Stryker Corporation — Q2 2019 Form 10-Q
Reporting period: Three and six months ended June 30, 2019. Dollar amounts are in millions except per-share data. Stryker develops and sells medical technology across Orthopaedics, MedSurg, and Neurotechnology and Spine.
Financial performance
| Metric | Q2 2019 | Q2 2018 | Six months 2019 | Six months 2018 |
|---|---|---|---|---|
| Net sales | $3,650 | $3,322 | $7,166 | $6,563 |
| Gross margin | 65.2% | 65.9% | 65.1% | 65.9% |
| Operating income | $613 | $672 | $1,141 | $1,263 |
| Net earnings | $480 | $452 | $892 | $895 |
| Diluted EPS | $1.26 | $1.19 | $2.35 | $2.35 |
Q2 sales rose 9.9% as reported and 11.5% in constant currency; excluding acquisitions, organic constant-currency growth was 8.5%. For the first half, reported sales rose 9.2%, constant-currency sales 11.1%, and organic constant-currency sales 7.9%. Currency reduced reported growth by 1.6 percentage points in Q2 and 1.9 points year to date.
Q2 segment sales growth as reported was 3.7% in Orthopaedics, 11.1% in MedSurg, and 18.9% in Neurotechnology and Spine. Spine growth reflected acquisitions in part; Neurotechnology and Spine growth excluding acquisitions was 8.7% in constant currency.
Reported operating margin declined to 16.8% in Q2 from 20.2%, and to 15.9% for the first half from 19.2%, largely reflecting recall, acquisition, amortization, restructuring, and other specified items. On the company’s non-GAAP adjusted basis, operating margin increased to 25.9% in Q2 from 25.7%, and to 25.5% for the first half from 25.4%. Adjusted diluted EPS was $1.98 in Q2, up 12.5%, and $3.86 year to date, up 12.2%. These non-GAAP measures exclude specified items and are not substitutes for GAAP results.
Gross margin pressure primarily reflected lower prices and product mix, partly offset by higher-volume leverage. Management cited continued operating-expense discipline and sales-volume leverage as support for adjusted margin improvement. The effective tax rate fell to 15.0% in Q2 and 14.6% year to date, primarily due to a favorable U.S. tax audit settlement for 2012 and 2013.
Cash flow, debt, and liquidity
- First-half operating cash flow was $827, down from $946, primarily reflecting working-capital uses, partly offset by cash received in connection with a prospective legal settlement.
- Investing cash outflow was $550, including $260 for acquisitions and $287 for capital expenditures. Financing cash outflow was $2,135, including $1,341 of debt repayments, $390 of dividends, and $307 of share repurchases.
- Cash and cash equivalents were $1,754 at June 30, down from $3,616 at year-end; cash, cash equivalents, and marketable securities totaled $1,839. Working capital was $4,239.
- Total debt was $8,513, including $539 current maturities; long-term debt was $7,974. No commercial paper was outstanding, available borrowing capacity was $1,531, and the company reported compliance with debt covenants.
- Dividends declared were $0.52 per share in Q2. The company repurchased 1.9 million shares for $307 in the first half; no shares were repurchased under the authorization during Q2.
Material changes, outlook, and risks
- Recall charges were $117 in Q2 and $130 for the first half, versus $2 and $6 in the comparable 2018 periods. For Rejuvenate/ABG II and LFIT V40 recall matters, the estimated remaining global probable loss range was approximately $350–$600; the company recorded charges at the minimum of the range. Ultimate costs could differ materially and adversely affect results and cash flows.
- In March, Stryker acquired OrthoSpace for $110 cash, with up to $110 in potential milestone payments. First-half acquisition cash spending was $260. The 2018 K2M and Entellus acquisitions also contributed to sales and acquisition-related expenses.
- Zimmer Biomet conditionally paid Stryker $167 in a patent dispute while seeking Supreme Court review; the filing does not state the ultimate outcome.
- Stryker adopted lease accounting effective January 1, 2019, recognizing approximately $350 of lease assets and liabilities at adoption. At June 30, right-of-use assets were $357 and lease liabilities totaled $357.
- Management provided no specific numerical full-year guidance in the supplied filing text. It stated that short-term liquidity needs were expected to be supported by operating cash flow, commercial paper, and credit lines. Foreign-exchange exposure was identified as the principal market-risk exposure; the company reported no material change in its market-risk disclosures.
- Other uncertainties include product-liability claims and ongoing legal, labor, intellectual-property, and regulatory matters. The company is self-insured for product liability and cautions that actual outcomes may exceed recorded estimates.
Key facts for investors to verify
- Progress and ultimate cost of the hip-product recalls, including whether the $350–$600 estimated loss range or related accruals change.
- Whether organic sales growth and adjusted-margin trends continue, particularly in Orthopaedics and after acquisition contributions in Spine.
- Working-capital performance and operating cash conversion, given the first-half decline in operating cash flow.
- Debt maturities, refinancing capacity, and the effect of continued dividends, repurchases, and acquisitions on liquidity.
- Developments in the Zimmer patent matter and other legal or regulatory contingencies.
- Reported GAAP results alongside non-GAAP adjustments, including the size and recurrence of recall, acquisition, restructuring, and regulatory costs.