Stryker Corporation — Q3 2009 Form 10-Q
Reporting period: Quarter and nine months ended September 30, 2009. Stryker is a medical technology company with Orthopaedic Implants and MedSurg Equipment reportable segments. Amounts are in U.S. dollars; financial statement amounts are in millions except per-share data.
Key financial results
| Metric | Q3 2009 | Q3 2008 | Nine months 2009 | Nine months 2008 |
|---|---|---|---|---|
| Net sales | $1,653.3 | $1,653.0 | $4,888.9 | $5,000.0 |
| Gross profit / margin | $1,114.6 / 67.4% | $1,111.3 / 67.2% | $3,298.4 / 67.5% | $3,424.6 / 68.5% |
| Operating income / margin | $311.4 / 18.8% | $364.1 / 22.0% | $1,080.4 / 22.1% | $1,148.7 / 23.0% |
| Net earnings | $229.0 | $273.8 | $801.4 | $870.1 |
| Diluted EPS | $0.57 | $0.66 | $2.01 | $2.09 |
- Q3 reported sales were flat year over year; constant-currency sales increased 1%. Nine-month reported sales declined 2%, while constant-currency sales increased 1%.
- Orthopaedic Implants sales rose 6% in Q3 and 2% for the nine months, reported. MedSurg Equipment sales fell 8% in both periods. Management attributed MedSurg weakness largely to reduced demand amid the economic slowdown, particularly for patient handling and emergency medical equipment.
- Q3 included $67.0 million of pretax restructuring charges ($48.4 million after tax), reducing diluted EPS by $0.12. Excluding the charge, adjusted Q3 net earnings were $277.4 million and adjusted diluted EPS was $0.69, up 1% and 5%, respectively. Nine-month adjusted net earnings were $849.8 million and adjusted diluted EPS was $2.13, down 2% and up 2%, respectively. These are non-GAAP measures.
- For the first nine months, operating cash flow was $920.6 million, versus $756.6 million a year earlier; capital expenditures were $89.6 million and dividends paid were $158.6 million. Cash and cash equivalents were $960.3 million at quarter-end.
- At September 30, current marketable securities were $1,969.1 million; working capital was $4,563.8 million. Borrowings totaled $18.1 million, and the company reported $1,048.0 million of additional borrowing capacity under its existing facilities. Management said cash, securities and expected operating cash flow should meet anticipated requirements.
Changes, outlook and management commentary
- Nine-month reported earnings and sales declined from 2008, while the third quarter’s flat sales contrasted with a 16% decline in reported net earnings. The Q3 earnings comparison reflects the new restructuring charge; adjusted Q3 earnings increased 1%.
- Foreign exchange reduced nine-month reported sales growth by four percentage points; management reported 1% constant-currency growth. Cost of sales rose to 32.5% of sales for the nine months from 31.5%, attributed to compliance costs, excess and obsolete inventory, and lower production absorption. Research and development and SG&A expense percentages declined.
- Management forecast 2009 adjusted diluted EPS of $2.90–$3.00, up 2%–6% from $2.83 in 2008, and constant-currency sales growth of 1%–2%. At September 30 exchange rates, it anticipated currency to benefit Q4 reported sales by approximately 3.2%–4.2%, but reduce full-year reported sales by approximately 1.6%–2.0%.
- The restructuring included EMEA agent-agreement terminations, asset impairments for discontinued products, workforce reductions affecting about 120 employees, and other contract costs. Initiatives were described as substantially complete; final severance payments were expected in 2009.
- After quarter-end, the Board changed to quarterly dividends and declared a $0.10-per-share transition dividend payable December 16, 2009. The filing said this would bring 2009 dividends to $0.50 per share.
Risks, contingencies and unusual items
- A federal grand jury indicted Stryker Biotech LLC and current and former employees in October 2009 on charges involving alleged fraud and FDA-related conduct. The company said the outcome was not reasonably estimable; a conviction could mean significant fines and exclusion from government healthcare programs. The FDA had also declined to recommend marketing approval for OP-1 Putty, and the company was reviewing strategic alternatives.
- Other disclosed regulatory and legal matters include FDA warning letters for product or quality-system compliance, a New Jersey Attorney General subpoena concerning physician arrangements in clinical trials, ongoing federal inquiries into physician consulting arrangements, and SEC/Department of Justice inquiries related to possible Foreign Corrupt Practices Act violations. The OP-1 facility warning letter was reported resolved in October 2009.
- The IRS proposed adjustments to the company’s 2003–2005 returns involving cost-sharing arrangements with Irish subsidiaries. Stryker said it would vigorously defend its positions; an adverse outcome could materially increase future tax expense and reduce earnings.
- The company held $157.4 million at par of illiquid auction-rate securities whose auctions had failed. It valued the securities and related rights using Level 3 assumptions; the UBS rights permit sales at par during a specified 2010–2012 period. The company recorded offsetting valuation changes in the related securities and rights during the nine months.
- Management cited economic weakness, pricing and reimbursement pressure, foreign exchange, product approvals, product liability, tax audits, financial markets and competition as risks to forward results. The filing stated there were no material changes to previously disclosed market-risk information.
Important facts for investors to verify
- Whether the 2009 adjusted EPS and constant-currency sales outlook was achieved, and how reported results compare after restructuring and currency effects.
- Whether MedSurg demand, inventory levels and cost pressures improved, particularly in patient handling and emergency medical equipment.
- Developments and potential financial or operating consequences of the Stryker Biotech indictment, FDA matters, physician-payment inquiries and tax disputes.
- The valuation, liquidity and eventual recovery of auction-rate securities, and the timing and terms of the UBS par-sale rights.
- The post-quarter dividend declaration and the company’s ability to sustain cash generation and liquidity while funding operations, investment and dividends.