Stryker Corporation — Q3 2011 Form 10-Q
Reporting period: Quarter and nine months ended September 30, 2011. Amounts are in U.S. dollars; financial-statement amounts are in millions except per-share data. Stryker reorganized reporting into Reconstructive, MedSurg, and Neurotechnology and Spine segments.
Financial performance
| Metric | Q3 2011 | Q3 2010 | Nine months 2011 | Nine months 2010 |
|---|---|---|---|---|
| Net sales | $2,031 | $1,768 | $6,092 | $5,325 |
| Gross profit | $1,362 | $1,227 | $4,021 | $3,663 |
| Operating income | $444 | $471 | $1,268 | $1,365 |
| Net earnings | $327 | $337 | $944 | $978 |
| Diluted EPS | $0.84 | $0.85 | $2.41 | $2.45 |
| Operating cash flow | $446 | $428 | $807 | $1,030 |
Sales increased 14.9% in Q3 and 14.4% year to date; on a constant-currency basis, growth was 11.7% and 11.3%. Acquisitions contributed $135 million to Q3 sales growth and $363 million year to date. Unit volume and mix also contributed, while price changes reduced growth by 2.0% in Q3 and 1.8% year to date.
Margins weakened: gross margin was approximately 67.0% in Q3 versus 69.4% a year earlier, and 66.0% year to date versus 68.8%. Operating margin was approximately 21.9% in Q3 versus 26.6%, and 20.8% year to date versus 25.6%. Management attributed pressure mainly to acquisition-related inventory fair-value step-ups, pricing pressure, and the effect of a weaker U.S. dollar on international manufacturing purchases. Reported net earnings declined 3.0% in Q3 and 3.5% year to date. Excluding acquisition and integration-related charges and specified prior-year items, adjusted net earnings rose 11.0% in Q3 and 10.4% year to date; these are non-GAAP measures.
Segments and material changes
- Reconstructive: Sales were $901 million in Q3, up 8.0% reported and 3.9% in constant currency. Nine-month sales were $2,729 million, up 5.7% and 1.8%, respectively. Knee sales were comparatively weak, including declines on a constant-currency basis.
- MedSurg: Sales were $767 million in Q3, up 12.0% reported and 9.8% in constant currency. Nine-month sales were $2,303 million, up 13.3% and 11.2%. Patient handling and emergency medical equipment was a principal growth contributor.
- Neurotechnology and Spine: Sales were $363 million in Q3 and $1,060 million year to date, up 45.8% and 48.9%. Growth was primarily acquisition-driven, particularly by Neurovascular.
In 2011 Stryker acquired Neurovascular assets for $1.45 billion, Orthovita for $316 million, and Memometal for consideration including $150 million cash and milestone payments. Acquisition and integration-related charges were $170 million pretax ($114 million after tax) for the first nine months, including $127 million of year-to-date inventory fair-value step-up cost. The company also sold its OP-1 product family and related facility for $60 million, with no material gain or loss. After quarter-end, it acquired Concentric Medical for $135 million.
Cash, debt, liquidity, and capital allocation
At September 30, cash and cash equivalents were $810 million, current marketable securities $2,403 million, and total debt $1,780 million, including $1,755 million of long-term debt. Cash and current marketable securities totaled approximately $3.2 billion. The company issued $750 million of 2.00% senior notes due 2016 and had $1.1 billion of additional borrowing capacity under existing credit facilities. No commercial paper was outstanding. Management stated available cash, expected operating cash flows, and borrowing capacity should fund operating needs, capital expenditures, debt service, and dividends.
Nine-month operating cash flow fell to $807 million from $1,030 million. Management cited payment timing and increased inventory investment; inventory days rose to 176 from 154 at year-end 2010. Investing cash use included $1,922 million for acquisitions and $162 million for capital expenditures. Financing included $539 million of share repurchases and $210 million of dividends. The quarterly dividend was $0.18 per share.
Outlook, risks, and unusual items
- The filing provides no specific numerical earnings or sales guidance. Management noted continued investment in product development and said nine-month results are not necessarily indicative of full-year results.
- Key stated risks include demand and economic conditions, pricing and reimbursement pressure, foreign-exchange movements, regulatory approvals, product liability, competition, acquisition integration, and financial-market changes.
- Tax matters include IRS proposed adjustments concerning Irish cost-sharing arrangements for 2003–2007 and European profit allocation assessments for 2005–2008. The company is defending these positions; adverse resolution could materially affect tax expense, results, and cash flows. Certain other U.S. tax matters were settled in 2011.
- Legal and regulatory matters include Hill-Rom patent-infringement suits seeking damages and injunctions; ongoing DOJ investigations concerning PainPump and OtisKnee; HHS and SEC/DOJ inquiries relating to physician arrangements and foreign practices; and a pending federal criminal case involving Stryker Biotech. The company states that the Biotech matter’s ultimate resolution is not reasonably estimable; a conviction could result in significant fines.
- Foreign-currency translation increased shareholders’ equity by $123 million during the first nine months. Marketable securities had $5 million of gross unrealized losses, which management attributed primarily to interest-rate changes and did not consider other-than-temporary impairments.
Important facts for investors to verify
- How much of reported sales growth and future segment performance is sustainable after separating acquisition, currency, volume/mix, and pricing effects.
- Whether acquisition integration delivers expected benefits and how inventory step-ups, integration costs, and increased amortization affect margins and earnings.
- Inventory levels, working-capital conversion, and the durability of operating cash flow.
- Potential financial exposure and timing for the disclosed tax disputes, lawsuits, and government investigations.
- Debt and liquidity needs after acquisitions, repurchases, dividends, and any further strategic transactions.