SYK 10Q 6.30.2013


 

UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
___________________________

FORM 10-Q
(Mark one)
 
[X]
QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the quarterly period ended
June 30, 2013

OR
[ ]
TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

Commission file number: 0-9165
STRYKER CORPORATION
(Exact name of registrant as specified in its charter)
Michigan
 
38-1239739
(State of incorporation)
 
(I.R.S. Employer Identification No.)
 
 
 
 
 
 
2825 Airview Boulevard, Kalamazoo, Michigan
 
49002
(Address of principal executive offices)
 
(Zip Code)
 
 
 
(269)-385-2600
(Registrant’s telephone number, including area code)

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.                          YES [X]          NO [   ]

Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).                 YES [X]         NO [   ]

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company. See the definitions of "large accelerated filer," "accelerated filer" and "smaller reporting company" in Rule 12b-2 of the Exchange Act.

Large accelerated filer
[X]
 
Accelerated filer
[ ]
 
 
 
 
 
Non-accelerated filer
[ ]
 
Small reporting company
[ ]

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).    YES [   ]        NO [X]

Number of shares outstanding of each of the issuer’s classes of common stock, as of the latest practicable date: 378,132,187 shares of Common Stock, $0.10 par value, as of June 30, 2013.
 




PART I. - FINANCIAL INFORMATION

ITEM 1.
FINANCIAL STATEMENTS.

Stryker Corporation and Subsidiaries

CONSOLIDATED STATEMENTS OF EARNINGS (Unaudited)
 
 
Three Months Ended June 30
 
Six Months Ended June 30
 
 
2013
 
2012
 
2013
 
2012
Net sales
 
$
2,212

 
$
2,106

 
$
4,402

 
$
4,267

Cost of sales
 
730

 
672

 
1,443

 
1,381

Gross profit
 
1,482

 
1,434

 
2,959

 
2,886

Research, development and engineering expenses
 
132

 
116

 
261

 
228

Selling, general and administrative expenses
 
1,015

 
823

 
1,931

 
1,642

Intangible asset amortization
 
36

 
31

 
68

 
62

Restructuring charges
 
9

 
19

 
23

 
33

Total operating expenses
 
1,192

 
989

 
2,283

 
1,965

Operating income
 
290

 
445

 
676

 
921

Other income (expense), net
 
(21
)
 
(10
)
 
(32
)
 
(18
)
Earnings before income taxes
 
269

 
435

 
644

 
903

Income taxes
 
56

 
110

 
127

 
228

Net earnings
 
$
213

 
$
325

 
$
517

 
$
675

 
 
 
 

 
 
 
 
Net earnings per share of common stock:
 
 
 
 
 
 
 
 
    Basic net earnings per share of common stock
 
$
0.56

 
$
0.85

 
$
1.36

 
$
1.77

    Diluted net earnings per share of common stock
 
$
0.56

 
$
0.85

 
$
1.35

 
$
1.76

 
 
 
 
 
 
 
 
 
Weighted-average shares outstanding—in millions:
 
 
 
 
 
 
 
 
Basic
 
378.0

 
381.0

 
378.8

 
381.0

Net effect of dilutive employee stock options
 
3.0

 
2.3

 
3.2

 
2.5

Diluted
 
381.0

 
383.3

 
382.0

 
383.5

Anti-dilutive shares excluded from the calculation of net effect of dilutive employee stock options
 
2.1

 
8.8

 
2.2

 
8.8



CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME (Unaudited)
 
 
Three Months Ended June 30
 
Six Months Ended June 30
 
 
2013
 
2012
 
2013
 
2012
Net earnings
 
$
213

 
$
325

 
$
517

 
$
675

Unrealized (losses) gains on securities, net of income tax benefit (expense) [$2 and $2 in 2013, $0 and ($1) in 2012]
 
(5
)
 
(3
)
 
(6
)
 
4

Unfunded pension (losses) gains, net of income tax benefit (expense) [$0 and $1 in 2013, $0 and $0 in 2012]
 
(1
)
 
1

 
2

 

Foreign currency translation adjustments
 
20

 
(293
)
 
(94
)
 
(208
)
Total other comprehensive income (loss)
 
14

 
(295
)
 
(98
)
 
(204
)
Comprehensive income
 
$
227

 
$
30

 
$
419

 
$
471


See accompanying notes to Consolidated Financial Statements.



1
 
Dollar amounts in millions except per share amounts or as otherwise specified



Stryker Corporation and Subsidiaries

CONSOLIDATED BALANCE SHEETS (Unaudited)
 
 
June 30
 
December 31
 
2013
 
2012
ASSETS
 
 
 
 
Current assets
 
 
 
 
Cash and cash equivalents
 
$
971

 
$
1,395

Marketable securities
 
3,681

 
2,890

Accounts receivable, less allowance of $59 ($58 in 2012)
 
1,413

 
1,430

Inventories
 
 
 
 
Materials and supplies
 
205

 
202

Work in process
 
85

 
71

Finished goods
 
1,055

 
992

Total inventories
 
1,345

 
1,265

Deferred income taxes
 
781

 
811

Prepaid expenses and other current assets
 
498

 
357

Total current assets
 
8,689

 
8,148

Property, plant and equipment
 
 
 
 
Land, buildings and improvements
 
663

 
625

Machinery and equipment
 
1,682

 
1,607

Total property, plant and equipment
 
2,345

 
2,232

Less allowance for depreciation
 
1,324

 
1,284

Net property, plant and equipment
 
1,021

 
948

Other assets
 
 
 
 
Goodwill
 
2,573

 
2,142

Other intangibles, net
 
1,545

 
1,424

Other
 
554

 
544

Total assets
 
$
14,382

 
$
13,206

 
 
 
 
 
LIABILITIES AND SHAREHOLDERS' EQUITY
 
 
 
 
Current liabilities
 
 
 
 
Accounts payable
 
$
277

 
$
288

Accrued compensation
 
356

 
467

Income taxes
 
53

 
70

Dividend payable
 
100

 
101

Accrued expenses and other liabilities
 
1,156

 
934

Current maturities of debt
 
29

 
16

Total current liabilities
 
1,971

 
1,876

Long-term debt, excluding current maturities
 
2,742

 
1,746

Other liabilities
 
1,066

 
987

Shareholders' equity
 
 
 
 
Common stock, $0.10 par value:
 
 
 
 
Authorized: 1 billion shares, outstanding: 378 million shares (380 million in 2012)
 
38

 
38

Additional paid-in capital
 
1,124

 
1,098

Retained earnings
 
7,410

 
7,332

Accumulated other comprehensive income
 
31

 
129

Total shareholders' equity
 
8,603

 
8,597

Total liabilities & shareholders' equity
 
$
14,382

 
$
13,206


See accompanying notes to Consolidated Financial Statements.


2
 
Dollar amounts in millions except per share amounts or as otherwise specified



Stryker Corporation and Subsidiaries

CONSOLIDATED STATEMENT OF SHAREHOLDERS’ EQUITY (Unaudited)
 
 
Common
Stock
 
Additional
Paid-In
Capital
 
Retained
Earnings
 
Accumulated
Other
Comprehensive
Income
 
Total
Balances at December 31, 2012
 
$
38

 
$
1,098

 
$
7,332

 
$
129

 
$
8,597

Net earnings
 
 
 
 
 
517

 
 
 
517

Other comprehensive loss
 
 
 
 
 
 
 
(98
)
 
(98
)
Issuance of 2.3 million shares of common stock under stock option and benefit plans, including $4 excess income tax benefit
 
 
 
(1
)
 
 
 
 
 
(1
)
Repurchase and retirement of 3.8 million shares of common stock
 
 
 
(11
)
 
(239
)
 
 
 
(250
)
Share-based compensation
 
 
 
38

 
 
 
 
 
38

Cash dividends declared of $0.53 per share of common stock
 
 
 
 
 
(200
)
 
 
 
(200
)
Balances at June 30, 2013
 
$
38

 
$
1,124

 
$
7,410

 
$
31

 
$
8,603


See accompanying notes to Consolidated Financial Statements.

In February 2013 we declared a quarterly dividend of $0.265 per share, payable April 30, 2013 to shareholders of record at the close of business on March 28, 2013. In April 2013 we declared a quarterly dividend of $0.265 per share, payable July 31, 2013 to shareholders of record at the close of business on June 28, 2013.


3
 
Dollar amounts in millions except per share amounts or as otherwise specified



Stryker Corporation and Subsidiaries

CONSOLIDATED STATEMENTS OF CASH FLOWS (Unaudited)
 
 
Three Months Ended June 30
 
Six Months Ended June 30
 
 
2013
 
2012
 
2013
 
2012
Operating activities
 
 
 
 
 
 
 
 
Net earnings
 
$
213

 
$
325

 
$
517

 
$
675

Adjustments to reconcile net earnings to net cash provided by operating activities:
 
 
 
 
 
 
 
 
Depreciation
 
43

 
38

 
81

 
77

Intangible asset amortization
 
36

 
31

 
68

 
62

Share-based compensation
 
18

 
18

 
38

 
39

Restructuring charges
 
10

 
19

 
24

 
33

Sale of inventory stepped up to fair value at acquisition
 
8

 
3

 
8

 
15

Changes in operating assets and liabilities, net of effects of acquisitions:
 
 
 
 
 
 
 
 
Accounts receivable
 
(18
)
 
73

 
(11
)
 
25

Inventories
 
(25
)
 
(1
)
 
(63
)
 
(30
)
Accounts payable
 
(21
)
 
(9
)
 
(30
)
 
(44
)
Accrued expenses and other liabilities
 
269

 
19

 
157

 
(183
)
Income taxes
 
(141
)
 
(84
)
 
(150
)
 
(127
)
Other
 
(36
)
 
25

 
(47
)
 
(50
)
Net cash provided by operating activities
 
356

 
457

 
592

 
492

 
 
 
 
 
 
 
 
 
Investing activities
 
 
 
 
 
 
 
 
Acquisitions, net of cash acquired
 
(62
)
 
(1
)
 
(662
)
 
(10
)
Purchases of marketable securities
 
(1,843
)
 
(356
)
 
(2,616
)
 
(1,570
)
Proceeds from sales of marketable securities
 
754

 
792

 
1,816

 
1,944

Purchases of property, plant and equipment
 
(47
)
 
(51
)
 
(96
)
 
(103
)
Net cash (used in) provided by investing activities
 
(1,198
)
 
384

 
(1,558
)
 
261

 
 
 
 
 
 
 
 
 
Financing activities
 
 
 
 
 
 
 
 
Proceeds from borrowings
 
102

 
50

 
1,162

 
94

Payments on borrowings
 
(100
)
 
(55
)
 
(151
)
 
(93
)
Dividends paid
 
(100
)
 
(81
)
 
(201
)
 
(162
)
Repurchase and retirement of common stock
 

 
(39
)
 
(250
)
 
(89
)
Other
 
5

 
(23
)
 
(2
)
 
(26
)
Net cash (used in) provided by financing activities
 
(93
)
 
(148
)
 
558

 
(276
)
 
 
 
 
 
 
 
 
 
Effect of exchange rate changes on cash and cash equivalents
 
(7
)
 
10

 
(16
)
 
11

Change in cash and cash equivalents
 
$
(942
)
 
$
703

 
$
(424
)
 
$
488



See accompanying notes to Consolidated Financial Statements.


4
 
Dollar amounts in millions except per share amounts or as otherwise specified



Stryker Corporation and Subsidiaries
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Unaudited)
June 30, 2013
NOTE 1 - BASIS OF PRESENTATION
General Information
The accompanying unaudited Consolidated Financial Statements have been prepared in accordance with accounting principles generally accepted in the United States of America (GAAP) for interim financial information and with the instructions to Form 10-Q and Article 10 of Regulation S-X. Accordingly, they do not include all of the information and footnotes required by GAAP for complete financial statements. As a result, this Form 10-Q should be read in conjunction with the Consolidated Financial Statements and accompanying Notes to Consolidated Financial Statements in our Annual Report on Form 10-K for the year ended December 31, 2012.
Management believes that the accompanying unaudited Consolidated Financial Statements reflect all adjustments, including normal recurring items, considered necessary for a fair presentation of the interim periods. The results of operations for the three- and six- month periods ended June 30, 2013 are not necessarily indicative of the results that may be expected for the year ended December 31, 2013. The balance sheet at December 31, 2012 has been derived from the audited Consolidated Financial Statements at that date but does not include all of the information and footnotes required by GAAP for complete financial statements.
NOTE 2 - ACCUMULATED OTHER COMPREHENSIVE INCOME (AOCI)
Changes in and reclassifications out of AOCI, net of tax, for the three- and six-month periods ended June 30, 2013 were as follows:
 
Foreign Currency Translation
 
Marketable Securities Unrealized Gain (Loss)
 
Defined Benefit Pension Plans
 
Total AOCI
 
Three Months
 
Six Months
 
Three Months
 
Six Months
 
Three Months
 
Six Months
 
Three Months
 
Six Months
Beginning balance
$
112

 
$
226

 
$
3

 
$
4

 
$
(98
)
 
$
(101
)
 
$
17

 
$
129

Other Comprehensive Income (OCI) before reclassifications
20

 
(94
)
 
(1
)
 
1

 
(1
)
 

 
18

 
(93
)
Amounts reclassified from AOCI

 

 
(4
)
 
(7
)
 

 
2

 
(4
)
 
(5
)
Net current-period OCI
20

 
(94
)
 
(5
)
 
(6
)
 
(1
)
 
2

 
14

 
(98
)
Balance at June 30, 2013
$
132

 
$
132

 
$
(2
)
 
$
(2
)
 
$
(99
)
 
$
(99
)
 
$
31

 
$
31

The following items were reclassified out of AOCI into earnings for the three- and six-month periods ended June 30, 2013:
 
 
Three Months
 
Six Months
Detail of AOCI Components
 
Amount Reclassified from AOCI
 
Affected Line Item in the Consolidated Statements of Earnings
 
Amount Reclassified from AOCI
 
Affected Line Item in the Consolidated Statements of Earnings
Unrealized gains on available-for-sale marketable securities
 
$
(4
)
 
Other (income) expense
 
$
(9
)
 
Other (income) expense
 
 

 
Income tax expense
 
2

 
Income tax expense
 
 
$
(4
)
 
Net of tax
 
$
(7
)
 
Net of tax
 
 
 
 
 
 
 
 
 
Amortization of defined benefit pension items:
 
 
 
 
 
 
 
 
Actuarial losses
 
$
1

 
Cost of sales
 
$
3

 
Cost of sales
 
 
(1
)
 
Income tax benefit
 
(1
)
 
Income tax benefit
 
 
$

 
Net of tax
 
$
2

 
Net of tax
NOTE 3 - FAIR VALUE MEASUREMENTS
Accounting guidance on fair value measurements for certain financial assets and liabilities requires that financial assets and liabilities carried at fair value be classified and disclosed in one of the following three categories:
Level 1:    Quoted market prices in active markets for identical assets or liabilities.
Level 2:    Observable market-based inputs or unobservable inputs that are corroborated by market data.
Level 3:    Unobservable inputs reflecting the reporting entity's own assumptions or external inputs from active markets. 
When applying fair value principles in the valuation of assets and liabilities, we are required to maximize the use of quoted market prices and minimize the use of unobservable inputs. We calculate the fair value of our Level 1 and Level 2 instruments based on the exchange traded price of similar or identical instruments, where available, or based on other observable inputs. There were no significant transfers into or out of Level 1 or Level 2 that occurred between December 31, 2012 and June 30, 2013. The fair value of our Level 3 assets and liabilities are calculated as the net present value of expected cash flows based on externally provided or obtained inputs. Certain Level 3 assets may also be based on sale prices of similar assets. Our fair value calculations take into consideration our credit risk and that of our counterparties. Should a counterparty default, our maximum exposure to loss is the asset balance of the instrument. We did not change our valuation techniques used in measuring the fair value of any financial assets and liabilities during the period.

5
 
Dollar amounts in millions except per share amounts or as otherwise specified



Valuation of assets and liabilities measured at fair value: 
 
Total
 
Level 1
 
Level 2
 
Level 3
 
June
December
 
June
December
 
June
December
 
June
December
 
2013
2012
 
2013
2012
 
2013
2012
 
2013
2012
Assets:
 
 
 
 
 
 
 
 
 
 
 
Cash and cash equivalents
$
971

$
1,395

 
$
971

$
1,395

 
$

$

 
$

$

Available-for-sale marketable securities
 
 
 
 
 
 
 
 
 
 
 
Corporate and asset-backed debt securities
1,681

1,280

 


 
1,681

1,280

 


Foreign government debt securities
791

848

 


 
791

848

 


United States agency debt securities
621

288

 


 
621

288

 


United States treasury debt securities
404

343

 


 
404

343

 


Certificates of deposit
152

114

 


 
152

114

 


Other
32

17

 


 
32

17

 


Total available-for-sale marketable securities
3,681

2,890

 


 
3,681

2,890

 


Trading marketable securities
62

57

 
62

57

 


 


Foreign currency exchange contracts
1

3

 


 
1

3

 


 
$
4,715

$
4,345

 
$
1,033

$
1,452

 
$
3,682

$
2,893

 
$

$

Liabilities:
 
 
 
 
 
 
 
 
 
 
 
Deferred compensation arrangements
$
62

$
57

 
$
62

$
57

 
$

$

 
$

$

Contingent consideration
69

103

 


 


 
69

103

Foreign currency exchange contracts
2

1

 


 
2

1

 


 
$
133

$
161

 
$
62

$
57

 
$
2

$
1

 
$
69

$
103

Rollforward of assets and liabilities measured at fair value using unobservable inputs (Level 3):
 
Total
 
Corporate and Asset-Backed Debt Securities
 
Contingent Consideration
 
 
 
 
June
 
December
 
June
 
December
 
June
 
December
 
2013
 
2012
 
2013
 
2012
 
2013
 
2012
Balance at the beginning of the period
$
(103
)
 
$
(114
)
 
$

 
$
1

 
$
(103
)
 
$
(115
)
Transfers into Level 3

 

 

 

 

 

Transfers out of Level 3

 

 

 

 

 

Gains or (losses) included in earnings
5

 
6

 

 

 
5

 
6

Sales

 
(1
)
 

 
(1
)
 

 

Settlements
29

 
39

 

 

 
29

 
39

Other

 
(33
)
 

 

 

 
(33
)
Balance at the end of the period
$
(69
)
 
$
(103
)
 
$

 
$

 
$
(69
)
 
$
(103
)
The estimated fair value of the liability for contingent consideration represents milestone payments for acquisitions. The fair value of these liabilities were estimated using a discounted cash flow technique. Significant inputs to this technique included our probability assessments of the occurrence of triggering events, appropriately discounted considering the uncertainties associated with the obligation. We remeasure these liabilities each reporting period and record the changes in the fair value in selling, general and administrative expense for changes in probability of occurrence and other income (expense) for changes in time value of money.
Quantitative information about the inputs and valuation methodologies we use for material fair value measurements classified in Level 3 at June 30, 2013:
 
 
 
 
Probability Range (Weighted Average)
 
Fair Value
Valuation Technique
Unobservable Input
Minimum
Maximum
Weighted Average
Contingent consideration
$69
Discounted cash flow
Probability of occurrence
85
100
98
Summary of marketable securities at June 30, 2013 and December 31, 2012:
 
Amortized Cost
 
Gross Unrealized Gains
 
Gross Unrealized (Losses)
 
Estimated Fair Value
 
June
December
 
June
December
 
June
December
 
June
December
 
2013
2012
 
2013
2012
 
2013
2012
 
2013
2012
Available-for-sale marketable securities:
 
 
 
 
 
 
 
 
 
 
 
  Corporate and asset-backed debt securities
$
1,683

$
1,277

 
$
2

$
4

 
$
(4
)
$
(1
)
 
$
1,681

$
1,280

  Foreign government debt securities
793

846

 

2

 
(2
)

 
791

848

  United States agency debt securities
622

288

 


 
(1
)

 
621

288

  United States treasury debt securities
404

343

 


 


 
404

343

  Certificates of deposit
152

114

 


 


 
152

114

  Other
32

17

 


 


 
32

17

  Total available-for-sale marketable securities
$
3,686

$
2,885

 
$
2

$
6

 
$
(7
)
$
(1
)
 
$
3,681

2,890

Trading marketable securities
 
 
 
 
 
 
 
 
 
62

57

Total marketable securities
 
 
 
 
 
 
 
 
 
$
3,743

$
2,947

Reported as:
 
 
 
 
 
 
 
 
 
 
 
  Current assets-marketable securities
 
 
 
 
 
 
 
 
 
$
3,681

$
2,890

  Noncurrent assets-other
 
 
 
 
 
 
 
 
 
62

57

 
 
 
 
 
 
 
 
 
 
$
3,743

$
2,947


6
 
Dollar amounts in millions except per share amounts or as otherwise specified



The unrealized losses on available-for-sale marketable securities at June 30, 2013 were primarily caused by increases in yields as a result of the rise in government benchmark rates. Less than 1% of our investments in available-for-sale securities had a credit quality rating of less than A2 (Moody's), A (Standard & Poors) and A (Fitch). Because we do not intend to sell the investments and it is not more likely than not that we will be required to sell the investments before recovery of their amortized cost basis, which may be maturity, we do not consider these investments to be other-than-temporarily impaired at June 30, 2013.
The cost and estimated fair value of available-for-sale marketable securities at June 30, 2013 by contractual maturity are: 
 
 
Cost
 
Estimated
Fair Value
Due in one year or less
 
$
769

 
$
767

Due after one year through three years
 
306

 
306

Due after three years
 
2,611

 
2,608

 
 
$
3,686

 
$
3,681

The gross unrealized losses and fair value of our investments with unrealized losses that are not deemed to be other-than-temporarily impaired, aggregated by investment category and length of time that the individual securities have been in a continuous unrealized loss position at June 30, 2013 are:
 
  Corporate and Asset-Backed Debt Securities
 
  Foreign Government Debt Securities
 
  United States Agency Debt Securities
 
  Other
 
  Total
 
Less Than 12 Months
Total
 
Less Than 12 Months
Total
 
Less Than 12 Months
Total
 
Less Than 12 Months
Total
 
Less Than 12 Months
Total
Number of investments
491

491

 
127

127

 
129

129

 
13

13

 
760

760

Fair value
$
1,073

$
1,073

 
$
620

$
620

 
$
656

$
656

 
$
30

$
30

 
$
2,379

$
2,379

Unrealized losses
$
(4
)
$
(4
)
 
$
(1
)
$
(1
)
 
$
(2
)
$
(2
)
 
$

$

 
$
(7
)
$
(7
)
Upon the sale of a security classified as available-for-sale, the security’s specific unrealized gain (loss) is reclassified out of AOCI into earnings based on the specific identification method.
Interest and marketable securities income was $5 and $13 for the three months ended June 30, 2013 and 2012, respectively, and $11 and $25 for the six months ended June 30, 2013 and 2012, respectively, and is included in other income (expense).
NOTE 4 - DERIVATIVE INSTRUMENTS AND HEDGING STRATEGIES
The estimated fair value of our forward currency exchange contracts represents the measurement of the contracts at month-end spot rates as adjusted by current forward points. We are exposed to credit loss in the event of nonperformance by counterparties on our outstanding forward currency exchange contracts but do not anticipate nonperformance by any of our counterparties. Should a counterparty default, our maximum exposure to loss is the asset balance of the instrument.
Foreign currency transaction losses recognized in other income (expense) totaled ($3) and ($2) for the three months ended June 30, 2013 and 2012, respectively, and ($4) and ($2) for the six months ended June 30, 2013 and 2012, respectively, and outstanding derivative contracts at June 30, 2013 were:
 
 
Notional Amount
 
Assets
 
Liabilities
 
Maximum Term (Days)
 
 
 
 
 
 
 
 
 
Forward currency exchange contracts
 
$1,660
 
$1
 
$2
 
92
NOTE 5 - CONTINGENCIES
We are involved in various ongoing proceedings, legal actions and claims arising in the normal course of business, including proceedings related to product, labor and intellectual property and other matters. The outcomes of certain of these matters will not be known for prolonged periods of time. To partially mitigate losses arising from unfavorable outcomes in such matters, we purchase third-party insurance coverage subject to certain deductibles and loss limitations. Future operating results may be unfavorably impacted by any settlement payments or losses beyond the amounts of insurance carried. In addition, such matters may negatively impact our ability to obtain cost effective third-party insurance coverage in future periods. In certain of the legal proceedings, the claimants seek damages, as well as other compensatory and equitable relief, that could result in the payment of significant claims and settlements and/or the imposition of injunctions or other equitable relief. For legal matters for which management has sufficient information to reasonably estimate our future obligations, a liability representing management's best estimate of the probable cost, or the minimum of the range of probable losses when a best estimate within the range is not known, for the resolution of these legal matters is recorded. Estimates are based on consultation with legal counsel, previous settlement experience and settlement strategies. If actual outcomes are less favorable than those projected by management, additional expense may be incurred, which could unfavorably affect future operating results.
In 2010 we received a subpoena from the United States Department of Justice (DOJ) related to the sales and marketing of the OtisKnee device.  The subpoena concerns allegations of violations of Federal laws related to sales of a device not cleared by the United States Food and Drug Administration (FDA).  We continue to discuss the settlement of this matter with the DOJ, but there can be no assurance that we will reach a consensual resolution rather than seeking a resolution through the courts. 

7
 
Dollar amounts in millions except per share amounts or as otherwise specified




In 2007 we disclosed that the United States Securities and Exchange Commission (SEC) made an inquiry of us regarding possible violations of the Foreign Corrupt Practices Act in connection with the sale of medical devices in certain foreign countries. The investigation is ongoing and we are fully cooperating with the SEC regarding these matters.
We have recorded charges totaling $94 related to the above DOJ and SEC regulatory matters, including $59 in the six months ended June 30, 2013.  The final outcome of these matters is difficult to predict, and the ultimate cost to resolve these matters may be materially different than the amount of the current estimate and accruals and could have a material adverse effect on our financial position, results of operations and cash flows.
In June 2012 we voluntarily recalled our Rejuvenate and ABG II modular-neck hip stems and terminated global distribution of these hip products. We notified healthcare professionals and regulatory bodies of this recall, which was taken due to potential risks associated with fretting and/or corrosion that may lead to adverse local tissue reactions. Product liability lawsuits relating to this voluntary recall have been filed against us. As previously announced, we intend to reimburse implanted patients for reasonable and customary costs of testing and treatment services, including any necessary revision surgeries. We continue to work with the medical community to evaluate the data and further understand this matter and the associated costs. The ultimate total cost with respect to this matter will depend on many factors that are difficult to predict with the limited information received to date and may vary materially based on the number of and actual costs of patients seeking testing and treatment services, the number of and actual costs of patients requiring revision surgeries, the number of and actual costs to settle lawsuits filed against us, and the amount of third-party insurance recoveries.  Based on the information that has been received, we estimate the probable loss to resolve this matter to be in the range of approximately $400 to $660, before third-party insurance recoveries.  In the six months ended June 30, 2013 we recorded charges to earnings of $210 representing the excess of the $400 minimum of the range over the previously recorded reserves. No contingent gain for third-party recoveries was recorded as of June 30, 2013. As noted above, the final outcome of this matter is dependent on many variables that are difficult to predict.  The ultimate cost to entirely resolve this matter may be materially different than the amount of the current estimate and accruals and could have a material adverse effect on our financial position, results of operations and cash flows.
For each of the following legal matters the final outcome is dependent on many variables and cannot be predicted. Accordingly, it is not possible at this time for us to estimate any material loss or range of losses. However, the ultimate cost to resolve these matters could have a material adverse effect on our financial position, results of operations and cash flows.
In April 2011 lawsuits brought by Hill-Rom Company, Inc. and affiliated entities (Hill-Rom) against us were filed in the United States District Court for the Western District of Wisconsin and the United States District Court for the Southern District of Indiana.  The Wisconsin lawsuit was subsequently transferred to the United States District Court in Indiana. The suits allege infringement under United States patent laws with respect to certain patient handling equipment we manufactured and sold and seek damages and permanent injunctions. The first lawsuit involved ten patents related to the use of a motorized wheel for hospital beds and stretchers. We have entered into an agreement settling that lawsuit. This agreement included a payment to Hill-Rom of $3.75, a covenant not to sue and a cross-license. The second lawsuit involves nine patents related to electrical network communications for hospital beds. The case has been stayed with respect to six of the patents, which are currently under reexamination by the United States Patent Office. With respect to the suit and the three remaining patents, we continue to vigorously defend ourselves. The ultimate resolution of the second suit may have no relation to the resolution of the first suit and cannot be predicted; however, the ultimate cost could have a material adverse effect on our financial position, results of operations and cash flows.
In 2010 we received a subpoena from the DOJ related to sales, marketing and regulatory matters related to the Stryker PainPump. We have received requests for certain documents in connection with this investigation. The investigation is ongoing and we are fully cooperating with the DOJ regarding this matter.
In 2007 the United States Department of Health and Human Services, Office of Inspector General (HHS) issued us a civil subpoena seeking to determine whether we violated various laws by paying consulting fees and providing other things of value to orthopedic surgeons and healthcare and educational institutions as inducements to use Stryker's orthopedic medical devices in procedures paid for in whole or in part by Medicare. We have produced numerous documents and other materials to HHS in response to the subpoena.
NOTE 6 - ACQUISITIONS
On March 1, 2013, we acquired Trauson Holdings Company Limited (Trauson) in an all cash transaction totaling $751. The acquisition of Trauson will enhance our product offerings, primarily within our Reconstructive segment, broaden our presence in China and enable us to expand into the fast growing value segment of the emerging markets.
The effect of the acquisition has been included in our Consolidated Financial Statements prospectively from the date of acquisition. Pro forma consolidated results of operations for the periods ended June 30, 2013 and December 31, 2012 would not differ significantly as a result of the acquisition. The purchase price allocation is based upon a preliminary valuation, and our estimates and assumptions are subject to change within the measurement period as the valuation is finalized. In the three-month period ended June 30, 2013, revisions to our estimates included an increase to customer relationship intangible assets of $47, an increase to liabilities of $14, and a reduction to goodwill of $29.

8
 
Dollar amounts in millions except per share amounts or as otherwise specified



The preliminary allocation of the purchase price to the acquired net assets of Trauson is as follows:
 
 
Trauson
Total purchase consideration
 
$
751

 
 
 
Tangible assets acquired:
 
 
Inventory
 
43

Other assets
 
169

Liabilities
 
(87
)
Identifiable intangible assets:
 
 
Customer relationship
 
119

Trade name
 
18

Developed technology
 
32

In-process research & development
 
5

Goodwill
 
452

 
 
$
751

NOTE 7 - LONG-TERM DEBT AND CREDIT FACILITIES
Our debt is summarized as follows:
 
June 30
 
December 31
 
 
2013
 
2012
3.00% senior unsecured notes, due January 15, 2015
 
$
500

 
$
500

4.375% senior unsecured notes, due January 15, 2020
 
498

 
497

2.00% senior unsecured notes, due September 30, 2016
 
749

 
749

1.30% senior unsecured notes, due April 1, 2018
 
598

 

4.10% senior unsecured notes, due April 1, 2043
 
394

 

Other
 
32

 
16

Total debt
 
2,771

 
1,762

Less current maturities
 
(29
)
 
(16
)
Long-term debt
 
$
2,742

 
$
1,746

In March 2013 we completed a public offering of $600 in 1.30% Notes due April 1, 2018, net of an offering discount of $3 (2018 Notes), and $400 in 4.10% Notes due April 1, 2043, net of an offering discount of $6 (2043 Notes and, together with the 2018 Notes, the Notes). Interest on the Notes is payable on April 1 and October 1 of each year, commencing on October 1, 2013. Unless previously redeemed, the 2018 Notes will mature on April 1, 2018 and the 2043 Notes will mature on April 1, 2043. We intend to use the net proceeds from the Notes for working capital and other general corporate purposes, including acquisitions, stock repurchases and other business opportunities.
Certain of our credit facilities require us to comply with certain financial and other covenants. We were in compliance with all covenants at June 30, 2013. We have lines of credit, issued by various financial institutions, available to fund our day-to-day operating needs. At June 30, 2013, we had $1,047 of borrowing capacity available under all of our existing credit facilities. The weighted average interest rate, excluding required fees, for all borrowings was 2.9% at June 30, 2013.
At June 30, 2013, the total unamortized debt issuance costs incurred in connection with our outstanding notes were $18. The fair value of long-term debt (including current maturities) at June 30, 2013 and December 31, 2012 was $2,795 and $1,866, respectively, based on the quoted interest rates for similar types and amounts of borrowing agreements.
NOTE 8 - CAPITAL STOCK
In December of 2012, 2011 and 2010, we announced that our Board of Directors had authorized us to purchase up to $405, $500 and $500, respectively, of our common stock (the 2012, 2011 and 2010 Repurchase Programs, respectively). The manner, timing and amount of purchases is determined by management based on an evaluation of market conditions, stock price and other factors and is subject to regulatory considerations. Purchases are to be made from time to time in the open market, in privately negotiated transactions or otherwise.
During the first six months of 2013 we repurchased 1.4 million shares at a cost of $95 under the 2010 Repurchase Program and 2.4 million shares at a cost of $155 under the 2011 Repurchase Program. The repurchase activity was attributable to our Accelerated Share Repurchase (ASR) program, which was completed in April of 2013.
As of June 30, 2013, the 2010 Repurchase Program was complete and the maximum dollar value of shares that may yet be purchased under the 2011 Repurchase Program was $345. We had not made any repurchases pursuant to the 2012 Repurchase Program at June 30, 2013. Shares repurchased under the share repurchase programs are available for general corporate purposes, including offsetting dilution associated with stock option and other equity-based employee benefit plans. At June 30, 2013, the maximum dollar value of shares that may be purchased under the authorized Repurchase Programs was $750.



9
 
Dollar amounts in millions except per share amounts or as otherwise specified



NOTE 9 - RESTRUCTURING CHARGES
In the six months ended June 30, 2013, we recorded $14 in severance and related costs in connection with the continuation of a focused reduction of our global workforce and other restructuring activities expected to reduce our global workforce by approximately 5%. The targeted reductions and other restructuring activities were initiated to provide efficiencies and realign resources in advance of the new Medical Device Excise Tax, as well as to allow for continued investment in strategic areas and drive growth. In addition, in the six months ended June 30, 2013 we recorded $10 in contractual and other obligations, as certain of our restructuring actions resulted in the exit of certain lease and other commitments. The restructuring charges that we recorded in 2012 and 2011 are described in Note 9 to the Consolidated Financial Statements included in our Annual Report on Form 10-K for the year ended December 31, 2012. We expect our current restructuring actions and related cash payments will be completed by the end of 2013.
Rollforward of restructuring liability balance and six months of restructuring activity for 2013 is as follows: 
 
 
Total
 
Agent Conversions
 
Severance and Related Costs
 
Contractual Obligations and Other
January 1 Balance
 
$
40

 
$
5

 
$
20

 
$
15

Charges to earnings
 
24

 

 
14

 
10

Cash paid
 
(33
)
 
(3
)
 
(16
)
 
(14
)
Other adjustments
 
(3
)
 

 
(2
)
 
(1
)
June 30 Balance
 
$
28

 
$
2

 
$
16

 
$
10

NOTE 10 - SEGMENT INFORMATION
We segregate our operations into three reportable business segments: Reconstructive, MedSurg, and Neurotechnology and Spine. Our reportable segments are business units that offer different products and services and are managed separately because each business requires different manufacturing, technology and marketing strategies. The accounting policies of the segments are the same as those described in the summary of significant accounting policies found in Note 1 to the Consolidated Financial Statements included in our Annual Report on Form 10-K for the year ended December 31, 2012.
Net sales and net earnings by business segment for the three- and six-month periods ended June 30, 2013 and 2012 are as follows:
 
Reconstructive
 
MedSurg
 
Neurotechnology and Spine
 
Total
 
Three Months Ended
 
Six Months Ended
 
Three Months Ended
 
Six Months Ended
 
Three Months Ended
 
Six Months Ended
 
Three Months Ended
 
Six Months Ended
 
2013
2012
 
2013
2012
 
2013
2012
 
2013
2012
 
2013
2012
 
2013
2012
 
2013
2012
 
2013
2012
Net sales
$
979

$
927

 
$
1,948

$
1,885

 
$
819

$
786

 
$
1,643

$
1,607

 
$
414

$
393

 
$
811

$
775

 
$
2,212

$
2,106

 
$
4,402

$
4,267

Segment net earnings
231

223

 
460

456

 
150

149

 
304

309

 
62

71

 
129

139

 
$
443

$
443

 
$
893

$
904

Less: other (net of income taxes)
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Other
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
(63
)
(68
)
 
(119
)
(150
)
Acquisition and integration related charges
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
(15
)
(5
)
 
(32
)
(22
)
Restructuring and related charges
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
(10
)
(12
)
 
(21
)
(24
)
Rejuvenate / ABG II hip recall
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
(120
)

 
(152
)

Regulatory matter charges
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
(22
)
(33
)
 
(52
)
(33
)
Net earnings
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
$
213

$
325

 
$
517

$
675

Other than assets associated with the acquisition of Trauson, which are discussed in greater detail in Note 6, there were no significant changes to total assets by segment from information provided in our Annual Report on Form 10-K for the year ended December 31, 2012.

10
 
Dollar amounts in millions except per share amounts or as otherwise specified



ITEM 2.
MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS.
We supplement the reporting of our financial information determined under accounting principles generally accepted in the United States (GAAP) with certain non-GAAP financial measures, including percentage sales growth in constant currency; adjusted gross profit; cost of sales excluding specified items; adjusted selling, general and administrative expenses; adjusted operating income; adjusted effective income tax rate; adjusted net earnings; and adjusted diluted net earnings per share (EPS). We believe that these non-GAAP measures provide meaningful information to assist shareholders in understanding our financial results and assessing our prospects for future performance. Management believes percentage sales growth in constant currency and the other adjusted measures described above are important indicators of our operations because they exclude items that may not be indicative of or are unrelated to our core operating results and provide a baseline for analyzing trends in our underlying businesses. Management uses these non-GAAP financial measures for reviewing the operating results of reportable business segments and analyzing potential future business trends in connection with our budget process and bases certain management incentive compensation on these non-GAAP financial measures. To measure percentage sales growth in constant currency, we remove the impact of changes in foreign currency exchange rates that affect the comparability and trend of sales. Percentage sales growth in constant currency is calculated by translating current year results at prior year average foreign currency exchange rates. To measure earnings performance on a consistent and comparable basis, we exclude certain items that affect the comparability of operating results and the trend of earnings. Because non-GAAP financial measures are not standardized, it may not be possible to compare these financial measures with other companies' non-GAAP financial measures having the same or similar names. These adjusted financial measures should not be considered in isolation or as a substitute for reported sales growth, gross profit, cost of sales, selling, general and administrative expenses, operating income, effective income tax rate, net earnings and diluted net earnings per share, the most directly comparable GAAP financial measures. These non-GAAP financial measures are an additional way of viewing aspects of our operations that, when viewed with our GAAP results and the reconciliations to corresponding GAAP financial measures at the end of the discussion of Results of Operations below, provide a more complete understanding of our business. We strongly encourage investors and shareholders to review our financial statements and publicly-filed reports in their entirety and not to rely on any single financial measure.
ABOUT STRYKER
Stryker is one of the world's leading medical technology companies, with 2012 revenues of $8,657 and net earnings of $1,298. We are dedicated to helping healthcare professionals perform their jobs more efficiently while enhancing patient care. We offer a diverse array of innovative medical technologies, including reconstructive, medical and surgical, and neurotechnology and spine products, to help people lead more active and more satisfying lives.
In the United States, most of our products are marketed directly to doctors, hospitals and other healthcare facilities. For the most part, we maintain separate and dedicated sales forces for each of our principal product lines to provide focus and a high level of expertise to each medical specialty served. Internationally, our products are sold in over 100 countries through company-owned sales subsidiaries and branches as well as third-party dealers and distributors. Our business is generally not seasonal in nature; however, the number of reconstructive surgeries is generally lower during the summer months.
Revenues in the United States accounted for 65.9% and 64.9% of total revenues in the first six months of 2013 and 2012, respectively, and international revenues accounted for 34.1% and 35.1% of total revenues in the first six months of 2013 and 2012, respectively.
RESULTS OF OPERATIONS
Consolidated results of operations for the three- and six-month periods ended June 30, 2013 and 2012 were:
 
 
Three Months
 
Six Months
 
 
2013
2012
% Change
 
2013
2012
% Change
Net Sales
 
$
2,212

$
2,106

5.0

 
$
4,402

$
4,267

3.2

Gross profit
 
1,482
1,434
3.3

 
2,959
2,886
2.5

Research, development and engineering expenses
 
132

116
13.8

 
261
228
14.5

Selling, general and administrative expenses
 
1,015
823
23.3

 
1,931
1,642
17.6

Intangible asset amortization
 
36
31
16.1

 
68
62
9.7

Restructuring charges
 
9
19

(52.6
)
 
23
33

(30.3
)
Other income (expense)
 
(21)
(10)
110.0

 
(32)
(18)
77.8

Income taxes
 
56
110
(49.1
)
 
127
228
(44.3
)
Net earnings
 
$
213

$
325

(34.5
)
 
$
517

$
675

(23.4
)
Diluted net earnings per share
 
$
0.56

$
0.85

(34.1
)
 
$
1.35

$
1.76

(23.3
)


11
 
Dollar amounts in millions except per share amounts or as otherwise specified



Geographic and segment net sales for the three- and six-month periods ended June 30, 2013 and 2012 were:
 
 
 
 
Percentage Change
 
 
 
Percentage Change
 
 
 
 
2013/2012
 
 
 
2013/2012
 
 
Three Months
 
 
 
Constant
Currency
 
Six Months
 
 
 
Constant
Currency
 
 
2013
 
2012
 
Reported
 
 
2013
 
2012
 
Reported
 
Geographic sales:
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
United States
 
$
1,458

 
$
1,384

 
5.4
 
5.4
 
$
2,899

 
$
2,768

 
4.7
 
4.7
International
 
754

 
722

 
4.2
 
8.6
 
1,503

 
1,499

 
0.3
 
4.2
Total net sales
 
$
2,212

 
$
2,106

 
5.0
 
6.5
 
$
4,402

 
$
4,267

 
3.2
 
4.5
Segment sales:
 
 
 
 
 
 
 
 
 

 
 
 
 
 
 
Reconstructive
 
$
979

 
$
927

 
5.6
 
7.6
 
$
1,948

 
$
1,885

 
3.3
 
5.2
MedSurg
 
819

 
786

 
4.2
 
4.8
 
1,643

 
1,607

 
2.2
 
2.8
Neurotechnology and Spine
 
414

 
393

 
5.4
 
7.5
 
811

 
775

 
4.7
 
6.6
Total net sales
 
$
2,212

 
$
2,106

 
5.0
 
6.5
 
$
4,402

 
$
4,267

 
3.2
 
4.5
Net sales increased 5.0% for the three-month period ended June 30, 2013 from 2012. Net sales grew 7.8% as a result of increased unit volume and changes in product mix and 0.6% due to acquisitions. Net sales were unfavorably impacted by 1.9% due to changes in price and 1.5% due to the unfavorable impact of foreign currency exchange rates on net sales. In constant currency, net sales increased by 6.5%. The increase was primarily due to higher shipments of trauma and extremities products, medical products, knees and hips.
Net sales increased 3.2% for the six-month period ended June 30, 2013 from 2012. Net sales grew 5.8% as a result of increased unit volume and changes in product mix and 0.4% due to acquisitions. Net sales were unfavorably impacted by 1.6% due to changes in price and 1.4% due to the unfavorable impact of foreign currency exchange rates on net sales. In constant currency, net sales increased by 4.5%. The increase was primarily due to higher shipments of trauma and extremities products, neurotechnology, and medical products; these gains were partially offset by slowness in the European markets, pricing impacts for spine products as well as pricing in the Japanese markets.
Supplemental sales growth information for the three- and six-month periods ended June 30, 2013 and 2012:
 
Three Months
 
Six Months
 
 
 
% Change
 
 
 
% Change
 
 
 
 
 
U.S.
International
 
 
 
 
 
U.S.
International
 
2013
2012
As Reported
Constant Currency
As Reported
As Reported
Constant Currency
 
2013
2012
As Reported
Constant Currency
As Reported
As Reported
Constant Currency
Reconstructive
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Hips
$
319

$
308

3.5
6.0
6.0
0.6

5.9
 
$
627

$
620

1.1

3.4
4.8

(3.0
)
1.7
Knees
340

329

3.4
4.7
1.8
6.7

10.4
 
685

681

0.6

1.7
0.7

0.5

3.7
Trauma and Extremities
266

233

14.4
17.0
18.9
9.8

15.0
 
532

476

11.8

14.2
22.5

1.9

6.5
TOTAL RECONSTRUCTIVE
979

927

5.6
7.6
6.3
4.6

9.4
 
1,948

1,885

3.3

5.2
6.4

(0.7
)
3.5
MedSurg
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Instruments
315

314

0.4
1.4
1.1
(1.4
)
2.2
 
627

628

(0.1
)
0.8
(0.1
)
(0.2
)
3.2
Endoscopy
274

264

4.0
4.6
4.8
2.1

3.9
 
552

543

1.8

2.5
1.8

1.8

4.1
Medical
172

158

9.2
9.3
6.3
22.1

22.5
 
354

337

5.0

5.1
5.3

3.9

4.7
TOTAL MEDSURG
819

786

4.2
4.8
4.4
3.4

5.8
 
1,643

1,607

2.2

2.8
2.5

1.3

3.8
Neurotechnology and Spine
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Neurotechnology
227

212

6.9
9.6
9.6
3.1

9.5
 
448

413

8.5

11.0
11.9

3.8

9.8
Spine
187

181

3.8
5.0
2.7
6.6

11.0
 
363

362

0.4

1.6
1.4

(2.0
)
2.1
TOTAL NEUROTECHNOLOGY AND SPINE
414

393

5.4
7.5
6.0
4.4

10.1
 
811

775

4.7

6.6
6.4

1.6

6.9
Reconstructive net sales in the three-month period increased 5.6%, due to a 9.9% increase in unit volume and changes in product mix and 1.1% due to acquisitions. Net sales were unfavorably impacted by 3.4% due to changes in price and 2.0% due to the unfavorable impact of foreign currency exchange rates on net sales. In constant currency, net sales increased 7.6%, primarily due to increases in trauma and extremities products worldwide. For the six-month period, net sales increased 3.3%, due to a 7.5% increase in unit volume and changes in product mix and 0.6% due to acquisitions. Net sales were unfavorably impacted by 3.0% due to changes in price and 1.8% due to the unfavorable impact of foreign currency exchange rates on net sales. In constant currency, net sales in the six-month period increased 5.2%, primarily due to sales growth in trauma and extremities products as well as hips and knees.
MedSurg net sales in the three-month period increased 4.2% due to a 4.8% increase in unit volume and changes in product mix. Net sales were unfavorably impacted by 0.6% due to the impact of foreign currency exchange rates on net sales and 0.1% due to changes in price. In constant currency, net sales in the three-month period increased 4.2%, led by higher medical product shipments. Net sales in the six-month period increased 2.2% due to a 2.6% increase in unit volume and changes in product mix and favorable pricing

12
 
Dollar amounts in millions except per share amounts or as otherwise specified



impacts of 0.2%. Net sales were unfavorably impacted by 0.6% due to the impact of foreign currency exchange rates on net sales. In constant currency, net sales in the six-month period increased 2.8%, led by higher medical product shipments.
Neurotechnology and Spine net sales in the three-month period increased 5.4%, primarily due to an 8.8% increase in unit volume and changes in product mix and 0.8% due to acquisitions. Net sales were unfavorably impacted by 2.1% due to changes in price and 2.0% due to the unfavorable impact of foreign currency exchange rates on net sales. In constant currency, net sales in the three-month period increased 7.5%, with higher shipments of neurotechnology products offset by slowness in the spine markets. Net sales in the six-month period increased 4.7%, primarily due to a 8.2% increase in unit volume and changes in product mix and 0.5% due to acquisitions. Net sales were unfavorably impacted by 2.1% due to changes in price and 1.9% due to the unfavorable impact of foreign currency exchange rates on net sales. In constant currency, net sales in the six-month period increased 6.6%, with higher shipments of neurotechnology products offset by slowness in the spine markets.
Cost of Sales
Cost of sales increased 8.6% and 4.5% for the three- and six-month periods to 33.0% and 32.8% of sales, respectively, compared to 31.9% and 32.4% of sales for the three- and six-month periods, respectively, in 2012. Cost of sales increased 2.5% and 2.9% in the three- and six-month periods due to the impact of the Medical Device Excise Tax (MDET). Cost of sales also includes $8 and $3 for the three-month periods and $8 and $15 for the six-month periods of 2013 and 2012, respectively, related to inventory that was stepped up to fair value following acquisitions. Restructuring and restructuring-related costs of $7 and $0 were recorded in the three-month periods and $7 and $2 in the six-month periods of 2013 and 2012, respectively. Excluding the impact of the costs described above, cost of sales in the three-month period was 32.3% of sales compared to 31.8% in 2012 and in the six-month period was 32.4% of sales in 2013 as compared to 32.0% in 2012.
Research, Development and Engineering Expenses
Research, development and engineering expenses increased 13.8% to $132, representing 6.0% of sales in the three-month period, compared to 5.5% in 2012 and increased 14.5% to $261, representing 6.0% of sales in the six-month period, compared to 5.3% in 2012. The timing of projects for anticipated future products and continued investment in new technologies causes the spending level to vary by period as a percentage of sales.
Selling, General and Administrative Expenses
Selling, general and administrative expenses increased by 23.3% to $1,015, representing 45.9% of sales in the three-month period, compared to 39.1% in 2012. The three-month periods included $10 and $8 in 2013 and 2012, respectively, in acquisition and integration related charges; $12 and $19, respectively, in restructuring and restructuring-related charges; $170 in 2013 related to the previously disclosed voluntary recall of the Rejuvenate and ABG II modular-neck hip stems; and $19 and $33 in 2013 and 2012, respectively, related to two previously disclosed United States regulatory matters. Excluding the impact of these charges, selling, general and administrative expenses were 36.7% of sales in 2013 compared to 37.1% in 2012.
Selling, general and administrative expenses increased by 17.6% to $1,931, representing 43.9% of sales in the six-month period, compared to 38.5% in 2012. The six-month periods included $32 and $17 in 2013 and 2012, respectively, in acquisition and integration related charges; $26 and $33, respectively, in restructuring and restructuring-related charges; $210 in 2013 related to the Rejuvenate and ABG II matter; and $59 and $33 in 2013 and 2012, respectively, related to two previously disclosed United States regulatory matters. Excluding the impact of these charges, selling, general and administrative expenses were 37.0% of sales in 2013 compared to 37.3% in 2012.
Restructuring Charges
Restructuring charges totaling $10 and $19 in the three-month periods and $24 and $33 in the six-month periods, in 2013 and 2012, respectively, were related to the continuation of focused reductions of our global workforce and other restructuring activities that are expected to reduce our global workforce by approximately 5% and be substantially complete by the end of 2013 at a total cost of approximately $225. The actions were initiated in 2011 to provide efficiencies and realign resources in advance of the MDET, which began on January 1, 2013, as well as to allow for continued investment in strategic areas and drive growth.
Other Income (Expense)
Other expense in the three- and six-month periods increased $11 and $14, respectively, from 2012, primarily as a result of lower interest income on marketable securities.
Income Taxes
Our effective income tax rate on earnings in the three-month period was 20.8% compared to 25.3% in 2012; for the six-month period, our effective income tax rate was 19.7% compared to 25.2% in 2012. In January 2013 we recorded tax benefits of $13 pursuant to the American Taxpayer Relief Act of 2012 that was signed into law on January 2, 2013. These tax benefits related to the retroactive

13
 
Dollar amounts in millions except per share amounts or as otherwise specified



extension of numerous tax provisions, including an extension of the research tax credit and other provisions for companies with significant international operations.
Net Earnings
Net earnings in the three-month period decreased to $213 or $0.56 per diluted share compared to $325 or $0.85 per diluted share in 2012. Reported net earnings includes restructuring and restructuring-related charges of $10 and $12 in 2013 and 2012, respectively, and acquisition and integration related charges of $15 and $5 in 2013 and 2012, respectively. In addition, 2013 also includes $120 related to the previously disclosed voluntary recall of the Rejuvenate and ABG II modular-neck hip stems as well as $22 and $33 in 2013 and 2012, respectively, related to two previously disclosed United States regulatory matters. Excluding the impact of these items, adjusted net earnings in the three-month period increased 1.3% to $380 or $1.00 per diluted share. The impact of foreign currency exchange rates on net earnings reduced diluted net earnings per share by approximately $0.04.
Net earnings in the six-month period decreased to $517 or $1.35 per diluted share compared to $675 or $1.76 per diluted share in 2012. Reported net earnings includes restructuring and restructuring-related charges of $21 and $24 in 2013 and 2012, respectively, and acquisition and integration related charges of $32 and $22 in 2013 and 2012, respectively. In addition, 2013 also includes $152 related to the previously disclosed voluntary recall of the Rejuvenate and ABG II modular-neck hip stems as well as $52 and $33 in 2013 and 2012, respectively, related to two previously disclosed United States regulatory matters. Excluding the impact of these items, adjusted net earnings in the six-month period increased 2.7% to $774 or $2.03 per diluted share. The impact of foreign currency exchange rates on net earnings reduced diluted net earnings per share by approximately $0.06.
The following reconciles the non-GAAP financial measures of adjusted gross profit; adjusted selling, general and administrative expense; adjusted operating income; adjusted net earnings; adjusted effective tax rate; and adjusted diluted net earnings per share with the most directly comparable GAAP financial measures:
Three Months Ended June 30
Gross Profit
 
Selling, General and Administrative Expenses
 
Operating Income
 
Net Earnings
 
Effective Tax Rate
 
Diluted EPS
 
2013