Stryker Corporation — 2016 Q3 Form 10-Q
Reporting period: Three and nine months ended September 30, 2016. Dollar amounts are in millions, except per-share data. Stryker operates in Orthopaedics, MedSurg, and Neurotechnology and Spine.
Financial performance
| Metric | Q3 2016 | Q3 2015 | Nine months 2016 | Nine months 2015 |
|---|---|---|---|---|
| Net sales | $2,833 | $2,420 | $8,168 | $7,231 |
| Gross profit / margin | $1,873 / 66.1% | $1,624 / 67.1% | $5,409 / 66.2% | $4,782 / 66.1% |
| Operating income | $486 | $378 | $1,505 | $1,213 |
| Net earnings | $355 | $301 | $1,137 | $917 |
| Diluted EPS | $0.94 | $0.79 | $3.01 | $2.40 |
| Adjusted diluted EPS, non-GAAP | $1.39 | $1.25 | $4.02 | $3.56 |
Q3 sales rose 17.1% as reported and 16.7% in constant currency; acquisitions contributed 10.5%. Excluding acquisitions and currency, sales increased 7.5%, reflecting higher unit volumes partly offset by lower prices. Nine-month sales grew 13.0% as reported and 13.3% in constant currency; acquisitions contributed 7.0%, while organic constant-currency growth was 7.6%.
Q3 sales by segment were Orthopaedics $1,077 (+5.6%), MedSurg $1,253 (+33.0%), and Neurotechnology and Spine $503 (+9.7%). Nine-month segment sales were $3,216 (+4.5%), $3,469 (+23.5%), and $1,483 (+10.3%), respectively. MedSurg growth was substantially acquisition-driven.
Cash flow, liquidity, and debt
- Nine-month operating cash flow was $1,164, versus $228 in 2015. Management attributed the increase mainly to lower recall-related payments, partly offset by higher inventory; working capital movements in receivables, inventory, and payables consumed $296.
- Investing cash outflow was $4,014, including $4,296 for acquisitions. Financing cash inflow was $2,403. Cash declined $426 to $2,953. Cash, cash equivalents, and marketable securities totaled $3,022 at September 30, down from $4,079 at year-end 2015.
- Current assets were $7,366 and current liabilities $3,026, leaving working capital of $4,340. Total debt was $6,848, compared with $3,998 at year-end 2015; long-term debt was $6,713. Available borrowing capacity under existing facilities was $1,560.
- The company issued $3,500 of senior unsecured notes in March and repaid $750 of notes due in September. It expanded its revolving facility to $1,500 and commercial paper capacity to $1,500. It reported covenant compliance.
- Moody’s downgraded unsecured note ratings to Baa1 from A3; S&P lowered corporate and long-term ratings to A from A+ and the short-term rating to A-1 from A-1+. Management said ratings remained investment grade and expected to be able to refinance debt as needed.
- Dividends paid were $426 in the first nine months. Share repurchases were $13, and the program was suspended through the remainder of 2016. Approximately 83% of cash and marketable securities were held outside the United States and considered indefinitely reinvested.
Material changes and notable items
- April acquisitions of Sage Products ($2,875 consideration), Physio-Control ($1,299), and Synergetics materially expanded MedSurg offerings and increased goodwill and intangible assets. Purchase price allocations were preliminary.
- Q3 gross margin declined to 66.1% from 67.1%, primarily due to acquisition-related inventory fair-value step-up and foreign exchange. For the nine months, gross margin was 66.2% versus 66.1%; the filing cites the suspension of the U.S. medical device excise tax as a benefit expected to continue through 2017.
- Other expense increased to $67 in Q3 and $172 for nine months, primarily due to higher interest expense following the debt offering. Intangible amortization also increased, mainly due to acquisitions.
- Rejuvenate and ABG II hip-stem recall charges were $57 in Q3 and $104 for nine months, below the comparable 2015 charges of $150 and $316. The company recorded an additional $45 Q3 charge. Estimated global probable loss was $1,915–$2,174, net of expected insurance recoveries; $1,483 in recall-related payments had been made, including $1,382 in settlements.
- Management cited disciplined expense management, while noting acquisition costs, higher sales-related compensation, R&D investment, and global ERP development affected expenses. Reported net earnings and adjusted results differ due to specified acquisition, amortization, restructuring, recall, legal, and tax items; adjusted measures are non-GAAP.
Outlook, risks, and contingencies
The filing provides no specific full-year revenue or earnings guidance. Management said the excise-tax suspension should benefit gross profit through 2017 and expected to meet short-term liquidity and operating needs through operating cash flow, commercial paper, and credit lines. Forward-looking statements remain subject to risks described in the company’s 2015 Form 10-K.
The hip recall’s ultimate cost may differ materially from the recorded estimate and could adversely affect financial position, results, and cash flows. The company is self-insured for product liability claims and says actual costs could materially exceed accruals. A Hill-Rom patent dispute remained unresolved; management could not estimate a probable loss range, and an adverse outcome could be material. The company also reported currency exposure as its greatest market risk, but no material change in market-risk disclosures.
Important facts for investors to verify
- Organic sales growth and the extent to which reported growth reflects acquisitions, particularly in MedSurg.
- Updated hip-recall enrollment, settlement payments, insurance recoveries, and adequacy of the $1,915–$2,174 estimated loss range.
- Debt-servicing costs, refinancing capacity, rating developments, and the effect of increased leverage on liquidity.
- Whether acquired businesses deliver expected growth and integration benefits, including final purchase price allocations and intangible-asset amortization.
- Underlying margins and earnings after reviewing both GAAP results and the filing’s non-GAAP reconciliations.