Stryker Corporation — 2014 Third-Quarter Form 10-Q
Reporting period: Three and nine months ended September 30, 2014. Dollar amounts are in millions, except per-share data. Stryker is a medical technology company reporting in Reconstructive, MedSurg, and Neurotechnology and Spine.
Financial performance
| Metric | Q3 2014 | Q3 2013 | Nine months 2014 | Nine months 2013 |
|---|---|---|---|---|
| Net sales | $2,389 | $2,151 | $7,057 | $6,553 |
| Gross profit | $1,567 | $1,469 | $4,658 | $4,428 |
| Operating income | $450 | $150 | $778 | $826 |
| Net earnings | $57 | $103 | $255 | $620 |
| Diluted EPS | $0.16 | $0.27 | $0.67 | $1.62 |
| Operating cash flow | $535 | $622 | $1,107 | $1,214 |
- Sales grew 11.1% in Q3 and 7.7% over nine months. Excluding acquisitions and currency effects, management reported constant-currency organic growth of 7.8% for Q3 and 5.9% for the nine-month period.
- Q3 gross margin was approximately 65.6%, versus 68.3% a year earlier; nine-month gross margin was approximately 66.0%, versus 67.6%. Management cited acquisition effects and product mix, including faster growth in lower-margin MedSurg capital equipment.
- Reported Q3 operating margin was approximately 18.8%, versus 7.0% in 2013; nine-month operating margin was approximately 11.0%, versus 12.6%. Q3 results compare against a prior-year quarter with unusually large recall charges.
- Cash and cash equivalents were $1,356 and marketable securities were $3,321 at September 30. Current assets were $9,326 against current liabilities of $4,211. Total debt was $3,962, including $731 current maturities; available borrowing capacity under credit facilities was $1,098. The company reported compliance with debt covenants.
- Operating cash flow declined year over year in both periods. Inventory growth used $217 of cash over nine months; acquisitions used $825 and capital expenditures used $172. Nine-month financing cash flow was $707 provided, including borrowings, partly offset by dividends and share repurchases.
Changes versus comparable periods
- Q3 sales increased across all segments: Reconstructive 8.5%, MedSurg 16.3%, and Neurotechnology and Spine 6.5%. MedSurg led growth, particularly in Instruments and Endoscopy.
- Despite higher sales, Q3 net earnings fell 44.7% and nine-month net earnings fell 58.9%. The 2014 periods included substantial discrete tax charges; the 2013 comparisons also included prior-year tax benefits and different recall and regulatory charges.
- Q3 other expense increased to $25 from $13, primarily reflecting higher interest expense. Nine-month other expense increased to $79 from $45, also reflecting foreign-exchange transaction losses.
- Accumulated other comprehensive income declined from $232 at year-end 2013 to a loss of $74, largely due to a $308 nine-month financial-statement translation loss.
Outlook, management commentary, and risks
- The filing provides no specific numerical sales or earnings guidance. Management said it expects to fund operating and short-term liquidity needs through operating cash flow, commercial paper, and existing credit lines, and believes its debt ratings support refinancing as debt comes due.
- Management plans to repatriate approximately $2,000 of overseas cash in the second half of 2015. The related European headquarters, intellectual-property transfer, and planned repatriation drove $300 of 2014 tax charges in Q3 and contributed to the elevated effective tax rates: 86.6% for Q3 and 63.5% for nine months.
- The Rejuvenate and ABG II hip-stem recall remains a material contingency. The estimated probable-loss range was $1,425–$2,290 before potential insurance recoveries; Stryker recorded an additional $25 charge in Q3 to bring its accrual to the range minimum. The ultimate cost may differ materially. Product-liability claims are self-insured.
- Other notable legal and regulatory matters include a DOJ investigation concerning OtisKnee, for which $80 of charges had been recorded; an ongoing DOJ investigation concerning PainPump; and Hill-Rom patent litigation. Stryker disclosed that outcomes and potential losses in certain matters could not be estimated. A favorable patent judgment against Zimmer, including at least $228, is under appeal and has not been recognized as a gain.
- Acquisitions completed in 2014 included Small Bone Innovations ($358), Berchtold ($172), and Patient Safety Technologies ($120), among others. Purchase-price allocations remained preliminary. The company also cited foreign-exchange exposure as a material market risk.
Investor verification points
- Track the hip-stem recall accrual, claims and treatment costs, and any insurance recoveries against the disclosed $1,425–$2,290 estimated range.
- Review the drivers and cash-tax implications of the $300 discrete tax charge and planned $2,000 repatriation in the second half of 2015.
- Assess underlying growth and margins separately from acquisition contributions, currency effects, and non-GAAP adjustments.
- Monitor inventory, operating cash conversion, debt maturities, and the use of commercial paper and available credit capacity.
- Follow developments in the DOJ investigations and material litigation, including the Zimmer appeal and Hill-Rom case.