Earnings Call Transcript
STRYKER CORP (SYK)
Earnings Call Transcript - SYK Q4 2022
Operator, Operator
Welcome to the Fourth Quarter and Full Year 2022 Stryker Earnings Call. My name is Tanya, and I will be your operator for today’s call. At this time, all participants are in a listen-only mode. Following the conference, we will conduct a question-and-answer session. This conference call is being recorded for replay purposes. Before we begin, I would like to remind you that the discussions during this conference call will include forward-looking statements. Factors that could cause actual results to differ materially are discussed in the company’s most recent filings with the SEC. Also, 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, CEO
Welcome to Stryker’s fourth quarter earnings call. Joining me today are Glenn Boehnlein, Stryker’s CFO; and Jason Beach, Vice President of Investor Relations. For today’s call, I will provide opening comments, followed by Jason with the trends we saw during the quarter, Mako performance insights and updates on Vocera and Wright Medical. Glenn will then provide additional details regarding our quarterly results and 2023 guidance before we open the call to Q&A. I will begin with the macroeconomic environment. 2022 was a year where we, alongside many companies, faced unprecedented supply chain challenges and inflationary pressures. We faced these challenges and delivered for over 130 million patients and for our customers all over the world. We also remain focused on the future, as we progress our pipeline of innovation, enabling a super cycle of new product launches across our portfolio in 2023 and 2024. I want to thank our 50,000 employees for their unrelenting determination and agility. In the fourth quarter, we delivered organic sales growth of 13.2%, which brought our full year organic sales growth to 9.7%. During my 10-plus years in this role, these were record quarterly and annual growth rates. The growth was balanced across our businesses and regions in implants, disposables, and capital equipment, and was highlighted by our Medical division, which had Q4 organic sales growth of over 25%. Additionally, for the fifth consecutive year, our international organic growth rate exceeded our U.S. growth rate, demonstrating the progress we are making on globalization. This was highlighted by Europe, Canada, Australia and emerging markets, which all posted double-digit growth in the quarter. International growth remains a significant opportunity in the years ahead that should continue to complement our strong U.S. business. Next, we delivered quarterly and full year adjusted EPS of $3 and $9.34, respectively, exceeding our latest guidance range. This was driven by our strong sales performance, which offset inflationary pressures and negative foreign currency. Also, we are progressing with our actions to address higher costs, which include both pricing and targeted restructuring plans. We have begun to see the impact of these initiatives and expect an improving trend over the course of 2023. We also expect the positive trends in procedural recovery to continue alongside strong demand for capital products. And while component availability will continue to be variable in 2023, we do expect that it will gradually improve throughout the year, lessening the need for spot buys. We will remain disciplined with our spend and we will continue to invest in innovation, including potential tuck-in M&A. We remain confident in the outlook of our business and expect to continue to deliver sales growth at the high end of medical technology, which is reflected in our full year 2023 guidance of organic sales growth of 7% to 8.5%. This growth combined with the continued challenging macroeconomic environment, our pricing and cost actions will translate to an adjusted EPS of $9.85 per share to $10.15 per share. I will now turn the call over to Jason.
Jason Beach, VP of Investor Relations
Thanks, Kevin. My comments today will focus on providing an update on the current environment, as well as Mako, Vocera and Wright Medical. Procedural volumes continue to recover throughout the fourth quarter in most countries. Parts of Asia-Pacific, however, have continued to be more volatile due to ongoing COVID-related impacts. While volumes are recovering, hospital staffing pressures have continued in pockets around the globe and patient backlog remains. As mentioned on the Q3 call, these challenges will likely resolve gradually and we continue to expect this will be a moderate tailwind as we move through 2023. Additionally, demand for our capital products remained very healthy in the quarter, as seen from the double-digit organic growth of our Medical, Endoscopy, and Instruments divisions. Even considering our finish, we exited the year with a very strong order book. Next, specific to Mako, we had a record quarter of installations in both the U.S. and internationally. We continue to be agnostic to the form these deals take and will continue to offer flexible options for our customers to acquire capital equipment. The great progress of our Mako offense has resulted in strong growth of our installed base alongside continued increases in utilization. In the U.S., we saw approximately 55% of knees and almost 30% of hips performed using Mako in the quarter. Also, in December, we surpassed our 1 million cementless knee procedures with cementless knees continuing to index higher in Mako accounts. So in addition to being the leader in robotic-assisted surgery, we are also well ahead on cementless knee adoption. Finally, we are making good progress with the development of our Mako spine and shoulder applications and expect to have the initial launch of spine in the back half of 2024 and the initial shoulder launch at the end of 2024. Now to our key acquisition and integration activities, our Vocera integration continues to progress well, and as a reminder, we will anniversary in February of this year. Q4 results were consistent with our commentary on the last earnings call, as is the expected sales ramp beginning in Q2 of this year. Turning the page to Wright Medical, we have now passed the two-year mark of the integration of Wright Medical. This has been our largest acquisition to-date. Now complete, we have exceeded expectations on both our sales and synergy assumptions, as the cultural fit was strong and we implemented our integration playbook very effectively. Additionally, it was a catalyst that drove the creation of three separate business units, allowing us to serve unique customers across core trauma, upper extremities, and foot and ankle. All three businesses exited the year with terrific momentum and strong R&D pipelines. Overall, this acquisition has proven to be a great success and we are excited about what the future holds. With that, I will now turn the call over to Glenn.
Glenn Boehnlein, CFO
Thanks, Jason. Today, I will focus my comments on our fourth quarter financial results and the related drivers. Our detailed financial results have been provided in today’s press release. Our organic sales growth was 13.2% in the quarter. The fourth quarter’s average selling days were in line with 2021. The impact from pricing in the quarter was unfavorable by 0.6%. We continue to see a positive trend from our pricing initiatives, particularly in our U.S. MedSurg businesses, which all contributed positive pricing for the quarter. Foreign currency had a 3.8% unfavorable impact on sales, the supply chain disruption somewhat lessened during the quarter and our capital order book continues to be very robust as demand from our customers remains strong. In the quarter, U.S. organic sales growth was 11.2%. International organic sales growth was 18.3%, impacted by positive sales momentum across most of our international markets. For the year, organic sales growth was 9.7% with U.S. organic sales growth of 8.9% and international organic growth of 11.7%. The impact from pricing in the year was unfavorable by 0.9% and 2022 had the same number of selling days as 2021. Our adjusted EPS of $3 in the quarter was up 10.7% from 2021, driven by higher sales and strict cost discipline, partially offset by inflationary pressures and the impact of foreign currency exchange translation, which was unfavorable $0.16. Our full year adjusted EPS was $9.34, which represents growth of 2.8% from full year 2021, reflecting the favorable impact of sales growth, lower net interest costs, and a lower effective tax rate, partially offset by inflationary pressures and the unfavorable impact of foreign currency exchange translation of $0.31. Now I will provide some highlights around our quarterly segment performance. In the quarter, MedSurg and Neurotechnology had constant currency sales growth of 19.3%, with organic sales growth of 16.9%, which included 14.9% of U.S. organic growth and 22.5% of international organic growth. Instruments had U.S. organic sales growth of 11.7%, led by double-digit growth in the Surgical Technology business. From a product perspective, sales growth was led by power tools, Steri-Shield, waste management and smoke evacuation. Endoscopy had U.S. organic sales growth of 9.7%, highlighted by strong growth in sports medicine, communications, video, general surgery, and ProCare. Medical had U.S. organic sales growth of 22.9%, driven by our emergency care and acute businesses. The growth was fueled by double-digit growth across our emergency care and Prime Structure businesses and also benefited from improvement in product supply throughout the quarter. Our U.S. Neurovascular business had organic sales growth of 1.5%, driven by continued market softness and competitive pressures. The U.S. Neurocranial business had impressive organic growth of 19.7%, which included double-digit growth in our Sonopet iQ, Signature High Speed Drills, silver glide bipolar forceps, and Max space Neuro product lines. Internationally, MedSurg and Neurotechnology had organic sales growth of 22.5%, reflecting double-digit growth in all businesses. Geographically, this included strong performances in Europe, Australia, Canada, and India. Orthopedics and Spine had constant currency sales growth of 8.3% with organic sales growth of 8.4%, which included organic growth of 6.2% in the U.S. and 13.6% internationally. Our U.S. hip business grew 11.3% organically, reflecting strong primary hip growth fueled by the recent launch of our Insignia Hip Stem, the ongoing success of the Mako THA 4.1 software upgrade, and continued procedural growth. Our U.S. knee business grew 7.8% organically against a very strong Q4 2022 comparable of over 14%. This reflects our market-leading position in robotic-assisted knee procedures. Our U.S. Trauma and Extremities business grew 11.9% organically with strong performances across all three businesses, led by double-digit growth in upper extremities and foot and ankle, and strong performances in plating and nailing. Our U.S. Spine business grew 0.5%, led by performance in our enabling technology business, including the recently launched Q Guidance navigation system. U.S. Other Ortho declined organically by 18.7%, primarily driven by the impact of deal mix changes, specifically more rentals related to Mako installations in the quarter. Internationally, Orthopaedics and Spine grew 13.6% organically, which reflects strong performances in Europe, Australia, Canada, and India. Now I will focus on operating highlights in the fourth quarter. Our adjusted gross margin of 62.7% was unfavorable, approximately 310 basis points from the fourth quarter of 2021 and in line with Q3 2022, reflecting the impact of the purchases of electronic components at premium prices and other inflationary pressures primarily related to labor, steel, and transportation costs, and unfavorable business mix. Adjusted R&D spending was 5.5% of sales, which represents a 90-basis-point decrease from the fourth quarter of 2021. Full year adjusted R&D spending was 6.7% of sales, which was slightly higher than our 2021 adjusted R&D spending of 6.6% of sales. Our adjusted SG&A was 30.6% of sales, which was 150 basis points lower than the fourth quarter of 2021. This reflects the impact of increased focus on discretionary cost control and headcount discipline. In summary, for the quarter, our adjusted operating margin was 26.6% of sales, which was approximately 70 basis points unfavorable to the fourth quarter of 2021. This performance is primarily driven by the aforementioned inflationary pressures, primarily on gross margin and the negative impact resulting from foreign currency exchange translation, somewhat offset by cost discipline.
Robbie Marcus, Analyst
Great. Thanks for taking the questions and congrats on a really nice quarter. I wanted to start out on the MedSurg side of the business, where you had really strong performance in the fourth quarter. You talked about a healthy order book, but I was hoping you could give a little more visibility into exactly what you saw, was there a bolus of demand there, was this all underlying or catch-up demand and then you talked about a healthy order book, but just what you are seeing in terms of your hospital clients around the world and their desire to continue to buy capital here?
Kevin Lobo, CEO
Yeah. As you can tell, Robbie, it was a terrific quarter for all of Instruments, Endoscopy, and Medical. Medical in particular had giant growth in the quarter, really digging out of some of the backlog that they had of orders. If you look at the backlog entering 2023, it’s actually higher than what we had at the end of 2022. So it was a little bit of catch-up from prior quarters, but as we think about next year, right, the outlook for all divisions is strong again next year. We also have a lot of new products coming in those three divisions. So strong order book, strong demand for our product, strong pipeline — terrific leadership teams. This really — these three divisions have been, if you go back even from 2016, every year they are either high single-digit or low double-digit growers and that was no different in 2022.
Glenn Boehnlein, CFO
Yeah. First of all, just picking up where Kevin left off, if you think about the topline, entering the year with such a strong order book, it’s really going to kind of bode well for growth of our big capital businesses. The other thing we are really seeing is this procedural expansion and so we feel really good about our momentum, especially in hips and knees and trauma and extremities. So we are going to continue to see those grow as well. That plays into the mix of what we see when we get down to gross margin. We do think the first half of the year we will be working our way through some of that higher dollar inventory that was built up at the end of last year. We are seeing some bright spots in the supply chain. We are seeing an environment where we think there will be less spot buys and so all of that will contribute to progressively improving both our gross margin and our operating margins. I think the other thing to keep in mind, too, is that our pricing initiatives and actions really took hold in Q4 and we felt that especially on the MedSurg side. We will benefit from those actions for the full year in 2023. We will also see that’s not included in price. All the new products that Kevin talked about that we will launch, those come out at premium prices. So that will also benefit and help us with our operating margin improvement. And then the last thing is, we still have some targeted restructurings that will take place in 2023, especially in the first half of 2023. So we will also begin to feel the benefit of those in the second half. So I think Q1 is a little pressured year-over-year just because the inflation wasn’t sitting in last year’s operating margin and it is sitting in 2023 operating margin. But I think as the year progresses, we will continue to improve on that operating margin, and obviously, that will drive to the EPS growth that we guided to.
Matthew O'Brien, Analyst
Good afternoon. Kevin, at the Analyst Day, when was it, this was a couple of years ago, you really emphasized international growth. The performance in the quarter was phenomenal and it’s been really strong. I am just wondering about the durability of that and should we think about international being not quite half of the growth on the topline this year, but something around that level. Is that how important international should be for you guys in 2023 and even beyond? Thank you.
Kevin Lobo, CEO
Yeah. Rather than thinking about what percentage of the growth is, is just how durable is it? Five years in a row now, organic sales growth has exceeded the U.S. organic sales growth, and of course, China really didn’t contribute anything in 2022. So Europe was a double-digit grower. It’s a growth engine for Stryker. I have talked about Europe for the last six years or seven years and we are hitting our stride in Europe. But even other emerging markets, whether it’s Latin America, whether it’s the Middle East, Eastern Europe, parts of East Asia, we have really started to hit our stride. It feels exciting. We have great leadership teams. We are getting great penetration now with Mako and fluorescence imaging, some of those power brands are now really starting to show up effectively. So the way I’d like to think about it is that emerging markets should grow roughly double the growth rate of Stryker’s growth rate, and overall, we should continue to grow above the Stryker growth rate in these international markets. And as over time, if we don’t continue to have large acquisitions in the U.S. then that will become a bigger percentage of our business. But being acquisitive it’s still pretty small, if you think about 72% roughly of our sales are in the United States. But it’s starting to have a material impact and you saw really an outstanding quarter in Q4.
Vijay Kumar, Analyst
Hi, guys. Thanks for taking my question and congratulations on a really strong finish year. Kevin, maybe the first one on the performance here in the fourth quarter, at least organic, that’s quite outstanding. Sequentially, it looks like your growth accelerated by 350 basis points. Can you put some of those numbers in context for us? Is this share gains or is this your supply chain situation improving? And I am assuming there was some headwind from China; maybe if you could quantify it and just help us understand what went into that pretty stellar 13% number in the fourth quarter?
Kevin Lobo, CEO
Yeah. Look, I think the outsized growth is in the Medical division, right? So the Medical division isn’t going to typically grow 26% organic, right? That’s outsized and that’s really, let’s call it, making up for supply. So they had huge orders and we were able to get healthy in some of the product lines and we were able to get a lot of shipments out the door. That kind of variability could happen from quarter to quarter. But if you look at a full year kind of organic growth rate, Instruments 10%, Endoscopy 15%, Medical 11%, kind of on a rolling four-quarter basis. Those are really outstanding results. So it’s not a one-quarter wonder. I would kind of look at the overall year having organic growth of 9.7%. That’s the highest I have had in my tenure. And we have new products, I would say, they are as good a set of pipeline as I have had since I have been in this role. So that bodes well for next year. We are starting with the highest organic growth guide that we have ever started with and assuming launches go well and everything, this should be another very, very strong year. I think you will see a little bit of volatility quarter to quarter primarily with Medical because they do have the largest backlog of all the divisions in the company and a more consistent performance with the implants side of the house.
Glenn Boehnlein, CFO
Hi, Vijay. I will take some of these. If I miss a part, you can correct me. First of all, the growth is not front-end loaded. It’s pretty steady throughout each of the quarters and you will see that there is going to be solid growth just given sort of the momentum that we are feeling from the fourth quarter. In terms of the order book, we exited 2022 with an increase in the order book year-over-year. So we are actually feeling very bullish about capital sales, about our customers' willingness to buy capital. So we don’t — we feel like that’s a great tailwind for the whole year.
Vijay Kumar, Analyst
Understood. And maybe off of those comments, Kevin, and maybe perhaps for Glenn as well, that 7% to 8.5% guide for fiscal 2023, is that a front-loaded guidance? Just when I look at the comps here for 2022, is that so 8.5% front-loaded? And what is it assuming for supply chain? Are you assuming supply chain to improve just given off of Q4 levels? And the order that you mentioned, Kevin, did that backlog grow versus the third quarter or are we starting to work down on the backlog?
Glenn Boehnlein, CFO
Yeah. As I mentioned, we assume that we will see gradual improvement in the supply chain. We saw some of that in Q4. We actually feel pretty good about our access to supply, we are seeing a reduced volume of spot buys, which are those really high cost items and we are also beginning to work with our original set of vendors and also going up the food chain and actually working with chip suppliers so that we feel like we have a good handle on what’s going to happen with supply chain, but it should become better quarter-to-quarter-to-quarter with good improvement and visible improvement in the back half of the year.
Shagun Singh, Analyst
Great. Thank you so much for taking the question. I was just wondering what you have assumed for margin expansion in 2023 relative to your at least 30 basis points of outlook that you previously shared. And then I was wondering if you could talk a little bit about the VCON business in hips and knees. In knees, your major competitor does have a new cementless launch. Do you see that as a price mix benefit for them or something that could drive competitive account conversion, and then on hips, it came out stronger than what we were expecting. I was just wondering if you could talk a little bit about the drivers and if we could see meaningful share gains on the hip side, similar to what we have seen in knees? Thank you for taking the questions.
Glenn Boehnlein, CFO
Yeah. Great question. I will start out and just touch on the margin expansion. We typically do not guide on operating margins. So we are not going to pinpoint an expansion number. I think backing up from EPS and looking at tax and OI&E and where we are with sales that, you will see that the math doesn’t work unless we expand op margin. So I think what you will see is a progressive improvement each quarter in that expansion, especially as the comparable includes inflation from the prior year.
Kevin Lobo, CEO
We are very pleased with our performance this year in both hips and knees, achieving global double-digit growth in these areas. The success in hips is largely due to the launch of the Insignia Hip Stem, and we are still in the early stages of that launch. We anticipate it will take the remainder of this year and possibly into the first quarter of 2024 to complete the rollout of Insignia, so we are still building momentum. This, along with the 4.1 Mako hip software, leads us to expect continued strength in our hip segment. Regarding knees, they have consistently outperformed for us over the past six to seven years since we introduced the Mako Total Knee application. With cementless options, we are still gaining traction, and I have no concerns about competition in this area. Our cementless product has a proven track record with over 1 million procedures already completed, while competitors are only just beginning to launch their offerings.
Ryan Zimmerman, Analyst
Hey. Thanks for taking the questions. Not to take away, this is a really good quarter, Kevin, but I do want to ask about two segments that are maybe a little softer than expectations. Neurovascular and Spine both come on the back of what I think what we would consider easier comps and you can probably challenge me on that. But what are you contemplating in terms of your guidance for growth in those areas for 2023, and just commentary on both the Neurovascular and the Spine segment this quarter and kind of what impacted results?
Kevin Lobo, CEO
We had strong performance in Neurovascular last year, but comparing it to the previous year and going back to 2019 presents challenges. While we've faced some difficulties in the U.S., we've seen solid growth internationally. The ischemic market segment has softened with increased competition. However, we believe there is still significant opportunity, as many patients with large vessel occlusions remain untreated. We're launching a new coil called Tetra Coil in the U.S. and are optimistic about a pending acquisition in the hemorrhagic segment, which we think will boost our position. Despite the challenges in the U.S. this year, our commitment to the Neurovascular market remains strong. Regarding the Spine segment, the Mako Spine launch is crucial, and the Q Guidance launch is progressing well. We experienced a gap in enabling technologies, which is vital for Spine. I believe 2023 will reflect growth in line with market trends, with the Mako launch positioning us for greater growth. Although these divisions may not be as prominent as others right now, they are still performing well and are essential for the long-term future of Stryker.
Ryan Zimmerman, Analyst
Very helpful. And then if I could just ask a follow-up. I mean this was the first time you really, I think, put those timelines out on spine and shoulder. We have kind of danced around these topics for some time. What is it now that’s a comfort to put those out there and ensure that those will be on time with the timelines you outlined?
Kevin Lobo, CEO
Yeah. As a company, we tend to be pretty conservative on getting timelines and robots are hard, right? Ask any of the companies who are trying to launch robots, whether they are in heart tissue robotics or soft robotics. Robots are difficult. What gives us confidence is our prototypes are built. We have tested it with surgeons. We have gotten feedback. We have had some meetings in one case with the agency to get an idea on the regulatory pathway. So we have enough in the pipeline right now.
Vik Chopra, Analyst
Hi. Thanks for taking the question. This is Vik on for Larry Biegelsen. Kevin, you talked about a super cycle of new products. Just remind us sort of what they are and how we should think about their impact in 2023. And my second question is, maybe just a comment on your trend in China, sort of what are you seeing there and maybe just the impact on Neurovascular? Any color you could provide would be helpful? Thank you.
Kevin Lobo, CEO
There are a few questions in there. I'll discuss the super cycle first and then hand it over to Jason for China. Regarding the super cycle, System 9, our new power tool and instruments, was launched at the end of last year, so we expect to see its first full year of impact in 2023, and the initial feedback has been extremely positive. We have experience with these products, having moved from System 6 to 7 to 8 and now to 9. This is one of our flagship products. Additionally, the 78 camera for Endoscopy will be launched initially in Q2, with a greater pickup expected in Q3 and Q4. It’s an excellent new camera, and we have a strong track record with similar products in the past. We also have Neptune S, a small footprint product specifically designed for GI, which enters a new market for us since Neptune products aren't currently used in GI. This device is designed to catch polyps, and nurses are expected to appreciate its impact, likely increasing their daily procedures, which will benefit the GI teams. Towards the end of the year, we will introduce a new defibrillator, which will be available outside the U.S. in 2023 and will launch in early 2024 within the U.S. This is a significant pre-hospital and complex life pack defibrillator. These three flagship products are notable, as it's uncommon to have them all launched within an 18-month span, making it a super cycle. Beyond these, the Insignia product continues to launch, and we have the CD Next product for depth perception while drilling. Signature 2, launched this year, will significantly impact the neurocranial market for neuro power drills next year. There are many products in the pipeline, including in the shoulder and foot and ankle spaces. Overall, the products I mentioned define this super cycle, as typically these launches occur every two to three years, not all within a compressed timeframe. The ProCuity bed is receiving high praise and is still in the early stages of its launch. This has been one of the healthiest product cadences I’ve experienced during my time at Stryker.
Jason Beach, VP of Investor Relations
Vic, as it relates to China, as you all know, right, China, as it relates to total Stryker less than 2% of our sales. So even as you consider some of the lockdowns and things in 2022, immaterial to our results in terms of Q4. Then as you think about 2023, early days as it relates to Neurovascular VBP. We are certainly keeping an eye on that and as we think about Q1 and the full year of 2023, when we get to the next earnings call, if there’s anything material to disclose, we will certainly do it at that time.
Matt Miksic, Analyst
I wanted to get a better understanding of the positive developments this year, particularly regarding Spine. The investment in the robot is significant, and the portability of that hardware along with the app upgrades, as you mentioned, is promising. As we move forward, whether it's guidance for the upcoming quarter, implant launches, system launches, or other investments, could you discuss any factors that might be gradually building momentum in that business leading up to the robot's introduction next year?
Kevin Lobo, CEO
Sure, Matt. We can't rely solely on Mako, and I can tell you that Q Guidance has actually surpassed our expectations. Customer feedback has been fantastic, and sales of those systems have been excellent. We also have several distribution agreements for expandables across different products. Additionally, we have the exciting new Monterey product with Tritanium. We have a planned series of new products, either developed by Stryker or through distribution, to address product gaps. I'm particularly thrilled that Andy Hamel, our sports medicine leader and Head of R&D, has transitioned to the Spine team. Over the past decade, our sports business has been the quickest in launching new products at Stryker, and I believe he will significantly benefit the Spine team.
Pito Chickering, Analyst
Hey. Thanks for taking my question. Can you guys hear me?
Kevin Lobo, CEO
Yes. We can.
Glenn Boehnlein, CFO
We can.
Pito Chickering, Analyst
All right. Great. So pre-COVID, the first quarter is about 23% of the annualized EPS. So with the commentary on no EPS growth for first quarter 2023, it looks like you guided about 20% of annual EPS. I understand the hard inflationary comps in 1Q, but why should 1Q be underweight the annual EPS number versus recovered years or should we take this as just back half margin expansion for 2023?
Glenn Boehnlein, CFO
Yeah. I think you are astute in your numbers. Definitely, it will be back half margin expansion for 2023. So you are right, we will see relative flat EPS in the first quarter, and then obviously, meaningful expansion starting in Q2, but really accelerating in Q3 and Q4 to drive to the EPS that we guided.
Jason Beach, VP of Investor Relations
Hey, Pito. It’s Jason. We won’t quantify in terms of what we have from an order book perspective. But I would just point back to, I think, what Glenn said earlier around and maybe it was Kevin. But the order book, as we exited 2022 is even larger than when we exited 2021. So we continue to be quite bullish on the capital side as we enter the New Year.
Glenn Boehnlein, CFO
Yeah. And that’s not a new commentary. So the last four months, I think our commentary has been very consistent on capital. Our hospitals having challenges with their P&L and in some cases, sure, it’s not yet — we are not seeing it in orders. We are not seeing any cancellation of orders. Are some projects being delayed here and there? Sure. But it really is not having any kind of material impact on our outlook for capital. Again, a lot of our capital is revenue-producing type of capital. So you wouldn’t expect any kind of slowdown. But even the large capital area, if I look at our communications business within Endoscopy, had a fantastic year, helped drive some of the Endoscopy growth and they have a terrific order book going into next year and that’s large capital that sometimes in prior recessionary cycles have been deferred. So we just aren’t seeing it yet. So that gives us optimism to kind of lean in on the growth for at least for 2023.
Steven Lichtman, Analyst
Okay. Great. Just on growth in the quarter, one of the factors you pointed to, Kevin, was procedural volume recovery. One of the factors discussed, obviously, throughout 2022 on in terms of capturing those procedures was hospital staffing. Are you starting to see an easing of that factor? Any color you are seeing in terms of that here in the U.S. would be helpful?
Kevin Lobo, CEO
There are areas where staffing remains a challenge, but hospital systems are improving their response. From September to the end of the year, we noticed a gradual increase in procedures and consistently high volume. The demand is evident, with surgeons typically booked three to four months in advance. We're observing a steady improvement and anticipate a moderate positive trend for the remainder of the year. The staffing challenges are often brief, and even in Europe, regions that faced strikes have quickly recovered. Overall, we are optimistic about the outlook for procedures and expect it to positively impact us throughout the year.
Glenn Boehnlein, CFO
I think it's important to consider inflation, as we certainly experienced its effects during Q3, which were quite significant. However, I would note that there was a moderation in Q4. It's important to remember that our purchases of raw materials and inventory have been affected by inflated raw material prices, which are capitalized in our inventory. Additionally, we will feel continued inflation in labor costs, which are now a fixed part of our expenses for the year. We are also still facing high inflation in freight and transportation costs, and energy costs, particularly in Europe, have inflation factored in as well. Looking ahead to 2023, we don't expect inflation to remain at the levels we saw in 2022.
Drew Ranieri, Analyst
Hi, everyone. Thanks for your questions. Kevin, to start off, we have discussed the capital order book being stronger year-over-year. Could you elaborate on what you're observing in hospitals compared to the ASC setting? Are there any noticeable trends in procedures in the ASC as we move into 2023? I have a follow-up as well.
Kevin Lobo, CEO
The trend of shifting procedures to ambulatory surgical centers is ongoing. It really sped up during the pandemic, and there are no signs of it slowing down. This year, we have seen a record number of Mako installations in the ASC setting. As more procedures are performed in ASCs, the demand for advanced technology will continue to grow. Every hospital system I speak with is planning construction around ASCs, indicating a clear future trend. While building out this capacity will take time, we observed an increase in the last quarter compared to the previous quarters. This gradual trend mostly applies to hip and knee replacements, but we are also seeing some spine procedures being performed in surgery centers, including shoulders. I believe there will be no slowdown; this growth will continue over the next few years.
Glenn Boehnlein, CFO
I think as you think about the biggest contributor to cash flow, honestly, it’s earnings. So as we see progressive improvement in earnings throughout the year, I think we will see that carry over into cash flow. There are some things that were maybe one-offs that we felt that we hope will get better in 2023. That bolus of AR that we had at the end of the year in 2022, obviously, we will collect that and kind of get back to a regular cadence of DSO. And then, finally, as inventory costs moderate and we feel more confident about supply, we will draw down on some of the safety stocks that we had pre-buy. We will also see just lower cost of inventory in raw materials and that should carry over to cash flow, too. And then the other area that I would highlight that maybe doesn’t get a lot of attention is, we continue to work on our AP and AP days, and we have made incredible improvements over the past two to three years in terms of working with vendors and pushing AP out to beyond 70 days and we will continue to work on that as well. So I think all of that bodes well for cash flow improvement. But generally, I think what you will see is as you see progressive improvement in earnings, you will also see cash flow fall out.
Michael Matson, Analyst
Thank you for including me. I'd like to ask about mergers and acquisitions. You mentioned that you are looking to pursue more tuck-in acquisitions. What are you observing regarding the valuation expectations from potential targets? It seems there has been a gap over the past year between what buyers are willing to pay and what sellers expect. Is that starting to align more realistically now? Could you share your general observations on deal flow?
Kevin Lobo, CEO
The stock market has reacted harshly over the past year to companies not making profits, and it takes time for this new reality to be accepted by sellers. As a company that actively pursues acquisitions, this situation could benefit us in the coming years if valuations remain stable. Most of our tuck-in acquisitions involve private companies rather than public ones, and we have a list of potential targets. We are also focused on reducing our debt, particularly since we took on significant debt for Wright Medical and Vocera. Our priority is to continue paying down our term loan, of which approximately $850 million remains. We are ready to act if good tuck-in opportunities arise, and we can manage both debt repayment and small acquisitions simultaneously. Our divisions are actively seeking these opportunities and will be prepared to move forward if the pricing is favorable. Overall, I believe the current pricing environment will be advantageous. Profits are important, and there has been a time when many companies avoided us due to their high valuations during periods of rapid growth.
Joanne Wuensch, Analyst
There is a moment when you were going over all the different growth in MedSurg and Neurotechnology. And I could not get my head around some of these numbers and I am just sort of curious, maybe this has been addressed. How did this happen? Was there some level of pent-up demand in the capital equipment cycle, was it just that at the end of the year people have money in their budgets and may want to let go? Help me understand what this is and do you expect there to be more of a depleted effort in the beginning of this year?
Kevin Lobo, CEO
Yes, Joanne. One of the highlights of this quarter is that it felt like a record quarter from before the pandemic. Our sales teams were performing at their usual high level. As you know from following us, having a strong fourth quarter is typical for Stryker. Our teams are skilled at meeting their targets, and hospitals often aim to utilize their budgets depending on their calendar cycle. What’s particularly exciting is that we managed to reduce some backlog, especially in medical, without fully depleting our resources. These are not just early sales; we still have strong orders and ongoing growth momentum that will carry into next year, which is reflected in our optimistic guidance for organic sales growth. We’re not anticipating a weak first quarter, and Glenn noted during the Q&A that we expect to maintain a solid top line. Our implant businesses are operating smoothly. And these businesses are just their special businesses. We have these dedicated business units. We have split them many times. If I look at within Instruments, Instruments had 10% organic growth in 2022 and that’s because we decided to split orthopedic instruments and circular technologies a few years ago and they are both growing extremely well. They both have new products, right? We have a new Neptune and we have a new power tool. In the old days, it was the same rep trying to sell both of those. Now we have different reps selling them. So our ability to scale those launches is so much better with specialization and dedication. That’s kind of our formula, our growth formula and that’s just — it’s absolutely happening in our company. So our leadership teams are terrific. Our dedicated business units are firing and the products are flowing. So I expect more of the same. But if you look back, even going back to 2016 as I mentioned before, and if you look at the kind of organic growth, it’s of these three divisions, Instruments, and Ortho, and Medical, not to mention Neurocranial, which has been an absolute home run, right? And that’s really run by instruments but we report it separately. They are growing every year, 8%, 9%, 10%, 11%, 12%. That’s not unusual. And now that they have — when you have new product launches that tends to be on the higher side of it. So, yeah, it’s a good point to be a Stryker right now, especially in those businesses. I want to thank everyone for your patience as we navigated our technical challenges. We finished last year strong and have started this year well. I've been out with our sales teams at Stryker, and the momentum is noticeable. It seems like it's going to be a strong year ahead. While we will continue to face some challenges related to the supply chain, it feels like the toughest times are behind us compared to last year. Thank you all for joining our call. We look forward to sharing our first quarter results with you in April.
Operator, Operator
This concludes the conference call. Thank you for your participation. You may now disconnect your lines.