioned, it is small. It's about 2% of our total business. And those products that are being currently impacted by VBP, so think about joint replacement, trauma and extremities, are less than half of that. And so we have that factored into our guidance. We've talked about that before. So we're expecting that to really play out this year from a trauma and joint replacement standpoint.

Neurovascular, it's early days. There are some activities happening at a province level. So we're still early in that process and don't really expect any major impacts there for 2022.

In terms of what we're seeing on the ground with regards to the COVID impacts, we're saying the same thing that everybody else is hearing. The strict lockdown policy is certainly having an impact on procedural volume. And we expect that to continue to play out in second quarter.

Where it goes from there, I think, is still to be determined. But we would expect probably easing as they go through this latest wave, look probably towards the back half in terms of procedural volumes.

[Operator]

The next question is from Joanne Wuensch with Citi.

[Joanne Wuensch, Citigroup]

I want to spend a little bit of time talking about Vocera, the closing of it and your expectations for growth in revenue in this fiscal year?

[Preston Wells, VP, IR]

Yes, Joanne, thanks for the question on both. I mean as I mentioned in my prepared remarks, it's very early. I mean we just closed the deal in February. When we announced the deal, we talked about our general expectations in this marketplace where the market and the sales are growing in the teens. And so we would expect that to continue initially. But as we get it integrated into our businesses that we're going to be able to accelerate the growth of Vocera by being able to put it into more hands and more hospitals. So we do expect that we'll be accelerating throughout the year. But again, we're early, early days in terms of the integration.

[Kevin Lobo, Chairman, CEO & President]

Yes. The only thing I'd add, Joanne, is so far so good in terms of retention. We were able to retain a lot of the employees that we had identified, frankly, all of the key employees have been retained. And the integration efforts, even though it's early, we had a very good month of March, no disruption whatsoever in the sales cycle.

So while it is early, so far, so good, and we're very bullish on the prospects. So Vocera having a very good year this year and obviously continuing into the future.

[Joanne Wuensch, Citigroup]

But to put a little finer point on that, what is your expected impact on revenue and EPS? Because we have organic revenue, and we have an EPS range, and I would assume this is incorporated in your updated guidance.

[Kevin Lobo, Chairman, CEO & President]

It is incorporated in our updated guidance. As we said from the beginning, we expect them to continue. And you'll see it in the inorganic numbers. Every quarter, you'll see where Vocera shows up, you will see very strong double-digit growth on the top line. And what we said on the bottom line is that it certainly -- there's a modest impact on the bottom line. So really, nothing really more to add there. We're going to fuel the growth. It will be a good year this year, and it will be accretive starting next year

[Operator]

We now have Pito Chickering of Deutsche Bank.

[Philip Chickering, Deutsche Bank]

One more question on the inflationary pressures. Can you provide some color on what percent the products came freight versus raw materials versus labor? I'm just trying to understand how much of this pressure is sort of permanent like labor, let's stick around in 2023. You said that the prices are trending to the high end of 100 basis points you talked about last quarter. What do you assume that ends in the fourth quarter?

[Preston Wells, VP, IR]

Yes. So Peter, we aren't going to provide that breakout in terms of the various parts of the business. I mean it does continue to fluctuate around depending on where some of the shortages are. Like Glenn said, if we have supply shortages, we are seeing increases in freight that's more mix based on airfreight and things like that.

So going to provide that breakout. Certainly, we do expect, as Glenn mentioned, there are going to be some portions of this that will be more permanent in nature and some of that will be more transient as we go through where it lands. I think we're still early. And certainly, as we think about our guidance that we laid out, we do expect it to have impact as we continue throughout the year, but certainly within the range of the guidance that we provided.

[Philip Chickering, Deutsche Bank]

Okay. And then talking to you about the hospitals recently, they're talking about a lot of supply inflation that they're seeing. Just back there with the pricing question, do you guys think that you have the ability to pass on some price help off to some of these inflationary pressures? And kind of how should we think about price for different divisions or different geographies?

[Preston Wells, VP, IR]

Yes. So I think the answer is yes. I mean we are evaluating that. We're looking at pricing actions across our businesses, and it will be different. It will be different based on the different types of businesses that we're in, the contracts that are in place and in different geographies for sure. So it's not going to be a one-size-fits-all as we think about this, it will be a very deliberate approach across our different business units and across our different geographies.

[Philip Chickering, Deutsche Bank]

Let me just -- to quantify that, if a negative 1% price or in the first quarter, I think we end the year sort of flat? Or kind of how much price that we can get during the year?

[Preston Wells, VP, IR]

Yes, not something that we're guiding on.

[Operator]

We now have a question from Ryan Zimmerman of BTIG.

[Ryan Zimmerman, BTIG]

I want to follow up on a couple of things. Glenn, on your comments on EPS guidance, you said that you continue to expect more transient spot buying and long-term supply challenges. I think that was pretty clear in your messaging. But as I think about companies like Hologic last night, who saw incremental headwinds on some of these electronic components more than they initially thought. I mean how derisked have you -- I mean at the low end of that 9 60, how comfortable are you that if this market gets worse for electronics that we wouldn't have to go lower? I mean, how much have you incorporated there, I guess?

[Kevin Lobo, Chairman, CEO & President]

Yes. That's a tough question. I mean I think I don't have a crystal ball. What I do have is I can see what we have prebought in our inventory. I do have the input from our suppliers and how they are looking at that sort of chip availability.

And I also see the amount of activity that we have currently ongoing in terms of buying in that spot market. And I would tell you that Q2 is probably going to look pretty similar to Q1 in terms of that kind of pressure. But I am building up inventories and I'm building up component inventories. And so I expect it to ease a little bit as I look at Q3 and Q4. And I think right now, that's the best I can do in terms of sort of eyeballing in where I think the impact of that will be in the P&L and also in terms of where our guidance has come in.

I think we didn't lower our guidance from Q -- from January because we still saw a pathway to get within this guidance based on the activity we're seeing now.

[Ryan Zimmerman, BTIG]

Okay. I appreciate the color there. And then Kevin, I appreciate the comments about Neurovascular having a tough comp. But as we think about that market, particularly in the U.S., and the product profile today, how do you think about the long-term growth rate in the Neurovascular segment given kind of where we're at? And the performance we saw this quarter? And what gets you back to kind of that sustained long-term growth rate?

[Kevin Lobo, Chairman, CEO & President]

Yes. Look, I still think this is a fabulous market long term. There's just no question. It's a great market. We had a tough comp -- there also was a bit of competitive activity in the U.S. in the ischemic side of the business. We see this from time to time from quarter-to-quarter. So we certainly weren't expecting double-digit growth in the U.S. It was a little lower than we expected because of the competitive activity, but nothing too alarming.

And we will have a very strong year. We're going to have a double-digit growth year in neurovascular globally, and the U.S. will pick up in Q2, Q3 and Q4. So it's still a great market. We're only treating a small fraction of the patients that have stroke today. And for that reason, with the pipeline and the great leadership team that we have over there in Neurovascular, I know that this is going to be a very good long-term business.

[Operator]

We now have David Saxon of Needham & Company.

[David Saxon, Needham & Company]

Just wanted to get a sense on if you're seeing backlog procedures come back? And if so, kind of where you're seeing those concentrated whether it's Hips or Knees or Spine?

[Preston Wells, VP, IR]

Yes. Thanks for the question. So in terms of the backlog, as we've said in previous calls, the backlog has built up over really the last 24 months as many patients hadn't had procedures done. So certainly, we saw that the uptick with procedures being done this past quarter.

It's hard to say what portion of that was backlog versus new patients entering into the funnel. So there has to be some piece of that backlog that's been worked down. But really, for the full backlog to be worked through, it's going to take a sustained recovery. So we're thinking about many quarters of recovery and being back to normal that's going to get that backlog all the way down.

In terms of where it's coming from, it's really going to be across all of those products that are more deferrable. So Hips, Knees, Spine, some of the Extremities products that we would expect to see that coming from. But as we've said previously, really, it's going to take several quarters of sustained normal that will work that full backlog down.

[David Saxon, Needham & Company]

Okay. Great. And just on the U.S. spine 3.7% growth. Just wonder, how you think you did from a market share perspective? And what's driving your growth?

[Preston Wells, VP, IR]

Yes, it's early in terms of the overall market growth assessment. But just like we look at Hips and Knees, we're pleased with the quarter. We're pleased with procedures recovering, certainly having an impact on Spine. We're happy with our product portfolio. And so we do expect that Spine will continue to benefit as procedures come back to more normal levels throughout the rest of the year.

[Operator]

The next question is from Matt O'Brien of Piper Sandler.

[Andrew Stafford, Piper Sandler & Co.]

This is Drew on for Matt. I just want to follow up on Vocera with maybe a little bit more of a high-level question. We're obviously translating -- transitioning from pandemic to a postpandemic environment, which will presumably result in the changes in some hostile environment have operated compared to the last couple of years. Is that changing how your customers are thinking about the value proposition or use case for Vocera at all?

[Kevin Lobo, Chairman, CEO & President]

Well, I think the pressure that's being put on the health care system and particularly nurses was obviously very acute during the pandemic. And with the shortages that are out there right now, hospitals are looking for solutions that are going to help keep their nurses engaged, help ensure that their errors aren't being made in the hospital, improved workflow, so I think our timing is perfect and that Vocera should be able -- this is a tailwind that's not over. I think this tailwind will continue to last for the next couple of years because it does provide really a reduced cognitive load for nurses. It makes their jobs easier. They're much happier when we have Vocera in their hospitals.

So we're really excited. We think our timing is really ideal, and this is a multiyear tailwind.

[Operator]

We now have Jason Wittes of Loop Capital.

[Jason Wittes, Loop Capital Markets]

Just on cash flows. Obviously, you're having some P&L impact from inflationary expenses. How is that impacting your cash flows? And generally speaking, what sort of cash flow generation should we anticipate for this year?

And I guess related to that, when do you think you get back to a point where we could see another Vocera-like-sized acquisition from Stryker?

[Glenn Boehnlein, VP & CFO]

Yes. I'll tell you what, I'll take the cash flow one, and I'll have Preston talk about the M&A one. So on cash flows, a couple of places. We're feeling the inflationary pressures that flow through with earnings first and foremost. And we'll see that all year long as those flow through all the way to cash flow.

I think the other thing that you can see is that because we're in a position where we're prebuying inventories and raw material inventories to make sure we have enough supply, we'll see increases in inventory that may be, under normal conditions, we wouldn't necessarily have.

In terms of where I think cash flows will land, I still think we're seeing really good performance in working capital. We're performing relative to guidance in terms of CapEx spending, and so those fundamentals are still in place. And I would still expect us to deliver sort of a 70% to 80% free cash flow conversion, excluding the Vocera impact related to that acquisition, the $130 million that related to a payout of -- related to the employees' acceleration of options in their stock. So aside from that, we'll still be in that 70% to 80% range.

[Preston Wells, VP, IR]

Yes. So in terms of -- sorry, in terms of acquisition activities as we move forward, as we've said previously, following the Vocera deal, our first focus is going to be on pay down of the debt. And then we'll certainly continue to evaluate tuck-in opportunities along the way as well.

As we think about larger type deals like Vocera, it really is going to depend on a couple of things. I think, number one, the cash flow performance, as Glenn mentioned before. And then the second is really going to be about the opportunities. I mean we're not going to just do larger-sized deals just to do them. Certainly, it's going to be the right opportunities. I think, overall, just thinking about it, we still have the bandwidth to continue to operate in that space and complete those type tuck-ins and eventually get back to a Vocera-type-sized deal.

[Matthew Miksic, Crédit Suisse]

I appreciate that detail. If I could just maybe a clarification on Mako. Did I hear you earlier specify that there were still some staffing issues sort of impacting installations there? Or did I mishear that? Just curious about the dynamics right now for installing Mako systems.

[Preston Wells, VP, IR]

No, that's correct. I think a lot of times when we talk about staffing, we immediately think about just the nursing staffing component, but staffing has been an impact at all different types of areas across the hospital. And so with a lot of our larger capital items, we've seen some delays in installations or even just in construction projects that have led to some of those delays in Mako was impacted by that during the quarter as well.

[Operator]

Our next question comes from Drew Ranieri from Morgan Stanley.

[Andrew Ranieri, Morgan Stanley]

Just more of a product question, and then I had a follow-up. But you guys highlighted Q guidance and System 8 power tools kind of AAOS, I know that they were more limited launches here in 2022. But just given the macro factors here, supply chain disruptions. I mean, does that really stall what we could expect these products to deliver in 2023 with your spine growth or any pull-through there with enabling technologies or pricing benefits on the power tools?

[Kevin Lobo, Chairman, CEO & President]

Yes. I mean, at this point, I would say there's no -- we're obviously not giving guidance on 2023. But in terms of those products, still early Q guidance not is still in the approval process. So we still have a ways to go there. But in terms of the next power tools, also similar we're still early in terms of getting that out from a launch standpoint next year. So at this point, no update in terms of major impacts or expectations to what it might have on our numbers for next year.

[Andrew Ranieri, Morgan Stanley]

Okay. And then just with Insignia, I think it was also highlighted that instrument tray, it's more attuned for ASC usage. So is there anything that you're seeing with the recent launch that really shows that ASCs are being receptive? Or is just the general environment may be masking any uptake there of the new platform at ASCs?

[Kevin Lobo, Chairman, CEO & President]

Yes. So what I'd say is Insignia product is ideal for direct interior, which, of course, is very popular in the ASCs. But not just in the ASCs, also in the hospital. And even though we only launched it very recently, the feedback has been incredibly positive. And so we have a great design for the product. Surgeons are finding it terrific approaching the offsets, the sizes, the fit that it's really delivering on what we thought. So we couldn't be happier with the launch at least this initial phase of the launch. And this will be a tailwind for our Hip business, and it will actually pick up as more and more sets are deployed in the field, you'll see it actually accelerate through Q3, Q4 and into next year.

[Operator]

Thank you. We now have Joshua Jennings of Cowen.

[Joshua Jennings, Cowen and Company]

Just two, one on just the natural margin tailwind, Glenn, that you talked about earlier in the year, potentially driving some operating margin expansion at least by the fourth quarter. Can you just help maybe frame that up a little bit better? Just thinking about you're not guiding to upside to the 6% to 8% range, we're getting to the top but getting through that top end of the revenue guidance range. Just how impactful that natural margin tailwind from increased volume could be? Any quantification, it's probably hard, but would be helpful even directionally.

And then just was curious, Kevin and Preston on just the strong recovery in Knees and Hips versus Spine. I mean, Spine is recovering but not as quickly. And any thoughts on just why Spine market recovery or volume recovery is a little bit slower than Knees and Hips so far in 2022?

[Glenn Boehnlein, VP & CFO]

Yes, Josh, I think I heard your question right, is what kind of op margin lift could we get out of sales performance that's above the 10%. So a couple of things. And anything that we delivered above the 10% would still have that kind of gross margin and inflation overhang. So we would feel that pressure. But you are correct that there's a natural operating expense leverage that incur that we incur when we sort of pierce through some of those larger double-digit growth items. So I expect that you would see delivery at the op margin level in excess of where you're seeing us now that the 22% roughly. So it would be accretive to that for sure.

[Kevin Lobo, Chairman, CEO & President]

Yes. On your second question around the spine market versus hip and knee market, even if you go back to pre-pandemic, the hip and knee market was growing on a dollar basis was growing faster than the spine market. And the spine market did have some elements of the more acute procedures that were less deferrable. And so it didn't decline nearly as much as the hip and knee business did. So not as much of a decline. And then, therefore, not as much of a pickup in a market that, frankly, hasn't been historically growing quite as fast as Hips and Knees. So those are the dynamics, I think, that you're seeing play out here. We're delighted with our performance certainly in our -- if you look at our Knee business and Hips just this quarter, we were leading the market in Knees for a long time. Mako has been an enormous driver. Our cementless procedures are roughly 1 out of every 2 knees in the United States are going in cementless. So we have a real competitive advantage that you're seeing play out with our Knee number, but excited that our Hip number is now moving up as well. But I'm not surprised to see those growing faster than the Spine business. We'll have to see when everyone else reports how the markets played out. But to me, it's not that surprising.

[Operator]

We now have a question from Danielle Antalffy from SVB Leerink.

[Danielle Antalffy, SVB Leerink]

Just a quick question on -- I'm not going to ask about inflationary pressures per se, but what I am going to ask is supply constraints that you saw if there's any way, I know there's a lot of balls in the air as far as trying to nail down the different impacts to the top line in the quarter between COVID and supply constraints things like that, but whether you can quantify, even just directionally, the impact from the supply constraints that you did see in the quarter? And then I have 1 follow-up on the backlog.

[Glenn Boehnlein, VP & CFO]

Yes. No, nothing that we're going to specifically quantify with regard to that. I mean we still had pretty strong growth in our MedSurg businesses, which are -- where primarily our capital businesses are. But just know that there was impact in that -- those sales as a result.

As we mentioned, from an electronic component standpoint, primarily in the medical business as opposed to some of the others. But not something that we're going to quantify.

[Danielle Antalffy, SVB Leerink]

Okay. I appreciate that. And then just a commentary on the backlog. The question I have there is, if there's still backlog being worked down in such a meaningful way, is this impacting the referral chain at all? And I guess what I'm getting about is -- getting at is how this impacts sort of midterm growth, sort of once we're through the acute COVID period, I'm trying to think about hospital staffing issues and how all of these reconciles and what this means for really midterm growth less near term?

[Glenn Boehnlein, VP & CFO]

No. I think if I understand your question correctly, I mean I think the way we have to think about this is we've had 24 months of irregular activity with regards to these procedures. And so throughout that time period, we've seen that backlog, quite frankly, just grow. I mean the number of people that haven't had procedures done as a result, whether they're currently in the funnel, whether they've been deferred from the funnel. And then as we keep going forward, the part of what we're going to continue to see is we're going to see new patients entering that funnel. So I don't think there's going to be a slowdown at all. And that's why what we're saying with this backlog, it's not something you're going to see pronounced in any 1 particular quarter or a month, it's going to be something that's going to be a longer-term work down that we're going to see from people kind of funneling through the whole process. So I think you're going to just see that growth rate continue to just be pretty steady and growing.

[Operator]

We now have the final question on the line from Richard Newitter of Truist.

[Richard Newitter, Truist]

So just the first one, going back to some of the pricing commentary. I was wondering if you might be willing to comment a bit by tariff setting. The reason I ask, I was trying to think through some areas, perhaps where Stryker's better positioned to take price even than other med tech companies and your potential or your competitive advantage in the ASCs immediately came to mind. I'm just wondering if that's one of the areas where potentially, there might be the possibility of renegotiated contracts, in particular, are going to offer some opportunity there?

[Kevin Lobo, Chairman, CEO & President]

Yes. Look, given the inflationary environment, as Preston mentioned earlier, we are obviously going to look at pricing actions across our portfolio. In some places, it's going to be easier than other places given the nature of our contracts. But for competitive reasons, we're really not going to disclose the tactics, the strategies, which products. Every quarter, you see we do report our price, you'll get to see the overall impact, but it's not something we're really -- I'm going to get into on this call.

[Richard Newitter, Truist]

Okay. Fair enough. And then just maybe one last one. I think you said you're steering towards the lower end of earnings guidance for earnings per share. And you said that this assumes that at the lower end, at least, assumes that supply chain pressures persist throughout the remainder of the year. But you also said that you expect some improvement as you move into 3Q and 4Q. I just want to make sure I'm reconciling those 2 comments appropriately.

[Glenn Boehnlein, VP & CFO]

Yes. I think you're conceptualizing, right? I think what we're trying to communicate is, in the short term, how we saw inflation impacting us in Q1 will feel similar inflation in Q2. We expect the environment to improve, which also means that we also expect to start delivering more of the capital that's been in our order book in Q3 and Q4. Plus, we'll feel the impact of a lesser comparable for one on the top line. And we'll also feel the impact of that sort of back procedural backlog starting to free up, which from a mix standpoint also helps the bottom line.

[Operator]

Thank you. There are no further questions. And I would like to hand the call back over to Kevin for some final remarks.

[Kevin Lobo, Chairman, CEO & President]

So thank you all for joining our call. We look forward to sharing our second quarter results with you in July. Thank you.

[Operator]

Thank you. This does conclude today's conference call. You may now disconnect your lines.