Stryker Corporation — Q1 2016 Form 10-Q
Business context and reporting period
Stryker is a global medical technology company reporting three segments: Orthopaedics, MedSurg, and Neurotechnology and Spine. This unaudited filing covers the three months ended March 31, 2016; dollar amounts are in millions except per-share data.
Financial performance and liquidity
| Metric | Q1 2016 | Q1 2015 |
|---|---|---|
| Net sales | $2,495 | $2,379 |
| Gross profit / margin | $1,694 / 67.9% | $1,553 / 65.3% |
| Operating income | $519 | $406 |
| Net earnings | $402 | $224 |
| Diluted EPS | $1.07 | $0.58 |
| Adjusted diluted EPS (non-GAAP) | $1.24 | $1.11 |
| Operating cash flow | $203 | $380 |
| Capital expenditures | $115 | $46 |
Sales rose 4.9% as reported and 6.1% in constant currency; foreign exchange reduced reported growth by 1.3 percentage points. Growth was primarily volume-led, partly offset by lower prices. Segment sales were Orthopaedics $1,057 (+3.3%), MedSurg $958 (+3.4%), and Neurotechnology and Spine $480 (+12.0%), all reported growth.
Gross margin improved, primarily from favorable product mix and manufacturing productivity, with a benefit from the U.S. medical device excise tax suspension. Reported net earnings also reflected a lower effective tax rate (16.4% versus 40.6%), primarily due to favorable audit settlements and discrete prior-year tax expense. Management reported 11.7% growth in adjusted diluted EPS; adjusted measures exclude specified items and are not GAAP measures.
Cash and cash equivalents were $6,976; marketable securities were $507. Cash and marketable securities totaled $7,483, and current assets exceeded current liabilities by $8,139. Total debt was $7,476, including $770 current maturities. In March, Stryker issued $3,500 of senior unsecured notes. It had $1,305 of available borrowing capacity and was compliant with credit covenants. Moody’s and S&P downgraded debt ratings following the issuance, while the company said ratings remained investment grade.
Material changes versus the prior comparable period
- Net earnings increased 79.5% and diluted EPS increased 84.5%; reported results benefited from lower recall charges and the lower tax rate. Adjusted diluted EPS increased 11.7%.
- Operating cash flow fell to $203 from $380, mainly reflecting higher recall-related payments, compensation payments, and tax-payment timing. Recall-related payments were $108 versus $19.
- Cash rose substantially, largely due to financing proceeds. Financing activities provided $3,318, versus $734 used in the prior-year quarter.
- Total debt increased from $3,998 at year-end 2015 to $7,476 at March 31, 2016, principally following the $3,500 notes issuance.
- International sales declined 4.6% as reported, but 0.4% in constant currency; U.S. sales grew 8.9%.
Outlook, commentary, risks, and unusual items
- No specific full-year revenue or earnings guidance is provided in the filing. Management expected the favorable gross-profit effect of the two-year medical device excise tax suspension to continue for the next two years and stated it expected to meet short-term liquidity and operating needs through operating cash flow, commercial paper, and credit facilities.
- Acquisitions of Sage Products for approximately $2,775, Synergetics’ neuro portfolio, and Physio-Control for approximately $1,280 closed after quarter-end. Their results are to be included beginning in Q2 2016; the filing does not give a clear purchase price for Synergetics.
- The Rejuvenate and ABG II hip-stem recall remains a major contingency. Stryker estimated a global probable-loss range of approximately $1,843 to $2,414, with the low end stated as $2,075 before $232 of third-party insurance recoveries. It recorded an additional $19 charge in Q1 and had paid $1,310 under the U.S. settlement. The ultimate cost could differ materially and adversely affect results, financial position, and cash flows.
- Other legal matters include continuing Zimmer patent litigation and a stayed Hill-Rom patent case; outcomes and potential losses are uncertain. Stryker also identifies foreign exchange as its greatest market-risk exposure.
- Share repurchases were $13 in Q1; the company suspended its repurchase program through the remainder of 2016. The quarterly dividend was $0.38 per share.
Important facts for investors to verify
- Subsequent disclosures on hip-recall enrollment, payments, insurance recoveries, and changes to the estimated loss range.
- Funding, integration, and performance of the Sage, Physio-Control, and Synergetics acquisitions, including their effect on debt and cash flow.
- Whether operating cash flow improves and inventory days, which increased 34 days from December 31, 2015, normalize.
- How much reported earnings growth persists after accounting for the unusually low Q1 tax rate and management’s non-GAAP adjustments.
- Developments in debt ratings, refinancing needs, and the disclosed legal proceedings.