Stryker Corporation — Q2 2016 Form 10-Q
Reporting period: Quarter and six months ended June 30, 2016. Dollar amounts are in millions except per-share data. Stryker operates in Orthopaedics, MedSurg, and Neurotechnology and Spine.
Key financial results
| Metric | Q2 2016 | Q2 2015 | Six months 2016 | Six months 2015 |
|---|---|---|---|---|
| Net sales | $2,840 | $2,432 | $5,335 | $4,811 |
| Gross profit / margin | $1,842 / 64.9% | $1,605 / 66.0% | $3,536 / 66.3% | $3,158 / 65.6% |
| Operating income | $500 | $429 | $1,019 | $835 |
| Net earnings | $380 | $392 | $782 | $616 |
| Diluted EPS | $1.00 | $1.03 | $2.07 | $1.61 |
| Adjusted diluted EPS | $1.39 | $1.20 | $2.63 | $2.31 |
| Operating cash flow | Not separately presented for quarter | $671 | $737 |
Q2 reported sales grew 16.8% (17.0% in constant currency); six-month sales grew 10.9% (11.6% in constant currency). Acquisitions contributed 10.4% and 5.3% of constant-currency growth, respectively. Excluding acquisitions and currency, sales grew 7.9% in Q2 and 7.7% year to date. Q2 net earnings fell 3.1% despite higher operating income; the filing cites higher other expense, while the prior-year quarter included a legal gain and unusually low tax expense. Adjusted diluted EPS rose 15.8% in Q2 and 13.9% for the six months.
Business performance and material changes
- MedSurg sales rose 33.8% in Q2 and 18.7% year to date, reflecting acquisitions and organic growth. Orthopaedics grew 4.6% and 3.9%; Neurotechnology and Spine grew 9.3% and 10.6%.
- April acquisitions included Sage Products for approximately $2,875 and Physio-Control for approximately $1,308, plus the Synergetics neuro portfolio. Acquisition-related inventory fair-value charges were $35 in the first half; higher acquired intangible amortization also affected results.
- Q2 gross margin declined to 64.9%, primarily from acquisition-related inventory step-up charges and unfavorable mix. First-half margin improved to 66.3%, helped by the U.S. medical-device excise tax suspension, which management expected to benefit gross profit through 2017.
- Research and development expense was $183 in Q2 and $342 year to date. SG&A was $1,043 and $1,987, respectively; excluding specified items, Q2 SG&A was 34.9% of sales versus 36.1% a year earlier.
Cash, debt, liquidity, and capital allocation
- Cash and cash equivalents were $3,490 at June 30; marketable securities were $166, for combined cash and securities of $3,656. Current assets exceeded current liabilities by $4,219.
- First-half operating cash flow was $671, down from $737, primarily due to recall payments, higher compensation payments, and inventory purchases. Inventory days on hand increased 14 days from year-end.
- Investing cash outflow was $3,912, including $4,219 net cash used for acquisitions and $229 of capital expenditures. Financing cash inflow was $3,342.
- Total debt was $7,644, versus $3,998 at year-end 2015; the company issued $3,500 of senior unsecured notes in March. It had $1,157 of available borrowing capacity and was in compliance with debt covenants.
- Moody’s lowered unsecured-note ratings to Baa1 from A3; S&P lowered the corporate and long-term rating to A from A+ and the short-term rating to A-1 from A-1+. Management said ratings remained investment grade and expected debt refinancing access to continue.
- First-half dividends paid were $284 ($0.76 per share). The share repurchase program was suspended through the remainder of 2016.
Outlook, risks, and unusual items
- No specific sales or earnings guidance is provided in the supplied filing text. Management said it expected the medical-device excise tax suspension to support gross profit through 2017 and anticipated meeting short-term liquidity and operating needs using operating cash, commercial paper, and credit facilities.
- The Rejuvenate and ABG II hip-stem recall remains a material uncertainty. The estimated global probable-loss range was approximately $1,870 to $2,411, net of $232 of estimated insurance recoveries at the low end. The company recorded an additional $28 charge in Q2 and had made $1,460 in recall-related payments. Actual costs may differ materially and adversely affect financial position, results, and cash flows.
- Other litigation includes a stayed Hill-Rom patent dispute for which the company could not estimate a probable loss. A patent case against Zimmer was remanded for reconsideration of enhanced damages after a Supreme Court action; the filing provides no clear estimate of any resulting recovery.
- Management identified foreign exchange as its greatest market-risk exposure. It reported no material change in market-risk disclosures and no material change in internal controls.
Important facts for investors to verify
- Whether acquired businesses deliver expected growth and integration benefits, and how acquisition-related amortization and financing costs evolve.
- Changes in the hip-recall reserve, enrollment and treatment claims, insurance recoveries, and ultimate cash payments.
- Debt repayment and refinancing plans, credit ratings, and liquidity needs after the 2016 acquisitions.
- Organic growth, pricing, and gross-margin trends by segment, including the effects of the excise-tax suspension and acquisition-related inventory charges.
- Reported versus adjusted earnings reconciliations and the assumptions behind excluded items; adjusted measures are non-GAAP.