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Stryker Corporation’s (SYK - Analyst Report) adjusted earnings per share (EPS) of $1.03 increased 4.0% year over year in the first quarter of 2013. It beat the Zacks Consensus Estimate by 2 cents. Adjusted EPS included the recently implemented Medical Device Excise Tax amounting to $14 million net of tax as well as an income tax benefit of $17 million associated with the American Taxpayer Relief Act of 2012. Adjusted net income increased 4.0% year over year to $394 million.

The adjusted earnings for the quarter exclude charges of $32 million, net of taxes, related to the Rejuvenate and ABG II hip products recall in Jun 2012, resulting in a total charge of $230 million. It also excluded charges of $11 million, net of tax, related to the previously communicated headcount reduction and other restructuring moves and $17 million, net of tax, in charges associated with the company’s takeover and integration of Trauson, Surpass Medical and Boston Scientific’s (BSX - Analyst Report) Neurovascular business. Additionally, a one-time expense of $30 million net of tax related to regulatory matters in the U.S. was also excluded.

The Michigan-based orthopedic devices major’s profit (as reported) declined 13.1% to $304 million (or 79 cents a share).    

Stryker completed the acquisition of a leading China-based trauma manufacturing company, Trauson Holdings in Mar 2013. Stryker acquired this entity in an effort to expand its foothold in the Chinese orthopedic market.
 
Revenues

Stryker’s first-quarter sales inched up 1.3% year over year (2.6% in constant currency) to $2,190 million but were below the Zacks Consensus Estimate of $2,207. Volume and mix contributed 3.8% to sales growth and acquisition contributed 0.2%. This was partly neutralized by unfavorable pricing impact and foreign currency exchange translation of 1.3% each. On an organic basis (excluding the impact of acquisitions) net revenues grew 2.6% in constant currency.

Sales in the U.S. improved 4.0% to $1,441 million but international sales dipped 3.4% (up 0.2% in constant currency) mainly due to the ongoing austerity measures in Europe.  

Segments Analysis

Revenues from Stryker’s core Reconstructive unit increased 1.2% (or 2.8% in constant currency) to $969 million in the first quarter. Solid sales in the U.S., up 6.5% year over year, led to the growth. Management asserts the U.S. recon market is stable, which is likely to sustain through 2013.

Domestic hip sales grew 3.7%, while international revenues dropped 2.4% in constant currency. Stryker’s knee business failed to maintain the growth momentum displayed in the prior quarter as it declined 0.4% in the U.S. and 5% in constant currency overseas, mainly due to the recall of the ShapeMatch Cutting Guides. The U.S. trauma and extremities business witnessed a 26.2% rise in sales, led by robust improvement in foot and ankle along with contributions from new offerings and sales force expansion. However, sales in the global markets dipped 0.8% in constant currency.

Revenues from Stryker’s MedSurg segment inched up 0.3% (up 1.0% in constant currency) year over year to $824 million, boosted by the Medical and Sustainability Solutions franchises. Volume and mix, and favorable pricing impact contributed 0.5% each to growth, partly neutralized by an unfavorable foreign currency exchange translation of 0.7%.

Within MedSurg, Instrument sales dropped 1.3% in the U.S. due to the Neptune recall but increased 4.1% in constant currency internationally. Endoscopy sales were also down 0.9% in the U.S. but grew 4.3% outside the U.S. We note that the Medical segment revenues were up 4.3% in the U.S. due to soft year-over-year comparables but down 6.6%, in constant currency, overseas.

Stryker’s Neurotechnology and Spine segment continues its solid growth streak with revenues increasing 4.0% (up 5.7% in constant currency) year over year to $397 million. Growth was led by Stryker’s neuro Powered Instruments platform, NSE, which posted a growth of about 20%.

Sales from the Neurotechnology sub-segment climbed 14.5% and 10.0% (constant currency) in the U.S. and global markets. Core spinal implant sales were flat in the U.S. and down 6.2% in constant currency, globally.

Margin Trends

Adjusted gross margin in the first quarter was 67.5% versus 67.8% in the previous year quarter. It included the impact of the medical device excise tax in 2013, which reduced gross margin by 100 basis points. Gross margin benefited from favorable mix, lower inventory charges, and cost curtailment efforts by the company’s global quality and operations group.

Selling, general and administrative (SG&A) expenses (as a percentage of sales) rose to 41.8% from 37.9%, mainly due to one-time expenses. On an adjusted basis, SG&A was 37.2% of sales compared with 37.5% of sales in the prior year. Research, development and engineering expenses, as a percentage of sales, increased to 5.9% from 5.2% a year ago, and up 5.5% sequentially due to increased investment in additional R&D projects and innovation activities.

Adjusted operating margin was 22.9%, an 80 basis points decline from the year-ago quarter. This was mainly due to the medical device tax and higher R&D spending, partially offset by factors that benefited gross margin.
 
Financial Health

Stryker ended the quarter with cash and cash equivalents and marketable securities of $4,487 million, up roughly 36.1% year over year. Long-term debt increased 56.4% to $2,738 million.

Stryker generated a solid $236 million of cash from operations during the first quarter, compared to $35 million in the prior year. The company repurchased 3.6 million shares in the quarter under the company’s $250 million Accelerated Share Repurchase (ASR) program.  The program was completed in Apr 2013 and resulted in the receipt of 0.2 million additional shares.

Outlook

Revenues are expected to grow 4.0%–6.5% in terms of constant currency in 2013. Constant currency sales growth, excluding acquisitions, is projected in the range of 3.0%–5.5%. The company expects foreign currency (assuming current exchange rates) to unfavorably impact sales by roughly 1%–2% in the second quarter as well as full year 2013.

However, Stryker continues to expect adjusted earnings in the range of $4.25–$4.40 a share for 2013. The current Zacks Consensus Estimate of $4.32 for 2013 is within the provided guidance.

Our Take

Stryker, with a market-cap of $24.63 billion, is one of the world’s largest medical device manufacturers operating in the global orthopedic market. The company’s well-diversified product portfolio and expanding foothold in emerging markets along with acquisitions are expected to drive future growth. Moreover, the company remains committed to delivering incremental returns to investors via share repurchase and dividends.

We are encouraged by the recent stability in the domestic recon market, but the company remains challenged by the prevailing austerity measures in Europe, which is dampening sales growth in some segments. However, Stryker faces several challenges, which include a tough hospital capital budget environment.

Stryker carries a short-term Zacks Rank #3 (Hold). Medical products companies, such as NuVasive (NUVA - Snapshot Report), carrying a Zacks Rank #1 (Strong Buy) and Perrigo (PRGO - Analyst Report), which carry a Zacks Rank #2 (Buy), are expected to do well.

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