Stryker Corporation — Q2 2017 Form 10-Q
Reporting period: Three and six months ended June 30, 2017. Dollar amounts are in millions, except per-share figures. Stryker develops and sells medical technology across Orthopaedics, MedSurg, and Neurotechnology and Spine.
Financial performance
| Metric | Q2 2017 | Q2 2016 | Six months 2017 | Six months 2016 |
|---|---|---|---|---|
| Net sales | $3,012 | $2,840 | $5,967 | $5,335 |
| Gross profit | $1,990 | $1,842 | $3,952 | $3,536 |
| Operating income | $501 | $500 | $1,055 | $1,019 |
| Net earnings | $391 | $380 | $835 | $782 |
| Diluted EPS | $1.03 | $1.00 | $2.20 | $2.07 |
| Gross margin | 66.1% | 64.9% | 66.2% | 66.3% |
| Net margin | 13.0% | 13.4% | 14.0% | 14.7% |
Q2 sales grew 6.1% as reported and 6.9% in constant currency; six-month sales grew 11.8% and 12.5%, respectively. Management attributed growth mainly to higher unit volumes, partly offset by lower prices and unfavorable currency. Q2 GAAP diluted EPS increased 3.0%; six-month EPS increased 6.3%. Adjusted diluted EPS, a non-GAAP measure, was $1.53 for Q2 (+10.1%) and $3.01 for six months (+14.4%).
- Segments: Q2 sales increased 5.5% in Orthopaedics, 6.2% in MedSurg, and 6.9% in Neurotechnology and Spine. Six-month growth was 6.4%, 19.2%, and 7.1%, respectively; MedSurg's reported growth included an 11.2% acquisition contribution.
- Margins and expenses: Q2 reported gross margin improved, while six-month reported gross margin edged down. Excluding specified items, gross margin was 66.3% versus 66.2% for Q2, but 66.4% versus 67.0% for six months. SG&A was 37.5% of Q2 sales versus 36.7%; on an adjusted basis it was 35.0% versus 34.9%. Research and development expense was 6.4% of sales in both comparable periods.
- Cash flow: Six-month operating cash flow was $801, versus $755. Investing used $338, including $270 of capital expenditures; financing used $177. Cash increased $333 to $3,649. Operating cash flow less capital expenditures was $531, a derived measure not reported as free cash flow by the company.
- Balance sheet and liquidity: At June 30, cash and marketable securities totaled $3,747; current assets exceeded current liabilities by $4,926. Total debt was $7,366, including $774 of current maturities and $120 of commercial paper. Available borrowing capacity was $1,518, and the company reported compliance with debt covenants. Approximately 89% of cash, cash equivalents, and marketable securities were held outside the United States; most was considered indefinitely reinvested.
Material changes and notable items
- Revenue growth accelerated year to date, aided by acquisitions. The prior-year comparison included significant acquisition cash outflows: acquisitions used $4,219 in the first half of 2016 versus $38 in 2017.
- Recall charges increased to $72 in Q2 and $98 for the first half, primarily relating to the Rejuvenate and ABG II hip-stem recalls. The company recorded an additional Q2 charge of $48. Its estimated global loss range was $2,037–$2,292 after $232 of third-party insurance recoveries; the ultimate cost could differ materially.
- Q2 operating income was nearly unchanged despite sales growth, with recall, restructuring, amortization, and other items affecting reported results. Reported net margin fell year over year in both Q2 and the first half; adjusted EPS grew faster than GAAP EPS.
- Total debt rose to $7,366 from $6,914 at year-end 2016, while current maturities rose to $774 from $228. The company issued $500 of 1.8% senior notes due 2019 in January. Higher debt contributed to increased first-half interest expense.
- In June, Stryker agreed to acquire NOVADAQ Technologies for approximately $701, with closing expected in Q3 2017. The filing does not provide a numerical earnings or sales outlook for the acquisition.
- After quarter-end, a trial court entered a $164 judgment in Stryker's favor against Zimmer concerning enhanced patent damages; Zimmer appealed. Also after quarter-end, Stryker agreed to pay Hill-Rom $15 to resolve litigation.
Outlook, risks, and management commentary
Management said constant-currency organic sales growth was in line with its goal of growing at the high end of the medical technology industry. The filing gives no specific full-year sales or earnings guidance. Management expected to fund operating needs, acquisitions, and recall-related payments through operating cash flow, commercial paper, and credit facilities, and noted continued access to capital markets.
Key risks include uncertainty in the final cost of the hip-stem recalls and other product-liability claims; legal and regulatory proceedings; foreign-exchange exposure, identified as the greatest potential market-risk exposure; and execution of acquisitions and the global ERP system. The company stated that actual recall outcomes could materially adversely affect financial position, results, and cash flows. It reported effective disclosure controls and no material change in internal control over financial reporting.
Important facts for investors to verify
- How the Rejuvenate and ABG II recall estimate, insurance recoveries, and related payments evolve, and whether additional charges are required.
- Whether reported sales and margin trends persist after separating acquisition effects, currency, pricing, and unusual charges.
- The use and comparability of adjusted, non-GAAP EPS and margin measures alongside GAAP results.
- Debt maturities, refinancing needs, and liquidity after planned acquisition spending and recall payments.
- NOVADAQ closing, purchase accounting, and subsequent financial contribution; and the final outcomes of the Zimmer and Hill-Rom matters.