Boston Scientific Corp (BSX) 2022 Q1 法說會逐字稿

Good morning, and welcome to the Boston Scientific First Quarter 2022 Earnings Call. (Operator Instructions) Please note, this event is being recorded.

I'd now like to turn the conference over to Lauren Tengler, Vice President, Investor Relations. Please go ahead.

Thank you, Andrew. Welcome, everyone, and thanks for joining us today. With me on today's call are Mike Mahoney, Chairman and Chief Executive Officer; and Dan Brennan, Executive Vice President and Chief Financial Officer.

We issued a press release earlier this morning announcing our Q1 2022 results, which included reconciliations of the non-GAAP measures used in the release. We have posted a copy of that release as well as reconciliations of the non-GAAP measures used in today's call to the Investor Relations section of our website under the heading Financials and Filings.

The duration of this morning's call will be approximately 1 hour. Mike will focus his comments on Q1 performance as well as future catalysts and the outlook for our business, including Q2 2022 and full year '22 guidance. Dan will review the financials for the quarter, provide more details regarding our Q2 and full year 2022 guidance, and then we'll take your questions. During today's Q&A session, Mike and Dan will be joined by our Chief Medical Officers, Dr. Ian Meredith and Dr. Ken Stein.

Before we begin, I'd like to remind everyone that on the call, operational revenue growth excludes the impact of foreign currency fluctuation and organic revenue growth further excludes acquisitions and divestitures for which there is less than a full period of comparable net sales. Relevant acquisitions excluded for organic growth are Preventice, Farapulse and Lumenis Surgical, which closed in March, August and September of 2021, respectively, as well as Baylis Medical, which closed on February 14, 2022. Divestitures include the BTG Spec Pharma business, which closed on March 1, 2021. For more information, please refer to our financial and operating highlights deck, which may be found on our Investor Relations website.

On this call, all references to sales and revenue, unless otherwise specified, are organic. This call contains forward-looking statements within the meaning of federal securities laws, which might be identified by words like anticipate, expect, may, believe, estimate and other similar words. They include, among other things, the impact of COVID-19 pandemic upon the company's operations and financial results; statements about our growth and market share, new product approvals and launches, acquisitions, clinical trials, cost savings and growth opportunities, our cash flow and expected use, our financial performance, including sales, margins and earnings as well as our tax rates, R&D spend and other expenses. Factors that may cause such differences include those described in the Risk Factors section of our most recent 10-K and subsequent 10-Qs filed with the SEC. These statements speak only as of today's date, and we disclaim any intention or obligation to update them.

At this point, I'll turn it over to Mike for his comments. Mike?

Thanks, Lauren. Thank you, everyone, for joining us today. We're very pleased with our first quarter performance and our outlook for the full year despite the impact of the ongoing pandemic and the macroeconomic headwinds. Growth in the quarter was fueled by improved procedure volume, our innovative portfolio and strong execution across our global team. In first quarter '22, total company operational sales grew 13% versus prior year, while organic sales grew 10%, above the high end of our guidance range of 5% to 8%. Importantly, this performance was strong across all regions, and we anticipate that most all of our businesses grew at or faster than their respective markets.

First quarter adjusted EPS of $0.39 grew 6.5% versus prior year, achieving the midpoint of our guidance range of $0.38 to $0.40. And despite continued macroeconomic headwinds and resulting supply chain pressure, first quarter adjusted operating margin was 25.8%, which was higher than anticipated due to the overachievement of sales and lower spend. While we continue to anticipate less of a global COVID impact on underlying procedure volumes for full year '22 versus '21, we continue to provide a wider guidance range to account for uncertainty related to COVID waves, staffing challenges and supply chain pressures. However, we are increasing our full year 2022 operational growth to 9% to 11% and organic growth to 6.5% to 8.5%. For second quarter '22 revenue, we are guiding to operational growth of 6% to 9% and organic growth of 3% to 6%.

We're also updating our full year 2022 adjusted EPS guidance to $1.74 to $1.79, and our second quarter adjusted EPS estimate to $0.41 to $0.43. Despite increased macroeconomic pressures, we continue to target adjusted operating margin expansion of 10 to 50 basis points or 26% to 26.4% for the full year, and Dan will provide some additional details. I'll now provide additional highlights in the first quarter, along with comments on our '22 outlook.

Globally, the impact from COVID varied by region during the first quarter. And within the quarter, we experienced a more significant COVID impact in both the U.S. and Europe in January and early Feb, with significantly improved volume growth during the remainder of the first quarter. Regionally, our business in the U.S. delivered operational growth of 13% versus prior year, which includes an approximate 400 basis point tailwind from acquisitions. First quarter performance in the U.S. was particularly strong in WATCHMAN, PI, cardiology and endoscopy.

In Europe, Middle East, Africa, we grew 12% on an operational basis versus prior year, while all businesses in the region experienced strong growth. We saw particular strength in structural heart, including TAVR, WATCHMAN, and other interventional cardiology therapies as well as electrophysiology. In Asia Pac, we grew 14% operationally versus prior year with new product launches, fueling the region's growth, notably POLARx and RANGER in Japan and WaveWriter Alpha in Australia.

The China team delivered another impressive quarter with double-digit growth in the first quarter with broad strength across the region, enabled by a diverse portfolio. Given the current COVID wave in China, we do anticipate more pressure on underlying procedural volumes in the second quarter. However, we remain confident in our team's ability in China to continue to drive toward double-digit growth for the full year 2022.

Now some additional thoughts on our business units. Urology and pelvic health grew sales 7% organic and 16% operational. The global integration of the Lumenis acquisition is going extremely well with an innovative MOSES laser platform, complementing our category-leading stone portfolio. Globalization remains a big opportunity in this business, and we're pleased with the approval of Rezum in China after a successful pilot, and we look forward to launching later this year. Additionally, we received approval in Canada for LithoVue Elite, which is our next-generation flexible single-use ureteroscope with advanced imaging and intrarenal pressure sensing capabilities.

Turning to our endoscopy business. Sales grew nicely, 9% organic versus prior year. The underlying business remains very strong, and we continue to innovate with new product offerings, supporting continued above-market growth. We're seeing momentum across our franchises, including biliary, hemostasis and our single-use imaging franchise as the SpyGlass DS visualization system continues to have strong growth, while our newer single-use scopes are gaining scale. Beyond products, we're also enhancing our digital capabilities with the recent launch of e-commerce platform to all endoscopy customers in the U.S.-based ambulatory surgical centers to enable easy online ordering from any device at any time.

In neuromodulation, first quarter organic grew faster than the market at 8% versus prior year. In pain, we continue to see positive momentum in spinal cord stimulation as physicians continue to be pleased with the performance of the WaveWriter Alpha system with fast therapy and our Cognita practice optimization suite of solutions.

In brain, we received FDA approval in the U.S. for the Neural Navigator software with STIMVIEW earlier this month. This was developed in collaboration with Brainlab and enables more streamlined programming for clinicians with integrated visualization for lead placement and stimulation field modeling.

In cardiology, organic sales grew 11% versus prior year and operational sales grew 16%, with all business units growing high single digit or better in the quarter. Within cardiology, our interventional cardiology therapies business had organic sales of 8% versus prior year. Coronary franchise grew mid-single digits, fueled by new product launches and globalization. And within the quarter, we received FDA clearance of the expanded portfolio of Emerge PTCA dilation catheters, making it the only complete portfolio of balloon sizes in the U.S. for the treatment of large vessels and lung lesions.

We really had another strong quarter with double-digit growth in our structural heart valves franchise, led by ACURATE neo2 in Europe. We continue to take market share in our existing accounts while also continuing to gain new accounts, exceeding our sales expectations in the first quarter. Additionally, we have initiated our -- and also are currently enrolling patients in our early feasibility study called ACURATE Prime XL, which is evaluating additional sizes for the ACURATE neo2 valve.

Turning to WATCHMAN. Organic sales grew 33% versus prior quarter -- versus prior year. WATCHMAN is on track to deliver full year double-digit growth with sustained momentum from the second-generation WATCHMAN FLX, ongoing clinical evidence, globalization and commercial execution. Within the quarter, the ongoing SURPASS analysis of the NCDR LAAO registry was presented at CRT, including more than 16,000 patients with real-world results that reinforce the differentiated safety and efficacy data seen in our pivotal PINNACLE FLX trial.

In cardiac rhythm management, organic sales grew 7% and operational sales grew 14% versus prior year. In Core CRM, we anticipate that our growth was in line to slightly above market with our low-voltage business growing high single digits and our high-voltage business growing low single digits, aided by stronger SICD sales. We look forward to the presentation of further clinical evidence at HRS later this week.

Within the diagnostics franchise, we continue to be pleased with the performance of our differentiated portfolio with both the LUX-Dx implantable cardiac monitor and preventive AECG portfolio outpacing the market in first quarter. Electrophysiology sales grew 11% and an organic 47% operationally versus prior year. International strength continues driven by our innovative portfolio and continued success of Farapulse, with late-breaking clinical data from the MANIFEST-PF survey presented at EHRA highlighting the real-world performance of the system. And more than 1,700 patients' investigators reported 99.9% success in achieving acute pulmonary vein isolation and excellent procedure times. We continue to further [the body of] clinical evidence elsewhere in the portfolio with real-world outcomes data from the POLARx ICE study, which was presented at EHRA and demonstrated a strong safety and efficacy of the POLARx Cryoablation System.

We also closed the Baylis acquisition in mid-February, and we're excited to bring a novel category leading technology and commercial synergies to our broader portfolio.

In Peripheral Interventions, organic sales grew 10% versus prior year. The arterial franchise was led by double-digit growth within the drug-eluting franchise, supported by ongoing clinical evidence and more broadly, our category leadership portfolio. And within venous, Varithena had another quarter of double-digit growth driven by a strong underlying market and penetration in new accounts.

Our Interventional Oncology franchise continues to do very well, led by TheraSphere, which grew double digits in the quarter. And earlier this month, we received FDA IDE approval to initiate the frontier study, which will assess TheraSphere as a treatment option for patients with glioblastoma, an aggressive cancer occurring in the brain or spinal cord. We also received FDA clearance for EMBOLD, which is a fiber embolization coil that further enhances our portfolio of embolization technologies.

Boston Scientific's dedicated transforming lives through innovative medical solutions while also minimizing the impact of the environment and making measurable contribution to the world. Corporate responsibility is core to our values and helps inform our priorities at advanced progress and aligned to our business goals. So we're excited to share our progress in the 2021 performance report, which we expect to release in May. Also in 2021, we announced 5 acquisitions, strengthening our underlying market growth with innovative technologies and accretive growth markets.

In 2022, we evolved our leadership structure to enhance customer focus and further enable our strategies. Joe Fitzgerald now leads the cardiology segment, including interventional cardiology therapies, WATCHMAN, CRM Diagnostics and Electrophysiology and Art Butcher now leads the MedSurg segment, including endoscopy, urology and neuromodulation, while continuing to oversee Asia Pac. This new structure supports agile business practices and drives collaboration and innovation across our similar call points while also empowering our leaders to maintain our deep customer focus.

We're excited about the outlook for 2022 and our long-range plans despite the macroeconomic challenges we continue to face. We remain committed to our financial goals, growing sales faster than the market, continuing operating margin expansion and double-digit adjusted EPS growth with strong adjusted free cash flow. I'm extremely grateful to our employees for their resiliency, their strong results and their winning spirit. And now I'll turn things over to Dan to review our financial performance in more detail.

Thanks, Mike. First quarter consolidated revenue of $3.026 billion represents 10% reported revenue growth versus first quarter of 2021 and reflects a $74 million headwind from foreign exchange, higher than our expectations, driven by the strengthened U.S. dollar. Excluding this 270-basis point headwind from foreign exchange, operational revenue growth was 12.6% in the quarter. Quarterly sales from the acquisitions of Farapulse, Lumenis and Preventice through February, and Baylis post the February 14 close date, contributed 340 basis points, partially offset by the divestiture of the BTG Specialty Pharmaceuticals business in 2021, resulting in 9.7% organic revenue growth, exceeding the high end of our guidance range of 5% to 8% growth versus 2021.

We saw a steady improvement in Q1 procedural volumes as COVID waned in most geographies throughout the quarter with a strong finish in March. April procedural volumes have continued to see minimal COVID impact with the exception of China, in line with our expectations. Top line results drove Q1 adjusted earnings per share of $0.39, representing 6.5% growth versus 2021 at the midpoint of our guidance range of $0.38 to $0.40. Included in the $0.39 was a $0.02 headwind from tax and below the line.

Adjusted gross margin for the first quarter was 70.3%. We expect Q2 adjusted gross margin to be in line with Q1 as we continue to face macroeconomic headwinds and resulting pressures on the global supply chain. Despite our expectation that these macroeconomic headwinds will continue throughout 2022, we anticipate a slight improvement to adjusted gross margin in the second half with the full realization of standard cost improvements and less unfavorable manufacturing variances. We now expect our full year adjusted gross margin to be in line with the second half of 2021 adjusted gross margin of 70.8%, which reflects an approximate $300 million headwind versus pre-COVID levels with nearly half of this headwind related to increased freight costs and the remaining headwind resulting from unfavorable manufacturing variances, driven by the availability of direct materials and the increased cost to procure them.

First quarter adjusted operating margin was 25.8%, slightly higher than our expectations, driven by top line revenue performance and disciplined spend management in the quarter. We continue to anticipate our full year adjusted operating margin to be within a range of 26% to 26.4%. Given the magnitude and level of persistence of the macroeconomic headwinds, it likely makes the high end of our adjusted operating margin guidance range, less certain, but we still believe the range is achievable. And on a GAAP basis, first quarter operating margin was 15.4%.

Moving to below the line. Adjusted interest and other expense totaled $110 million in Q1, slightly higher than our expectations. And based on the timing of our debt refinancing within the quarter included minimal benefit from the debt transaction, which I'll provide further detail on in a moment. Our tax rate for the first quarter was 14.3% on an adjusted basis, including unfavorable discrete tax items and the benefit from stock compensation accounting. Excluding these items, our operational tax rate was 13.9%, higher than our expectations, driven by differences in the treatment of interest expense in the issuing jurisdiction of our euro-denominated bonds. We ended Q1 with 1.438 billion fully diluted weighted average shares outstanding. Our adjusted free cash flow for the quarter was $70 million, and free cash flow was an outflow of $171 million with a $58 million outflow from operating activities and $113 million of net capital expenditures.

For full year 2022 adjusted free cash flow, we continue to aim to be at or above 2021 adjusted free cash flow of $2.2 billion. As of March 31, 2022, we had cash on hand of $325 million after closing the acquisition of Baylis Medical in February. Our top priority for capital allocation remains high-quality tuck-in M&A, and we'll continue to assess opportunities in conjunction with our financial goals.

Within the first quarter, we completed an opportunistic transaction, refinancing approximately $3.3 billion of U.S. bonds funded through an offering of EUR 3 billion denominated bonds. The transaction was debt neutral, and we remain committed to our long-term leverage goals of 2.25 to 2.5x leverage. And as of March 31, our leverage was 2.76x.

I'll now walk through guidance for Q2 and full year 2022. We expect full year 2022 operational revenue growth to be in a range of 9% to 11% versus 2021, which excludes an approximate 200 basis point headwind from foreign exchange based on current rates and includes 250 basis point contribution from the acquisitions of Preventice, Farapulse, Lumenis and Baylis and $13 million of pre-divestiture specialty pharmaceutical sales in 2021.

As a result of our strong Q1 performance, we are raising our full year 2022 organic revenue growth range to 6.5% to 8.5% versus 2021, excluding the impact of closed acquisitions and divestitures. We expect second quarter 2022 operational revenue growth to be in a range of 6% to 9% versus 2021, which excludes an approximate 300 basis point headwind from foreign exchange based on current rates and includes a 300-basis point contribution from the acquisitions of Farapulse, Lumenis and Baylis. Excluding the impact of acquisitions, we expect second quarter 2022 organic revenue growth to be in a range of 3% to 6% against a much tougher Q2 comp. We now expect our full year 2022 adjusted below-the-line expenses to be approximately $360 million, down from the $400 million guidance issued in February due to lower interest expense as a result of our debt refinancing transaction, partially offset by the cost to manage our VC portfolio and execute our hedging program.

As a result of the difference in tax treatment of interest expense related to our debt refinancing transaction, we now expect our full year 2022 operational tax rate to be approximately 14% with an adjusted tax rate of approximately 13%, including the benefit of the accounting standard for stock compensation. We expect a fully diluted weighted average share count of approximately 1.443 billion shares for Q2 and 1.445 billion shares for the full year 2022. We now expect full year adjusted earnings per share to be in a range of $1.74 to $1.79 and for the second quarter expected to be in a range of $0.41 to $0.43. Please check our Investor Relations website for Q1 2022 financial and operational highlights, which outlines more detailed Q1 results.

With that, I'll turn it back to Lauren, who will moderate the Q&A.

Thanks, Dan. Andrew, let's open it up to questions for the next 35 minutes or so. (Operator Instructions) Andrew, please go ahead.

(Operator Instructions) The first question comes from Robbie Marcus with JPMorgan.

Congrats on a nice quarter. Maybe to start, it's great to see the outperformance in a tough quarter and the organic sales guidance raise. I was hoping maybe you could just walk us through the thought process of coming up with the second quarter guide, which came in maybe just a hair below where the Street was. I imagine the China lockdowns are impacting that, if you could comment? And just how you're thinking about the balance of the year and what's assumed?

Thanks, Robbie. Yes, we're really excited about our start to the year and increasing our full year organic guidance a bit, as you mentioned. And in terms of second quarter, as we mentioned, we want to provide a little bit wider range. There's certainly some impact that we're going to see throughout the second quarter in China. And as Dan mentioned, our comps are toughest in the second quarter. I think it's important to note at the second quarter, if you just look at the midpoint of the guide, comp adjusted, it does show a sequential acceleration versus first quarter. And so we're comfortable with that. We have slightly more favorable comps as well as the second half of the year and a strong first quarter. And at the midpoint, sequential growth 2Q over first quarter comp adjusted.

So I think that's all really reasonable guidance and reflects the momentum that we've had for the first quarter as well as the comps and some of the impact in China. But as you saw in the report, really across every business unit in every region, the businesses grew -- most businesses grew faster than market and some grew at market. So it's really consistent, strong performance and a heavy pipeline that's coming with the company. So we're pleased to increase our full year guidance range a bit.

Great. And maybe as a follow-up, it's great to -- I appreciate the WATCHMAN growth at over 30%. It's well above what I was expecting, coming into first quarter and very robust, given that competition is starting in the U.S. I was hoping you could spend a minute on what you're seeing in the competitive landscape. Where that growth is really coming from? Is it U.S.? Is it global? And what the reception is to flex so far?

I'll make a couple of comments. And it's really consistent with previous orders. We've been really putting up strong numbers for WATCHMAN for many quarters in a row now, and it just continues to build on the momentum. I think first of all, in Dr. Stein or Dr. Meredith can comment. You've seen lots of data that 16,000, I think it's 16,000 SURPASS data, just -- which is real world, all comers, first time doctors using this device, and the safety profile of the device is just proving to be excellent. And so the primary growth driver of this business continues to be the U.S. in a significant way. There's some small growth in Japan. So small growth in Europe and in China, but the big lever here is the U.S. And it's occasionally some new account openings, but it's just driving increased utilization in current accounts, more physicians using the device, more referring physicians seeing excellent results and more confidence being built really every day and then support it with clinical trials and excellent results and new clinical trials that we have.

And as we talked about before, in addition to clinical trials, which you know about Champion and [option], there's a really strong cadence of new products coming behind WATCHMAN over the next 3 years. So we think we have a differentiated product today, a stronger commercial and clinical organization and a portfolio that makes it a terrific product for us.

I don't know -- Dr. Stein?

Yes. And just to add to what Mike said, I think FLX is clearly a game changer. Clearly, the safest device on the market, safer than the competitive device, even in trials that the competitor sponsored like SWISS-APERO, better seal, better long-term results. And I just don't know anyone who's doing implants who hasn't really fallen in love with FLX.

The next question comes from Rick Wise with Stifel.

I was hoping perhaps just a larger picture question, you could talk about integrating the deals. It's Baylis, Devoro, Farapulse, Lumenis, Preventice, et cetera. It seems like it's going well. Where are you in your mind, is integration going smoothly? I know that, for example, Farapulse had to go through a pretty significant production ramp. Just where are we -- how are you feeling about it? And is that part of your foundational part of your optimism for the second half, et cetera?

Sure. Happy to. In terms of the slight increase of our full year guide, it's really unrelated to the impact of the acquisitions because really with the exception of Preventice everything else won't go organic until it varies by day, but primarily 2023 is where you'll see the bigger impact of the organic impact with the exception of Preventice. I'm really pleased overall. I'm really excited about the class of these acquisitions we did last year. And as we've talked about, there really is balanced across our business units. And we've delved a pretty good process internally to integrate these tuck-in deals. Preventice went organic and that provides excellent complementary nature to our LUX-Dx the pre quarter. And we're really enhancing the turnaround time and AI capabilities of Preventice and leveraging our CRM and neuromod team to do that. So that's doing quite well.

Lumenis was a complicated transaction to pull off, but we've really pleased with the capabilities that we have in Israel with that deal. And having that full portfolio now and owning the laser platform, improving margins and owning the channel will be really successful for us. And it gives us R&D capabilities in Israel that quite frankly, we didn't have that we can leverage outside of even our urology business.

Then you look at Baylis, we just closed that one, so that's quite early. But as you know, that's a pretty very established, highly reputable company with website access. And we can -- we've also just done our first patients using Baylis and WATCHMAN to further improve the procedure times with that product. Then we have 2 earlier deals. And the earlier deals always have more variability in them. Farapulse, we acquired that company about 6 months before our option -- before we could have, I guess. So we did it early because we knew the supply chain ramp and the nature of their outsourced manufacturing would take us more time. So we've made great progress with that. Some of the supply chain issues have hindered some of the progress but we anticipate a really strong second half ramp consistent we've said in the past in Europe this year with Farapulse, and that trial is enrolling incredibly well.

And then the one that's the earliest one is Devoro. And that's a prime R&D topic for our PI team, and we expect to be -- have our first patients done in the second half of this year with our clot removal device and we'll initiate a PE trial hopefully in 2023. So a lot of work that is being done on them, but really excited about this class of deals that we did in '21.

Yes. No, it sounds great. And just a follow-up on Farapulse specifically. I have to say that in my career, I can't call out many where doctors are excited about the technology that's on its way. You talk to us a little bit about the early European experience, given the limitations that you talked about with manufacturing, but what's your experience in terms of utilization in some of the initial centers? Can you talk to us about -- how many centers or give us any incremental color or detail about that early experience and et cetera on Farapulse?

Yes, I'll just mention on some of the sites, but Dr. Stein will give you the more important information on what they're seeing clinically. So it's really, I would say, limited sites through, call it, year-to-date because of the supply chain challenges that we had and really us wanting to bring in all the manufacturing and supply chain capabilities internally, which were previously all outsourced which were a little bit more challenging in order to -- challenging just from the respect to be able to scale it to the level that we think this product will demand. And so that team has made great progress there.

So again, in the second half, the year -- really third quarter and fourth quarter, you're going to see significantly increased the number of accounts that are open, which today has been more limited. So Dr. Stein, if you want to comment.

Yes. Again, I'm not going to talk to just the actual number of centers that we're at. We do believe we've done over 3,000 commercial cases in Europe already by the only approved PSA technology in the world right now is what we have in Europe. So going to be well ahead of any competition in terms of commercial clinical experience by the time anyone else comes to market. And as Mike mentioned in his prepared comments, did already presented the results of the MANIFEST-PF survey at the European Heart Rhythm Meeting last month. And so that was a survey that reported over 1,700 commercial cases post launch. And as Mike said, 99.9% acute success in pulmonary vein isolation. Obviously, you don't have a long-term data yet.

And I think equally important, outstanding total procedure times in terms of efficiency, outstanding safety results with generic-type complications that you get with any type of left-sided access comparable to what you see with RF or cryo. But again, the promise of PFA, no esophageal injury, no chronic phrenic nerve palsy, no pulmonary vein stenosis. So to sum up in our commercial experience, really seeing Farapulse living up to the promise of high degree of efficacy, high degree of safety, high degree of efficiency in the lab.

The next question comes from Joanne Wuensch with Citibank.

Can we go back to gross margins, please? I want to make sure I understood your language correctly and what to expect for the year and then the remaining 3 quarters? And then sort of peel apart a little bit the factors which you mentioned, freight, unfavorable manufacturing cost of obtaining materials, et cetera?

Sure, Joanne. So let me kind of walk through the year and make sure that everybody is clear on the commentary. So the actual for Q1 adjusted gross margin, 70.3%; for Q2, in line with Q1; for the second half, improvement versus the first half; and for the full year, in line with second half '21, which was 70.8%. So that's a run through the numbers.

In terms of what we're seeing and what drives those numbers, maybe I could be helpful and just give you a little more detail on some of the things that I mentioned in our prepared comments. So we talked about freight, we talked about direct materials availability and cost, and we talked about unfavorable manufacturing variances. So for freight, and I mentioned, it's about a $300 million headwind versus our pre-COVID kind of that 72.4% that we were in 2019. Freight makes up nearly half of that. And that's just simply moving our products around the world, as you would expect, higher cost and a bit more of a challenge there. The direct material availability and cost as you would expect. We have thousands of products with components. We don't have any outsized risk on any one material, but not unique to us, certain materials and inputs into our process have been harder to source and more to procure. So that creates a bit of a hiccup in the manufacturing process, and it also creates unfavorable purchase price variances as well.

And then on the manufacturing variance side, as you know, and we detailed on our last call, we saw increased variances driven by the Omicron related absenteeism in our plants, mostly late Q4 and early Q1. Those were capitalized on the balance sheet and will be recognized over 6 months. So majority of those we worked through by the end of Q3, and we expect to generate less unfavorable manufacturing branches over time.

And then the why does it get better in the second half? Those are mostly micro issues. We're not forecasting a lot of macro relief here in the rest of '22. On the micro side, we have the full recognition of our standard manufacturing improvements that we have year-over-year. We have that every year. It's very consistent with prior years. So that's one of the big drivers of why it gets better over the second half. So hopefully, that gives you a good walk-through of the numbers and why the numbers are what they are.

And on the product side, could you give us an update on what you're seeing in neuromodulation?

Sure. First quarter, there were slow out of the gates given the surge that we saw really in U.S. and Europe, and they had a really strong second half of the quarter. And for the quarter, our pain business grew -- looks like about 8%, which we're pretty confident faster than the peer groups faster, than some that have reported. And it's really -- again, it's just a combination of the portfolio innovation with our FAST algorithm and the digital capabilities that the team has continued to develop. And also that business continues to get larger in Europe, in particular, where they continue to do an excellent job with our deep brain stimulation products as well as SCS.

So it's a pretty dynamic market. We're investing in new clinical trials, always investing in new capabilities and pleased with the quarter.

The next question comes from Larry Biegelsen with Wells Fargo.

So on margins, I'm just curious on the -- Mike, if you could comment on your ability to take price in this environment, and Dan, on the operating margin, does the guidance imply -- I didn't hear the same kind of cadence through '22 that you gave for gross margin. Does the guidance imply Q2 is down sequentially? And if so, why? And then is that the right way to think about it? And then with the stronger second half? And I had one follow-up.

Thanks, Larry. The biggest strategy that we continue to focus on quarter-over-quarter since I've been here almost 11 years now, 10 years, is improving the growth profile of our end markets. And you've seen that every quarter you saw that with 5 acquisitions we did last year as well as organic focus. And although Core CRM and Core DES are great businesses for us, generate a lot of cash flow and capabilities of the company, they're in markets that are less strong than our others. And each quarter, the size of those businesses get smaller as a net -- as our portfolio continues to shift in our addressable market, now we think is about a 6% growth market, used to be flat because of that shift in the portfolio. So as that portfolio shifts, we still are -- we still have negative price, but that negative price impact has actually improved each year because of the winning of the portfolio.

So sometimes it's difficult to take price depending on what the segment is, but our overall kind of portfolio mix continues to get better each quarter. And in products where we have unique differentiation and we can show to customers the economic value because we know they're under tremendous pressure with staffing shortages and labor costs as well. Where it's appropriate, where we have unique value and economics to support it, we do our best to have appropriate price increases. But overall, in the mix, we're still a slightly negative price giver, but that overall impact improves every year.

And then relative to your question on the cadence of OI through the year, Larry. So as you know, we don't provide quarterly operating margin ranges. But I think I would support your thesis. I would expect Q2 to be lower than Q1. So think of our gross margin commentary, we said that it's likely in line with Q1. We probably will see a little bit of an increase in SG&A. That's a normal trend that we see every Q2 each year where we have a particularly heavy industry trade show and travel quarter with things like PCR, DDW, AUA, HRS, all those types tend to be heavily concentrated in Q2.

So I think likely to see lower than the Q1 operating margin in Q2. And then an improvement in the second half to hit that range of 26% to 26.4%. And again, that aligns with our gross margin commentary, which says you should see an improvement in gross margin in the second half. So I think it all holds together, and I think that thesis makes sense.

The next question comes from Vijay Kumar with Evercore ISI.

Congrats on nice Q1 [pretty share]. My first question on guidance here. Dan, Q1 organic [bps] by 200 basis points. So it looks like the guide rate for annual -- just annualize the Q1 bps . Any reason why the Q1 strength [wouldn't sustain] and what specifically are you assuming for China impact? Similarly on EPS was raised by $0.01 at the low end, right, given the debt refi (inaudible) it looks like operating margin is in line-ish. Maybe talk about the annual guidance for a second?

Sure. I'll take both of them. I think I would probably just reiterate what Mike said on the Q2 guidance, which is -- we talked about in the prepared commentary, April trends are favorable. I think it's an appropriate range given the -- whether it's staffing or China or places where COVID is still not gone within Q2. And at the midpoint of 4.5%, it shows comp-adjusted sequential growth versus the 9.7% organic growth we had in Q1. So I think it's a -- I think it's a solid range there.

On the full year range, take the midpoint of where we were for Q1 guidance and the beat there, and we basically added that to the high end of -- to the low end, the high end to get to that 6.5% to 8% now. So I think that -- that's a solid range for the full year with the 50-basis point range, and I think a solid range for Q2 with sequential comp adjusted growth versus Q1.

And then relative to EPS. So let me give you a quick bridge on that probably. So I would imagine you sit there and say, $1.73 to $1.79 guidance in February. You did the Baylis transaction, you told us that's $0.01 favorable. And then you did the debt refinancing transaction you told us that was $0.02 favorable. So where is the $0.03? And the $0.03 basically is -- there are 3 $0.01 each item that are on the other side of that, that have us at that $1.74 to $1.79, the reason we didn't raise $0.03. So below the line is $0.01 overall, and that's just, again, I mentioned this cost of managing our VC portfolio and executing the FX hedging program. And then tax is a penny for the year. It's immaterial to each quarter, so you probably won't hear us talk a lot about it in each of the next 3 quarters, but it's just slightly less expectation of the benefit of stock comp versus our prior expectations.

And that FX, I think the team has done a great job with the hedging program. Obviously, we've seen the changes in FX rates and what that's done to the top line. We do have $0.01 for the year. Again, it's immaterial for each quarter, but it does add to a $0.01 full year. So if you net the Baylis and the debt refinancing transactions against $0.01 below the line, $0.01 of tax and $0.01 of FX, we're kind of left where we were, which is that $1.74 to $1.79. And we did raise just -- we have a quarter behind us. So we did raise the low end up $0.01, given we've got one quarter behind us, and we achieved that at the midpoint of the range.

That's helpful, Dan. And Mike, maybe one big picture for you. When you think about the last cycle, right, post -- '09, '08. How do you see the medtech pricing environment? Has the industry become more rational? Because the reason I ask is hospitals talk about labor pressure, if there was some pushback on hospitals and pricing environment, is the industry more rational this time around to hold the line on pricing?

It's a tough question to ask because there's so many different segments within medtech. Most companies are feeling the same macroeconomic pressures. Very few aren't feeling the distribution impact, the raw materials impact, labor and our customers are feeling the same thing. So it's around the world. So as really the previous comment, I think holds true is where you have differentiation and you can prove clinically and economic value. And also, it's supportive -- it's also oftentimes profitable for hospitals. Then we have to build better muscles to take appropriate price in those areas, and the teams are working on that. And as I'm sure the competitors are, given the inflation environment, where their products are more commoditized and less differentiated, it's tougher. And that's -- and you still see price erosion in those segments. Are people more rational with that one? I don't know, it depends sometimes. But our overall price mix is still a bit negative, but it's improved significantly over the years.

The next question comes from Travis Steed with Bank of America.

Congrats on a good start for the year. A question on the $300 million of anchor are the headwind that you built in on freight and direct materials versus pre-COVID levels. How much of this is incremental versus the prior guide 3 months ago? Just trying to get a sense for the rate of change on some of these inflationary pressures. And also trying to get a sense for how much of this is actually locked into the P&L for sure versus the potential things to actually improve versus what you built in?

Yes. I won't specifically quantify how much was in guidance and how much it is now. It's clearly $300 million in total versus where we were. And the incremental piece since February is not insignificant. It's not like it was -- it was [$290 million and now it's $300 million]. I mean it's a pretty -- it's a very significant piece that's increased since then.

And then as we do with all guidance ranges, we try to put in a modicum of prudency against being able to achieve the high and the low end of each of the ranges. So how much is baked in and how much isn't baked in. If there's more that comes, can we offset it in other areas of the P&L, I mean, that's what we do all the time is manage. It's not all about gross margin. We have the entire P&L to manage. So I wouldn't specifically say how much is baked in and how much isn't. We still feel comfortable with the 26% to 26.4% adjusted operating margin range for the year, and we feel comfortable with the $1.74 to $1.79.

All right. No, that's fair. And on China, I don't think I heard your expectations for when you expect a recovery there. I think some companies have said a pretty quick rebound in the second half of Q2. Love to hear your thoughts on that. And any sense for how much China is down right. Other companies have said down 15% to 20%. Just curious if you'd offer any comments on China.

Yes. Well, we printed a really strong first quarter there and we expect double digits for the full year. It's going to be a tougher second quarter for them, given you see all the lockdowns and impact on procedure volume and you also have some challenges sometimes with shipping and other operational activities in China and supply chain. But we do anticipate a tougher second quarter there that's baked into the guidance, and we expect a really strong second half out of China.

I won't comment on how much they're down, but we have a very talented team there. So we baked in the tough second quarter for China into that guidance range, which is still sequential growth over first quarter comp adjusted, and we know the China team will deliver strong double-digit growth for full year.

The next question comes from Danielle Antalffy with SVB Leerink.

Congrats on a really good quarter. I just wanted to get a sense -- I just wanted to get a sense of the recovery within the quarter. And I just wanted to bounce something off you and see how this will translate to the rest of the year. So -- our sense from reports to date and from talking to some other privately held companies is that the first half of the quarter, you saw suppressed procedure volumes than a quick rebound. And everything got compressed into the quarter within itself, the compressed procedure trends -- I'm sorry, suppressed procedure trends and then the recovery, whereas previously it was like down one quarter, the recovery in the next quarter. Do you guys think you saw that is my first question? And then as we think about the rest of the year and potential more COVID wave, do you think the recovery from here is going to look more like that or there is risk -- of the volatility that we saw previously? I guess what I'm getting at is, is there still a backlog of patients, number one? Number two, do we think this is going to be more consistent, more linear going forward? Sorry, that was a long question.

That was -- it was a good question, Danielle. Just general trends, maybe similar first quarter. We were lighter out of the gate for sure. It wasn't a trough like we saw in some of the other cycles, but we're certainly later the first 5, 6 weeks, and we were very strong in the second 6, 7 weeks of the quarter. As I mentioned in the comments, we do expect a significantly less COVID impact in '22 versus '21. And we're going to see it in China here in the second quarter. And I don't know, these things are tough to predict. But outside of pockets in Asia, the rest of the world appears to be pretty strong right now. And so tough to predict what might happen in the future here. But overall, we expect a more consistent performance in our top line throughout the year with less variability. We talked about some of the comps, but if you just neutralize the comps, we see less variability and more consistent durable performance and growth throughout the year as part of our guidance.

The next question comes from Cecilia Furlong with Morgan Stanley.

I wanted to follow up a bit on Danielle's question, but really asking specifically about deferrable procedures, whether neuromod or else in your uro portfolio, but how you saw case recapture in the quarter? I know you talked about now. But just as you think forward as well, deferrable -- procedures deferred that you're able to recapture, the impact from staffing, potentially limiting the rebound. I'm just curious how you're thinking about that trajectory into 2Q and beyond?

Yes. The -- some of those headwinds are baked into the guidance. And I would say the most significant one there really is staffing. The whole backlog question is a really difficult one to quantify because our physicians are super busy. Many times, there's wait time to get in to get these procedures anyway. And so we're very comfortable, I would say, with the demand. And it's always difficult to say, as backlog been captured or not. These hospitals are busy and there's a very strong patient volume. So we don't expect really any spikes or troughs in that area. For my comments with Danielle, we expect more consistent, durable, continued procedure volume, except maybe in China in the second quarter here. So that's kind of baked into our top line guidance. And then I don't know, anything else, Dan, on that.

No, I think as you saw, they were the slowest growing in the first quarter, which makes sense given the deferability and the acuity of the procedures there. As Mike said, pain was 8 and urology was 7. So the most COVID impacted. They had the most COVID impact, obviously, in January and probably that first half of February. So I think it tracks.

Okay. Great. And if I could follow up as well, just on your venous side of your peripheral business, what you saw in the quarter with EKOS and AngioJet? And then as you think about Devoro starting to ramp in the back half of this year, can you just talk about your expectations for that business late '22 as well as '23? And really how you think about the mix across your portfolio?

Sure. Our overall PI business, you saw grew to 10%. Arterial and interventional oncology were the strongest leaders of the segments and venous was the weaker one. Within venous, Varithena is the shiny star within that category. And EKOS is doing well outside the U.S. We're running trials, high Petro or something like that is being run. And we are giving some share in the U.S. that's where that Devoro platform, we think, will be the gap filler with new innovation with that. So you're going to see really us putting implanting Devoro using that implant but using Devoro in the second half of this year. And so we expect to see venous to be continued some under pressure throughout the second half of this year.

And hopefully, we can launch Devoro in a more significant way in '23 because really, that's the only segment where we have some lighter spots within a portfolio, within the overall PI business. We think Devoro is the fill for that. We expect the venous business to perform quite a bit better in 2023 and beyond because of Devoro. But then the interventional oncology and arterial segments are the bigger segments for us, and they continue to grow double digits.

And the last question today will be from Matthew O'Brien with Piper Sandler.

I'll stick with one because it's getting a little bit late here. And it's started to beat the dead horse here, Dan, but just on gross margins, $300 million, a couple of hundred basis points of the headwind from all these freight issues, et cetera. As we head into the end of the year, I know labor is not going to get a lot better, not cheaper anyway. It seems like freight should come in a little bit. It seems like raw materials should get better. Can this be -- can the pressure on the gross margin line ease $100 million as we head into '23? And then we think we can kind of get back to pre-COVID gross margin levels around 72%?

Yes. So I wouldn't comment on the specific dollar amount that we think it's going to ease. But I think overall, qualitatively, we do believe that it will ease over time, right? So as you go through the end of this year and start heading into '23. Labor for us is not a big driver of that, right? The drivers I mentioned relative to direct materials and the availability and the cost there and some of the freight challenges. That's really what's driving the majority of that $300 million. And if I look at that, I don't believe that all of those things are going to come back to pre-COVID levels. But they don't necessarily have to for us to continue to expand gross margin and operating margin because we have that gap quantify it, as you said, in that 200-basis point range from where we once were. So I'm optimistic that as we head into '23 and beyond the gross margin could be a driver of continued margin expansion for the company, which it has been for many years prior.

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