Stryker Corporation — Q3 2018 Form 10-Q
Reporting period: Quarter and nine months ended September 30, 2018. Unless noted otherwise, dollar amounts are in millions. Stryker is a medical technology company reporting Orthopaedics, MedSurg, and Neurotechnology and Spine segments.
Financial performance
| Metric | Q3 2018 | Q3 2017 | Nine months 2018 | Nine months 2017 |
|---|---|---|---|---|
| Net sales | $3,242 | $3,006 | $9,805 | $8,973 |
| Gross profit / margin | $2,155 / 66.5% | $1,984 / 66.0% | $6,482 / 66.1% | $5,939 / 66.2% |
| Operating income / margin | $576 / 17.8% | $525 / 17.5% | $1,839 / 18.8% | $1,583 / 17.6% |
| Net earnings | $590 | $434 | $1,485 | $1,269 |
| Diluted EPS | $1.55 | $1.14 | $3.90 | $3.34 |
Q3 sales grew 7.9% as reported and 8.8% in constant currency; management reported 9.5% constant-currency growth excluding acquisitions and the ASC 606 adoption impact. Nine-month sales grew 9.3% as reported and 8.4% in constant currency; normalized constant-currency growth excluding acquisitions and ASC 606 was 9.0%. Growth was primarily volume-led and partially offset by lower prices.
Q3 adjusted operating margin was 24.9%, up 60 basis points, and adjusted diluted EPS was $1.69, up 11.2%. For nine months, adjusted operating margin was 25.2%, up 70 basis points, and adjusted diluted EPS was $5.13, up 13.2%. These are non-GAAP measures; reported results include acquisition-related amortization, restructuring, recall, regulatory/legal and tax items.
Q3 segment sales growth was strongest in Neurotechnology and Spine: 16.7% reported (17.7% constant currency), versus 8.0% for MedSurg and 3.4% for Orthopaedics. Nine-month reported growth was 17.4%, 8.8%, and 6.1%, respectively.
Cash flow, liquidity and debt
- Nine-month operating cash flow was $1,564, compared with $880 in 2017. Investing cash outflow was $1,229, including $770 for acquisitions and $418 for capital expenditures; financing cash outflow was $951.
- Cash and cash equivalents were $1,918 at September 30, down from $2,542 at year-end 2017. Cash, cash equivalents and marketable securities totaled $2,210. Working capital was $3,765, down from $4,508.
- Total debt was $7,203, including $1,275 of current maturities and $5,928 of long-term debt. The company had no commercial paper outstanding and reported $1,553 of available borrowing capacity; it was in compliance with debt covenants.
- Nine-month dividends paid were $528 and share repurchases were $300. Cash outside the United States was approximately 30% of cash and marketable securities.
Material changes, outlook and notable matters
- Q3 reported net earnings included an income tax benefit of $56; the reported effective tax rate was negative 10.5%, primarily reflecting adjustments related to the 2017 Tax Cuts and Jobs Act. The company said its accounting for the Act was not yet complete. Nine-month effective tax rate was 12.6%, versus 10.3%.
- Recall charges declined to $4 in Q3 and $10 for nine months, from $66 and $164 in the comparable 2017 periods. The estimated probable loss for the Rejuvenate and ABG II hip-stem matter was $2,077–$2,318 net of estimated third-party insurance recoveries ($2,309–$2,550 before recoveries); the ultimate cost could differ materially.
- Regulatory and legal matters reduced operating income by $66 in Q3 and $121 for nine months. Stryker also disclosed ongoing product-liability, intellectual-property and other proceedings; outcomes may require additional expense. The company is self-insured for product-liability claims.
- Acquisitions completed during the period included Entellus Medical for $697 net of cash acquired. After quarter-end, Stryker completed the HyperBranch acquisition for approximately $220 on October 1 and Invuity for approximately $230 on October 23. The proposed approximately $1,400 K2M acquisition was pending customary approvals, with closing expected in Q4 2018.
- In March, Stryker issued $600 of 3.65% senior notes due 2028 and repaid $600 of 1.30% notes in April. Management stated it expected to meet near-term liquidity needs through operating cash flow, commercial paper and existing credit lines.
- No specific earnings or sales guidance was provided in the supplied filing text. Management cited foreign-exchange exposure as its greatest market-risk area; it reported no material change in market-risk disclosures from the prior annual filing.
Investor verification priorities
- Reconcile the drivers of reported versus constant-currency and acquisition-/ASC 606-adjusted sales growth, including the contribution from volume, price, acquisitions and currency.
- Review the non-GAAP reconciliations and the effect of discrete tax items on reported Q3 earnings and EPS.
- Track the Rejuvenate/ABG II recall estimate, insurance recoveries, enrollment and remaining litigation, as well as regulatory/legal contingencies.
- Assess liquidity against the $1,275 of current debt maturities, planned acquisitions and ongoing investment needs.
- Confirm the closing, financing and integration outcomes of K2M and the post-quarter HyperBranch and Invuity acquisitions.
- Monitor working-capital use, particularly the $439 inventory cash outflow, and whether operating cash-flow improvement is sustained.