Stryker Corporation — Q3 2015 Form 10-Q
Business context and period. Stryker is a medical technology company reporting three segments: Orthopaedics, MedSurg, and Neurotechnology and Spine. This unaudited report covers the three and nine months ended September 30, 2015; dollar amounts are in millions except per-share data.
Financial performance
| Metric | Q3 2015 | Q3 2014 | Nine months 2015 | Nine months 2014 |
|---|---|---|---|---|
| Net sales | $2,420 | $2,389 | $7,231 | $7,057 |
| Gross profit / margin | $1,624 / 67.1% | $1,560 / 65.3% | $4,782 / 66.1% | $4,637 / 65.7% |
| Operating income | $378 | $450 | $1,213 | $778 |
| Net earnings | $301 | $57 | $917 | $255 |
| Diluted EPS | $0.79 | $0.16 | $2.40 | $0.67 |
| Adjusted diluted EPS (non-GAAP) | $1.25 | $1.15 | $3.56 | $3.29 |
| Operating cash flow | Not presented by quarter | $228 | $1,103 |
- Sales and growth: Reported sales rose 1.3% in Q3 and 2.5% year to date. Constant-currency growth was 5.9% and 7.0%, respectively; foreign exchange reduced reported growth by 4.6 and 4.5 percentage points. Q3 constant-currency segment growth was 5.8% in Orthopaedics, 4.1% in MedSurg, and 9.9% in Neurotechnology and Spine.
- Margins and earnings: Q3 gross margin improved 1.8 percentage points, but operating income fell 16% as recall charges rose to $150 from $29. Nine-month operating income increased as recall charges declined to $316 from $649. GAAP earnings comparisons were also substantially affected by prior-year tax matters: the effective tax rate was 12.8% versus 86.6% in Q3 and 18.3% versus 63.5% year to date. Adjusted diluted EPS, a company-defined non-GAAP measure, increased 8.7% in Q3 and 8.2% year to date.
- Cash flow and liquidity: Nine-month operating cash flow was $228, down from $1,103, primarily due to $1,172 of recall-related payments and the timing of tax payments. Cash and cash equivalents were $3,163; cash plus marketable securities totaled $3,372. Current assets exceeded current liabilities by $4,480. The company reported $1,250 of available borrowing capacity.
- Debt and capital allocation: Current and long-term debt totaled approximately $3,482 at September 30, versus $3,973 at year-end 2014. The company repaid $500 of notes due in January 2015. Nine-month dividends paid were $391 and share repurchases were $446; 4.7 million shares were repurchased during the nine-month period.
Material changes, outlook, and risks
- The Rejuvenate and ABG II modular-neck hip recall remains the principal contingency. Stryker recorded an additional Q3 charge of $149 and made initial settlement payments of $1,133. The estimated global probable-loss range was $2,027 to $2,554, including $179 of third-party insurance recoveries at the low end; actual costs could differ materially and adversely affect results, financial position, and cash flows.
- Management said it expects to meet short-term liquidity and operating needs, including recall settlements, using operating cash, commercial paper, and existing credit lines. It expected to repatriate additional overseas cash in Q4; approximately 70.8% of consolidated cash and marketable securities was held outside the U.S. at quarter-end.
- Capital expenditures were $191 year to date, and management expected them to be higher than in 2014 for the remainder of 2015. The filing provides no specific earnings or revenue guidance.
- Other matters include a $54 net gain recorded in Q2 from a patent judgment against Zimmer; enhanced damages and attorney-fee issues remained unresolved, and the Supreme Court agreed to hear the enhanced-damages appeal. A separate Hill-Rom patent dispute remained stayed for reexamination; potential loss could not be estimated.
- Foreign exchange is identified as the company’s greatest potential market-risk exposure. Management reported no material change in market-risk disclosures, and stated that it was in compliance with debt covenants and that disclosure controls were effective.
Important facts for investors to verify
- How the hip-recall settlement enrollment, remaining claims, and final costs compare with the recorded accrual and estimated loss range.
- Whether reported sales and margins sustain underlying growth after foreign-exchange effects, pricing pressure, and acquisition impacts.
- Whether operating cash flow recovers after the large recall payments and whether working-capital and inventory trends improve.
- How tax items, the overseas cash position, and future repatriations affect the effective tax rate and available liquidity.
- The status and financial outcome of the Zimmer appeal and the Hill-Rom patent matter.