Stryker Corporation — Q2 2018 Form 10-Q
Reporting period: Three and six months ended June 30, 2018. Dollar amounts are in millions, except per-share data. Stryker reports Orthopaedics, MedSurg, and Neurotechnology and Spine.
Financial performance
| Metric | Q2 2018 | Q2 2017 | First half 2018 | First half 2017 |
|---|---|---|---|---|
| Net sales | $3,322 | $3,012 | $6,563 | $5,967 |
| Gross profit / margin | $2,190 / 65.9% | $1,991 / 66.1% | $4,327 / 65.9% | $3,955 / 66.3% |
| Operating income / margin | $672 / 20.2% | $502 / 16.7% | $1,263 / 19.2% | $1,058 / 17.7% |
| Net earnings | $452 | $391 | $895 | $835 |
| Diluted EPS | $1.19 | $1.03 | $2.35 | $2.20 |
| Operating cash flow | Not stated by quarter | $946 | $801 |
Q2 sales rose 10.3% as reported and 9.1% in constant currency; excluding acquisition and revenue-standard effects, constant-currency growth was 7.9%. First-half sales rose 10.0% as reported and 8.1% in constant currency; excluding those effects, constant-currency growth was 7.5%. Unit volume drove growth, partly offset by lower prices. Q2 growth was strongest in Neurotechnology and Spine (+19.4% reported), while first-half segment growth was 17.8% in Neurotechnology and Spine, 9.1% in MedSurg, and 7.4% in Orthopaedics.
GAAP operating margins benefited from much lower recall charges versus 2017. On the company’s non-GAAP adjusted basis, operating margin was 25.7% in Q2 versus 25.0%, and 25.4% for the first half versus 24.6%. Adjusted diluted EPS was $1.76 in Q2 (+15.0%) and $3.44 for the first half (+14.3%). These non-GAAP measures exclude specified items and are not substitutes for GAAP results. Gross margin declined year over year, with management citing ASC 606 adoption and lower selling prices.
Cash, liquidity, and debt
Cash and cash equivalents were $1,641 at June 30, down from $2,542 at December 31, 2017; cash plus marketable securities was $1,920, versus $2,793. Working capital was $3,367, down from $4,508. Total debt was $7,202, including $1,277 current maturities and $5,925 long term. No commercial paper was outstanding; available borrowing capacity was $1,552, and the company reported compliance with debt covenants.
First-half operating cash flow was $946. Investing used $1,073, mainly including the $697 Entellus acquisition; financing used $772, including $352 of dividends, $300 of share repurchases, and debt activity. Cash from operations increased from $801 in the prior-year period. Approximately 76% of cash, cash equivalents, and marketable securities was held outside the United States.
Material changes, outlook, and risks
- Stryker acquired Entellus Medical in February for $697 net of cash acquired. The purchase added $481 of goodwill and $289 of identified intangible assets, subject to preliminary valuation.
- The company issued $600 of 3.650% senior notes due 2028 and repaid $600 of 1.300% notes due 2018.
- The effective tax rate rose to 27.4% for Q2 and 23.2% for the first half, from 11.8% and 11.4%, respectively. Management attributed the increase primarily to an additional $57 transition-tax charge under the 2017 Tax Act and acquisition-integration restructuring. Accounting for the Act remained provisional.
- Stryker provided no quantitative earnings or sales guidance in the supplied filing text. Management described liquidity as sufficient for operating needs through operating cash flow, commercial paper, and credit lines, and noted access to capital markets.
- The Rejuvenate and ABG II hip-stem recall remained a material contingency. The estimated global probable loss range was $2,073–$2,313 after $232 of third-party insurance recoveries; no additional charge was recorded in the first half because the existing reserve equaled the low end of the range. Actual costs could differ materially.
- Other risks include ongoing product, regulatory, labor, intellectual-property, and other legal proceedings; foreign-exchange exposure; acquisition integration; and uncertainty in the final tax effects of the 2017 Tax Act. The company stated that its disclosure controls were effective and reported no material change in internal control over financial reporting.
- Adoption of ASC 606 reduced opening retained earnings by $64; adoption of intra-entity tax-transfer guidance reduced it by $695. The company expected lease accounting adoption in 2019 to add right-of-use assets and lease liabilities, without a material impact on net earnings or cash flow.
Important facts for investors to verify
- Whether organic, constant-currency sales growth and the strong Neurotechnology and Spine performance continue, and how much growth depends on acquisitions.
- How much of adjusted margin and EPS growth reflects underlying operations versus exclusions, especially lower recall charges and tax adjustments.
- Developments in the hip-stem recall, including patient participation, remaining claims, insurance recoveries, and reserve adequacy.
- Debt maturities, cash generation, and the effect of the large reduction in cash alongside acquisition spending, dividends, and repurchases.
- The final tax effects of the 2017 Tax Act and the balance-sheet impact of lease-standard adoption.