Stryker Corporation — Q2 2015 Form 10-Q
Reporting period: Quarter and six months ended June 30, 2015. Dollar amounts are in millions except per-share data. Stryker operates in Orthopaedics, MedSurg, and Neurotechnology and Spine.
Financial performance
| Metric | Q2 2015 | Q2 2014 | Six months 2015 | Six months 2014 |
|---|---|---|---|---|
| Net sales | $2,432 | $2,363 | $4,811 | $4,668 |
| Gross profit / margin | $1,605 / 66.0% | $1,548 / 65.5% | $3,158 / 65.6% | $3,077 / 65.9% |
| Operating income / margin | $429 / 17.6% | $197 / 8.3% | $835 / 17.4% | $328 / 7.0% |
| Net earnings / margin | $392 / 16.1% | $128 / 5.4% | $616 / 12.8% | $198 / 4.2% |
| Diluted EPS | $1.03 | $0.33 | $1.61 | $0.51 |
| Adjusted diluted EPS (non-GAAP) | $1.20 | $1.08 | $2.31 | $2.14 |
Q2 reported sales rose 2.9% (7.6% in constant currency); first-half sales rose 3.1% (7.5% constant currency). Foreign exchange reduced reported growth by 4.7 and 4.5 percentage points, respectively. Management attributed constant-currency growth mainly to higher unit volumes, partly offset by lower prices. Adjusted diluted EPS increased 11.1% in Q2 and 7.9% for the first half.
- Segments, Q2 reported sales: Orthopaedics $1,035, up 0.6%; MedSurg $939, up 3.9%; Neurotechnology and Spine $458, up 6.4%. Constant-currency growth was 6.2%, 7.4%, and 11.5%, respectively.
- Cash flow, first half: Operating cash flow was $737, versus $579. Investing provided $2,226, primarily reflecting marketable-security sales; financing used $1,051. Cash and cash equivalents increased $1,831 to $3,626.
- Liquidity and debt: Cash, cash equivalents, and marketable securities totaled $4,277 at June 30, versus $5,000 at year-end. Current assets exceeded current liabilities by $5,213. Total debt was $3,469 ($227 current and $3,242 long-term), compared with $3,973 at December 31. Available credit-facility capacity was $1,248; the company reported compliance with debt covenants.
Material changes and notable items
- Recall charges fell to $112 in Q2 from $276 and to $166 in the first half from $620. The lower charges were a major factor in the sharp increase in reported operating income and earnings.
- Q2 included a $54 gain, net of legal costs, from a Zimmer patent judgment, recorded as a reduction of SG&A. Stryker received the payment in July. Excluding this gain and other specified items, SG&A as a percentage of sales rose to 36.1% from 35.5% in Q2, with European headquarters and selling costs and compensation cited as contributors.
- The Q2 effective tax rate was 2.2%, versus 23.5%; the first-half rate was 20.8%, versus 27.8%. The filing attributes the decrease mainly to the tax jurisdiction applicable to recall charges, with discrete tax matters also affecting the first-half rate.
- First-half repurchases totaled $324; dividends paid totaled $261. A new $2,000 repurchase authorization was announced in March. The quarterly dividend declared was $0.345 per share.
- The January acquisition of CHG Hospital Beds had purchase consideration of $85, including contingent consideration, and expanded MedSurg offerings.
Outlook, risks, and contingencies
- The filing provides no specific sales or earnings guidance. Management expected capital expenditures to be higher than in 2014 for the remainder of 2015 and anticipated additional cash repatriation in the second half. It said short-term liquidity needs, including recall settlements, could be supported by operating cash flow, commercial paper, and credit lines.
- Rejuvenate and ABG II hip-stem recall: The estimated global probable-loss range was approximately $1,699 to $2,539, including $179 of third-party insurance recoveries in the lower-end estimate. Stryker recorded a $112 Q2 charge and made initial payments of $1,078 in July to eligible U.S. patients. The ultimate cost and timing of further payments remain uncertain and could materially affect financial position, results, and cash flows.
- Other litigation includes a Hill-Rom patent dispute; the filing says the outcome cannot be predicted and a probable-loss estimate was not possible. Product-liability claims are self-insured, and actual costs could differ materially from accruals.
- Foreign exchange is identified as the company’s greatest potential market-risk exposure. Management reported no material change in market-risk disclosures from the 2014 Form 10-K.
Important facts for investors to verify
- Track recall enrollment, settlement awards, further care costs, payments, insurance recoveries, and changes to the recorded loss estimate.
- Separate reported growth and GAAP earnings from constant-currency growth and adjusted EPS; assess the impact of foreign exchange, recall charges, and the Zimmer gain.
- Monitor segment and geographic trends, particularly international sales, which declined 9.9% as reported in Q2 but grew 4.1% in constant currency.
- Review cash conversion, debt maturities and refinancing, repurchases, and the effect of repatriating cash held outside the United States.
- Assess the status and potential financial exposure of the remaining legal proceedings and self-insured product-liability claims.