Earnings Call Transcript - SYK Q1 2022

Operator, Operator

Welcome to the First Quarter 2022 Stryker's Earnings Conference Call. My name is Brika, and I'll be your operator for today. 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

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, Vice President of Investor Relations

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 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 impacts 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.

Glenn Boehnlein, 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 the 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

The first question we have comes from Vijay Kumar of Evercore ISI.

Vijay Kumar, Analyst

Congrats on a strong start 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, CEO

Yes, Vijay. First, I want to emphasize that hospital liquidity remains very robust, which has positively impacted our order growth in the quarter. We entered the year with a strong order book and added significantly to it with impressive double-digit growth in orders during the first quarter. As we noted earlier, large capital expenditures have faced some disruption, mainly due to shortages of electronics and the hospitals' capacity to receive capital, either because of staffing shortages or delays in construction projects. I'm not worried about the shortage in other ortho for the first quarter. Our order book for Mako is exceptionally strong, despite several delays in installations, and we expect a solid year ahead. While we had a challenging comparison from the prior year, the order book for Mako remains robust, as does the order book for all our capital. We demonstrated strong sales in Instruments, Endoscopy, and Neurocranial. We are generally able to meet orders for small capital; our main challenge lies in fulfilling orders for larger capital, particularly in Medical, and to a lesser extent, Mako. Overall, there are no concerns regarding demand for Mako, and we saw strong results in the Hip and Knee business, which greatly benefited from Mako's strong performance throughout the pandemic.

Vijay Kumar, Analyst

That's helpful, Kevin. And maybe one on guidance here. To one-off 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, CEO

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 baked into that just because the environment is pretty uncertain. We do assume continued improvement in procedural volumes. If that continues to play out well, there is the potential for us to do even better than what we've guided. But based on what we know today, 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, Operator

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

Matt Miksic, Analyst

Congratulations on a very strong quarter. Kevin, I'll ask the question since I'm sure others are curious, and then I have a quick follow-up if that's okay. Regarding Vijay's question about the trends in robotics, would you say these challenges are being faced by all competitors in large capital robotics and related sectors in terms of getting systems into hospitals? In other words, do you think these issues won't put you at a competitive disadvantage over the next few quarters? I also have one quick follow-up.

Preston Wells, Vice President of Investor Relations

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.

Matt Miksic, Analyst

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 are 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, Vice President of Investor Relations

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, Operator

We now have a question from Robbie Marcus of JPMorgan.

Robbie Marcus, Analyst

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, CFO

Yes, Robbie. When we provided guidance in January, we indicated a pressure of 50 to 100 basis points on our gross margin, and it appears we're trending toward the upper end for the full year. Most of this increase is likely to be felt in Q1 and Q2, with some relief expected in Q3 and Q4. We've experienced high prices for spot buys of chips and related electronic components, along with rising costs for labor, supplier labor, warehouse, and distribution. Additionally, supply shortages are causing inefficiencies in our manufacturing facilities. All of these factors are putting pressure on our gross margin. Freight costs are also rising significantly due to a tight supply chain, and we're resorting to more overnight deliveries and air freight instead of more economical shipping options. While I see some easing in these pressures, labor and transportation costs may be more permanent compared to other costs in the long term. In terms of R&D spending, we are committed to maintaining our innovation budget to support our product pipeline, including launches like the Insignia Hip, which will drive growth as long as we keep funding R&D. In SG&A, we have worked to moderate discretionary costs, but the largest expense remains sales commissions. As long as our sales team is active, we will continue to compensate them well because it's vital. We also have some adjustments in other income and expenses, and I've provided guidance on taxes. Overall, I believe we are trending in line with these considerations.

Robbie Marcus, Analyst

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, Vice President of Investor Relations

Yes, Robbie. We certainly believe we will work through the backlog. It's still early as we face supply challenges. We are actively collaborating with our chip suppliers to address this. As Kevin mentioned, the second quarter will likely experience more disruptions compared to the latter part of the year. We will continue to address this throughout the year. Our overall guidance aims for us to reach or exceed the upper end, which depends on resolving the backlog. Right now, our focus is solely on securing the supply and managing it for the rest of the year.

Operator, Operator

We now have Larry Biegelsen of Wells Fargo.

Larry Biegelsen, Analyst

I wanted to start with the inflation and pricing. How are you managing the rising costs, and what is your ability to offset them? Where are you able to increase prices? It seems like pricing has improved a bit when comparing Q1 to Q4, if I'm seeing that correctly. I also have one follow-up.

Preston Wells, Vice President of Investor Relations

Yes, Larry, thanks for the question. So we're looking at it a few different ways. 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, 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.

Larry Biegelsen, Analyst

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, Vice President of Investor Relations

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. 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. We 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. We expect that to continue to play out in the 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, Operator

The next question is from Joanne Wuensch with Citi.

Joanne Wuensch, Analyst

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, Vice President of Investor Relations

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. We would expect that to continue initially. But as we get it integrated into our businesses, we're going to be able to accelerate the growth of Vocera by being able to put it into more hands and more hospitals. 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, CEO

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. 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, Analyst

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, CEO

It is included in our updated guidance. As we mentioned from the start, we anticipate that this will persist. You will see it reflected in the inorganic numbers. Each quarter, when Vocera's performance is reported, you will notice robust double-digit growth at the top line. Regarding the bottom line, we do expect a modest impact. So, there’s really nothing more to elaborate on. We will support the growth. This year is looking promising, and it will become accretive starting next year.

Operator, Operator

We now have Pito Chickering of Deutsche Bank.

Philip Chickering, Analyst

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, Vice President of Investor Relations

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 an impact as we continue throughout the year, but certainly within the range of the guidance that we provided.

Philip Chickering, Analyst

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, Vice President of Investor Relations

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, Analyst

To quantify that, if we see a negative 1% price in the first quarter, I think we'll end the year around flat. How much price increase can we expect throughout the year?

Preston Wells, Vice President of Investor Relations

Yes, not something that we're guiding on.

Operator, Operator

We now have a question from Ryan Zimmerman of BTIG.

Ryan Zimmerman, Analyst

I want to follow up on a couple of things. Glenn, regarding your comments on EPS guidance, you mentioned that you continue to expect more transient spot buying and long-term supply challenges. That was clear in your messaging. However, when I think about companies like Hologic who faced unexpected headwinds with certain electronic components, I wonder how well you have mitigated risk. At the lower end of your guidance at 9.60, how confident are you that if the market worsens for electronics, you wouldn't need to lower that estimate? How much of that uncertainty have you considered?

Kevin Lobo, CEO

That's a difficult question. I don't have a crystal ball, but I can assess our inventory and the input from our suppliers regarding chip availability. I also observe the current activity in the spot market. I would expect that Q2 will likely resemble Q1 in terms of pressure. However, I am increasing our inventories, particularly for components. I anticipate some easing in Q3 and Q4. At this moment, that's the best estimate I can provide regarding the potential impact on our P&L and the guidance we've issued. We did not lower our guidance from January because we believe there is still a pathway to meet it based on our current activities.

Ryan Zimmerman, Analyst

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, CEO

Yes, I still believe this market is excellent in the long run. It's a great market without a doubt. We faced a challenging comparison and experienced some competitive activity in the U.S. related to the ischemic side of our business. This competitive activity tends to fluctuate each quarter. Therefore, we were not anticipating double-digit growth in the U.S. While the growth was slightly below our expectations due to this competition, it is not concerning. We are set for a strong year ahead, expecting double-digit growth in neurovascular globally, and we anticipate improvement in the U.S. during Q2, Q3, and Q4. It remains a promising market as we are currently addressing only a small percentage of stroke patients. Given our pipeline and the excellent leadership team in Neurovascular, I am confident this will develop into a strong long-term business.

Operator, Operator

We now have David Saxon of Needham & Company.

David Saxon, Analyst

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, Vice President of Investor Relations

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 haven't had procedures done. We certainly 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. We're thinking about many quarters of recovery and being back to normal that will 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, Analyst

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, Vice President of Investor Relations

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. We do expect that Spine will continue to benefit as procedures come back to more normal levels throughout the rest of the year.

Operator, Operator

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

Andrew Stafford, Analyst

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 transitioning from pandemic to a post-pandemic environment, which will presumably result in the changes in some hospital 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, CEO

The pressure on the health care system and especially on nurses was particularly intense during the pandemic. With current shortages, hospitals are actively seeking solutions to keep their nurses engaged, minimize errors, and improve workflow. Our timing is ideal because this support for the nursing workforce is ongoing. I believe this supportive trend will continue for the next few years as it significantly lightens the workload for nurses. They feel more satisfied when Vocera is implemented in their hospitals. We are very optimistic about our position, and we see this as a long-term positive trend.

Operator, Operator

We now have Jason Wittes of Loop Capital.

Jason Wittes, Analyst

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, CFO

I will address the cash flow question, and then Preston can cover the M&A topic. Regarding cash flows, we are definitely experiencing inflationary pressures that will affect earnings throughout the year, which will also impact cash flow. Additionally, we are prebuying inventories and raw materials to ensure we have sufficient supply, which may lead to higher inventory levels that wouldn't typically occur under normal circumstances. I believe our cash flow performance remains strong, particularly in working capital. We are on track with our guidance for capital expenditures, and the underlying fundamentals are solid. I still expect to achieve between 70% and 80% free cash flow conversion, excluding the impact from the Vocera acquisition, specifically the $130 million related to the accelerated payout of employee stock options. Apart from that, we anticipate staying within the 70% to 80% range.

Preston Wells, Vice President of Investor Relations

Yes. So 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. 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. 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. 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, Analyst

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, Vice President of Investor Relations

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. 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 were impacted by that during the quarter as well.

Operator, Operator

Our next question comes from Drew Ranieri from Morgan Stanley.

Andrew Ranieri, Analyst

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, CEO

Yes. At this point, I would say we are not providing guidance for 2023. Regarding those products, we are still in the early stages of the approval process, so we have some time before we have any updates. Similarly, for the next power tools, we are also in the early stages of their launch next year. Therefore, there are currently no updates on major impacts or expectations regarding how these developments might affect our numbers for next year.

Andrew Ranieri, Analyst

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 maybe masking any uptake there of the new platform at ASCs?

Kevin Lobo, CEO

Yes. So what I'd say is Insignia product is ideal for direct anterior, which, of course, is very popular in the ASCs. But not just in the ASCs, also in the hospital. Even though we only launched it very recently, the feedback has been incredibly positive. 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. 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, Operator

Thank you. We now have Joshua Jennings of Cowen.

Joshua Jennings, Analyst

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.

Glenn Boehnlein, 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. 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 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, CEO

Regarding your question about the spine market compared to the hip and knee markets, historically, even before the pandemic, the hip and knee markets were experiencing dollar growth at a pace faster than the spine market. Although the spine market included some more urgent procedures that couldn't be postponed, it did not see a decline as significant as that of the hip and knee sectors. Consequently, there wasn't as pronounced a recovery in a market that hasn't traditionally grown as quickly as hips and knees. These are the trends you are observing. We are pleased with our performance, particularly in our knee and hip segments this quarter. We have been leading the knee market for an extended period, and Mako has been a major contributor to that success. Approximately half of the knee procedures in the United States are now done without cement, which gives us a substantial competitive edge. Our knee figures reflect this advantage, and I am also pleased that our hip numbers are increasing. It is not surprising to see faster growth in those areas compared to the spine market. We will need to wait for the reports from others to see how the markets compare, but this outcome is not unexpected for me.

Operator, Operator

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

Danielle Antalffy, Analyst

I 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, Vice President of Investor Relations

Operator, Operator

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

Richard Newitter, Analyst

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, CEO

Yes, considering the current inflationary environment, as Preston mentioned earlier, we will be evaluating pricing actions throughout our portfolio. In certain areas, this will be easier than in others due to the nature of our contracts. For competitive reasons, we won't disclose our specific tactics or strategies regarding which products will be affected. Each quarter, we report our pricing, so you will see the overall impact, but I won't go into further details on this call.

Richard Newitter, Analyst

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 Q3 and Q4. I just want to make sure I'm reconciling those 2 comments appropriately.

Glenn Boehnlein, 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 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. 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, 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, CEO

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

Operator, Operator

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