Stryker Corporation — Q1 2014 Form 10-Q
Reporting period: Three months ended March 31, 2014. Unless otherwise noted, amounts are in millions of U.S. dollars, except per-share data. Stryker operates in Reconstructive, MedSurg, and Neurotechnology and Spine.
Financial performance
| Metric | Q1 2014 | Q1 2013 | Change |
|---|---|---|---|
| Net sales | $2,305 | $2,190 | +5.3% |
| Gross profit | $1,536 | $1,477 | +4.0% |
| Operating income | $131 | $386 | -66.1% |
| Net earnings | $70 | $304 | -77.0% |
| Diluted EPS | $0.18 | $0.79 | -77.2% |
| Operating cash flow | $206 | $236 | -$30 |
Gross margin was 66.6%, versus 67.4% a year earlier; operating margin was 5.7%, versus 17.6%; net margin was 3.0%, versus 13.9%. Management’s adjusted, non-GAAP diluted EPS was $1.06, compared with $1.09; adjusted net earnings were $404 versus $417. These adjusted measures exclude specified charges and should be considered alongside GAAP results.
Sales growth was 6.4% in constant currency. Increased unit volume and product mix contributed 6.9% and acquisitions 1.4%; pricing reduced growth by 1.8% and foreign exchange by 1.1%. U.S. sales grew 7.1%; international sales grew 1.8% reported and 5.2% in constant currency. Segment sales: Reconstructive $999 million (+4.5%), MedSurg $886 million (+5.8%), and Neurotechnology and Spine $420 million (+5.9%).
Cash, liquidity and debt
- Cash and cash equivalents were $1,381 million and current marketable securities were $2,666 million, totaling $4,047 million. Current assets exceeded current liabilities by $4,888 million. The current ratio was approximately 2.4, compared with 3.1 at December 31, 2013.
- Total debt was $3,064 million, including $820 million classified as current; debt was $2,764 million at year-end 2013. Commercial paper outstanding was $300 million at a weighted-average rate of 0.3%. Available borrowing capacity was $762 million; the company reported compliance with debt covenants.
- Operating cash flow was $206 million; investing activities used $351 million, primarily for acquisitions and capital spending; financing activities provided $186 million. Cash increased $42 million during the quarter.
- Capital expenditures were $70 million; acquisition cash outlays were $272 million; dividends paid were $115 million. No shares were repurchased in the quarter.
Material changes and management commentary
- Net earnings declined sharply primarily because of a $340 million pre-tax charge for the Rejuvenate and ABG II hip-stem recall, included in SG&A. The quarter also included acquisition, restructuring, amortization and other specified costs. Excluding listed items, SG&A was 36.3% of sales versus 37.2% in 2013; reported SG&A was 52.3% of sales.
- Cost of sales rose to 33.4% of revenue from 32.6%, reflecting product mix and acquisition-related inventory step-up and restructuring costs. R&D expense increased 16.3% to $150 million, or 6.5% of sales.
- The effective tax rate was 34.5%, versus 18.9%; 2014 included $8 million of discrete tax expense, while 2013 benefited from $13 million of retroactive tax benefits.
- Acquisitions included Patient Safety Technologies for $120 million and Pivot Medical; the Berchtold acquisition for approximately $172 million closed on April 15, 2014, after quarter-end. The company said these acquisitions are expected to strengthen MedSurg offerings.
- Management stated it expects to meet short-term liquidity and operating needs, including recall-related settlements, using operating cash flow, commercial paper and credit lines. No specific earnings or sales guidance was provided in the filing text.
Risks, contingencies and unusual items
- For the Rejuvenate and ABG II recall, the estimated probable loss was $1.13 billion to $1.58 billion before third-party insurance recoveries. The company recorded an additional $340 million pre-tax charge in Q1; no contingent insurance recovery was recorded. The ultimate cost could differ materially and adversely affect results, financial position and cash flows.
- The company reported ongoing product-liability, intellectual-property and regulatory matters. It had recorded cumulative charges of $80 million for the OtisKnee DOJ matter; the related settlement discussions continued. A separate DOJ investigation concerning the PainPump was ongoing.
- Zimmer was ordered to pay at least $228 million in a patent case, but was appealing; Stryker had not recorded a contingent gain. Hill-Rom patent litigation also remained unresolved in part.
- Foreign exchange is identified as a material market risk. The company reported a $4 million net currency-exchange loss for the quarter. Approximately 77.4% of cash, cash equivalents and marketable securities were held outside the United States and considered indefinitely reinvested.
Important facts for investors to verify
- How the estimated $1.13–$1.58 billion hip-recall loss, patient treatment needs, litigation outcomes and potential insurance recoveries evolve.
- Whether acquisition performance and integration costs support the expected growth, and how final purchase-price allocations affect goodwill and intangible assets.
- The composition and timing of the $820 million in current debt maturities, and the company’s liquidity as recall payments and other obligations are settled.
- Whether underlying sales and adjusted earnings trends persist, particularly given pricing pressure, foreign-exchange effects and the gap between GAAP and adjusted results.
- Developments in the OtisKnee and PainPump DOJ matters, Hill-Rom litigation, and the appeal in the Zimmer patent case.