SYK 10Q 6.30.2014


 

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, 2014

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: 378,582,992 shares of Common Stock, $0.10 par value, as of June 30, 2014.
 


STRYKER CORPORATION                                    2014 Second Quarter Form 10-Q

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
 
 
2014
 
2013
 
2014
 
2013
Net sales
 
$
2,363

 
$
2,212

 
$
4,668

 
$
4,402

Cost of sales
 
808

 
730

 
1,577

 
1,443

Gross profit
 
1,555

 
1,482

 
3,091

 
2,959

Research, development and engineering expenses
 
158

 
132

 
308

 
261

Selling, general and administrative expenses
 
1,148

 
1,015

 
2,353

 
1,931

Intangible asset amortization
 
47

 
36

 
92

 
68

Restructuring charges
 
5

 
9

 
10

 
23

Total operating expenses
 
1,358

 
1,192

 
2,763

 
2,283

Operating income
 
197

 
290

 
328

 
676

Other income (expense), net
 
(30
)
 
(21
)
 
(54
)
 
(32
)
Earnings before income taxes
 
167

 
269

 
274

 
644

Income taxes
 
39

 
56

 
76

 
127

Net earnings
 
$
128

 
$
213

 
$
198

 
$
517

 
 
 
 

 
 
 
 
Net earnings per share of common stock:
 
 
 
 
 
 
 
 
  Basic net earnings per share of common stock
 
$
0.34

 
$
0.56

 
$
0.52

 
$
1.36

  Diluted net earnings per share of common stock
 
$
0.33

 
$
0.56

 
$
0.51

 
$
1.35

 
 
 
 
 
 
 
 
 
Weighted-average shares outstanding—in millions:
 
 
 
 
 
 
 
 
Basic
 
378.8

 
378.0

 
378.5

 
378.8

Net effect of dilutive employee stock options
 
3.9

 
3.0

 
4.2

 
3.2

Diluted
 
382.7

 
381.0

 
382.7

 
382.0

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

 
2.1

 
2.5

 
2.2



CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME (Unaudited)
 
 
 
Three Months Ended June 30
 
Six Months Ended June 30
 
 
 
2014
 
2013
 
2014
 
2013
Net earnings
 
$
128

 
$
213

 
$
198

 
$
517

Other comprehensive income (loss), net of tax
 
 
 
 
 
 
 
 
 
Marketable Securities
 
4

 
(5
)
 
7

 
(6
)
 
Pension Plans
 
1

 
(1
)
 

 
2

 
Hedges
 
(9
)
 

 
(12
)
 

 
Financial Statement Translation
 
(33
)
 
20

 
4

 
(94
)
Total other comprehensive income (loss), net of tax
 
(37
)
 
14

 
(1
)
 
(98
)
Comprehensive income
 
$
91

 
$
227

 
$
197

 
$
419


See accompanying notes to Consolidated Financial Statements.

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

STRYKER CORPORATION                                    2014 Second Quarter Form 10-Q

Stryker Corporation and Subsidiaries

CONSOLIDATED BALANCE SHEETS (Unaudited)
 
 
June 30
 
December 31
 
2014
 
2013
ASSETS
 
 
 
 
Current assets
 
 
 
 
Cash and cash equivalents
 
$
1,319

 
$
1,339

Marketable securities
 
3,426

 
2,641

Accounts receivable, less allowance of $68 ($72 in 2013)
 
1,503

 
1,518

Inventories
 
 
 
 
Materials and supplies
 
254

 
227

Work in process
 
104

 
85

Finished goods
 
1,229

 
1,110

Total inventories
 
1,587

 
1,422

Deferred income taxes
 
941

 
880

Prepaid expenses and other current assets
 
605

 
535

Total current assets
 
9,381

 
8,335

Property, plant and equipment
 
 
 
 
Land, buildings and improvements
 
693

 
686

Machinery and equipment
 
1,933

 
1,811

Total property, plant and equipment
 
2,626

 
2,497

Less allowance for depreciation
 
1,499

 
1,416

Net property, plant and equipment
 
1,127

 
1,081

Other assets
 
 
 
 
Goodwill
 
4,101

 
3,844

Other intangibles, net
 
2,090

 
1,989

Other
 
530

 
494

Total assets
 
$
17,229

 
$
15,743

 
 
 
 
 
LIABILITIES AND SHAREHOLDERS' EQUITY
 
 
 
 
Current liabilities
 
 
 
 
Accounts payable
 
$
337

 
$
314

Accrued compensation
 
399

 
535

Income taxes
 
97

 
131

Dividend payable
 
116

 
115

Accrued recall expenses
 
1,354

 
772

Accrued expenses and other liabilities
 
780

 
765

Current maturities of debt
 
630

 
25

Total current liabilities
 
3,713

 
2,657

Long-term debt, excluding current maturities
 
3,237

 
2,739

Other liabilities
 
1,277

 
1,300

Shareholders' equity
 
 
 
 
Common stock, $0.10 par value:
 
 
 
 
  Authorized: 1 billion shares, outstanding: 378 million shares (378 million in 2013)
 
38

 
38

Additional paid-in capital
 
1,208

 
1,160

Retained earnings
 
7,525

 
7,617

Accumulated other comprehensive income
 
231

 
232

Total shareholders' equity
 
9,002

 
9,047

Total liabilities & shareholders' equity
 
$
17,229

 
$
15,743


See accompanying notes to Consolidated Financial Statements.


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

STRYKER CORPORATION                                    2014 Second Quarter Form 10-Q

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, 2013
 
$
38

 
$
1,160

 
$
7,617

 
$
232

 
$
9,047

Net earnings
 
 
 
 
 
198

 
 
 
198

Other comprehensive income (loss)
 
 
 
 
 
 
 
(1
)
 
(1
)
Issuance of 1.6 million shares of common stock under stock option and benefit plans, including $5 excess income tax benefit
 
 
 
9

 
 
 
 
 
9

Repurchase and retirement of 0.8 million shares of common stock
 
 
 
(2
)
 
(59
)
 
 
 
(61
)
Share-based compensation
 
 
 
41

 
 
 
 
 
41

Cash dividends declared of $0.61 per share of common stock
 
 
 
 
 
(231
)
 
 
 
(231
)
Balances at June 30, 2014
 
$
38

 
$
1,208

 
$
7,525

 
$
231

 
$
9,002


See accompanying notes to Consolidated Financial Statements.



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

STRYKER CORPORATION                                    2014 Second Quarter Form 10-Q


Stryker Corporation and Subsidiaries

CONSOLIDATED STATEMENTS OF CASH FLOWS (Unaudited)
 
 
Three Months Ended June 30
 
Six Months Ended June 30
 
 
2014
 
2013
 
2014
 
2013
Operating activities
 
 
 
 
 
 
 
 
Net earnings
 
$
128

 
$
213

 
$
198

 
$
517

Adjustments to reconcile net earnings to net cash provided by operating activities:
 
 
 
 
 
 
 
 
Depreciation
 
47

 
43

 
93

 
81

Amortization of intangible assets
 
47

 
36

 
92

 
68

Share-based compensation
 
20

 
18

 
41

 
38

Restructuring charges
 
5

 
10

 
10

 
24

Sale of inventory stepped up to fair value at acquisition
 
9

 
8

 
14

 
8

Recall accruals
 
252

 
187

 
582

 
227

Changes in operating assets and liabilities, net of effects of acquisitions:
 
 
 
 
 
 
 
 
Accounts receivable
 
(40
)
 
(18
)
 
53

 
(11
)
Inventories
 
(59
)
 
(25
)
 
(120
)
 
(63
)
Accounts payable
 
(19
)
 
(21
)
 
11

 
(30
)
Accrued expenses and other liabilities
 
57

 
82

 
(142
)
 
(70
)
Income taxes
 
(81
)
 
(141
)
 
(137
)
 
(150
)
Other
 

 
(36
)
 
(123
)
 
(47
)
Net cash provided by operating activities
 
366

 
356

 
572

 
592

 
 
 
 
 
 
 
 
 
Investing activities
 
 
 
 
 
 
 
 
Acquisitions, net of cash acquired
 
(185
)
 
(62
)
 
(457
)
 
(662
)
Purchases of marketable securities
 
(1,580
)
 
(1,843
)
 
(2,597
)
 
(2,616
)
Proceeds from sales of marketable securities
 
804

 
754

 
1,812

 
1,816

Purchases of property, plant and equipment
 
(54
)
 
(47
)
 
(124
)
 
(96
)
Net cash used in investing activities
 
(1,015
)
 
(1,198
)
 
(1,366
)
 
(1,558
)
 
 
 
 
 
 
 
 
 
Financing activities
 
 
 
 
 
 
 
 
Proceeds from borrowings
 
1,469

 
102

 
1,813

 
1,162

Payments on borrowings
 
(665
)
 
(100
)
 
(720
)
 
(151
)
Dividends paid
 
(116
)
 
(100
)
 
(231
)
 
(201
)
Repurchase and retirement of common stock
 
(60
)
 

 
(60
)
 
(250
)
Other
 
(40
)
 
5

 
(28
)
 
(2
)
Net cash provided by (used in) financing activities
 
588

 
(93
)
 
774

 
558

 
 
 
 
 
 
 
 
 
Effect of exchange rate changes on cash and cash equivalents
 
(1
)
 
(7
)
 

 
(16
)
Change in cash and cash equivalents
 
$
(62
)
 
$
(942
)
 
$
(20
)
 
$
(424
)


See accompanying notes to Consolidated Financial Statements.


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

STRYKER CORPORATION                                    2014 Second Quarter Form 10-Q

Stryker Corporation and Subsidiaries
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Unaudited)
June 30, 2014
NOTE 1 - BASIS OF PRESENTATION
General Information
These statements should be read in conjunction with our Annual Report on Form 10-K for the year ended December 31, 2013. Management believes that the accompanying unaudited Consolidated Financial Statements include all adjustments, including normal recurring items, considered necessary for a fair presentation of the interim periods. However, the results of operations included in such financial statements may not necessarily be indicative of annual results. Certain prior year amounts in our Segment Information in Note 11 have been reclassified to conform with the presentation used in 2014.
Recently Issued Accounting Pronouncements
No new accounting pronouncement issued or effective during the year had or is expected to have a material impact on the Consolidated Financial Statements.

NOTE 2 - SUBSEQUENT EVENT
Subsequent to the announcement of our second quarter 2014 operating results on July 17, 2014, we have updated our preliminary estimate of the probable loss to resolve the Rejuvenate and ABG II recall matter based on all information received to date which resulted in a $110 increase to the actuarially determined range of probable loss to resolve the matter to approximately $1,400 to $2,090 before third-party recoveries. Our results for the three months ended June 30, 2014 now include charges to earnings totaling $270, representing the excess of the $1,400 minimum of the range over the previously recorded reserves.


NOTE 3 - ACCUMULATED OTHER COMPREHENSIVE INCOME (AOCI)
Changes in and reclassifications out of AOCI in 2014 were as follows:
 
Marketable Securities
 
Pension Plans
 
Hedges
 
Financial Statement Translation
 
Total
 
Three Months
 
Six Months
 
Three Months
 
Six Months
 
Three Months
 
Six Months
 
Three Months
 
Six Months
 
Three Months
 
Six Months
Beginning balance
$
3

 
$

 
$
(82
)
 
$
(81
)
 
$
4

 
$
7

 
$
343

 
$
306

 
$
268

 
$
232

Other comprehensive income (OCI)
7

 
11

 

 
(3
)
 
(12
)
 
(16
)
 
(33
)
 
4

 
(38
)
 
(4
)
Income tax expense on OCI
(1
)
 
(1
)
 

 

 
5

 
7

 

 

 
4

 
6

Reclassifications out of AOCI into:


 


 


 


 


 


 


 


 


 


     Cost of sales

 

 
2

 
4

 

 

 

 

 
2

 
4

     Other (income) expense
(2
)
 
(4
)
 

 

 
(3
)
 
(5
)
 

 

 
(5
)
 
(9
)
     Income tax expense (benefit)

 
1

 
(1
)
 
(1
)
 
1

 
2

 

 

 

 
2

Total other comprehensive income
4

 
7

 
1

 

 
(9
)
 
(12
)
 
(33
)
 
4

 
(37
)
 
(1
)
Balance at June 30
$
7

 
$
7

 
$
(81
)
 
$
(81
)
 
$
(5
)
 
$
(5
)
 
$
310

 
$
310

 
$
231

 
$
231


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

STRYKER CORPORATION                                    2014 Second Quarter Form 10-Q

NOTE 4 - FAIR VALUE MEASUREMENTS
Our valuation of our assets and liabilities measured at fair value is: 
 
Total
 
Level 1
 
Level 2
 
Level 3
 
June
December 31
 
June
December 31
 
June
December 31
 
June
December 31
 
2014
2013
 
2014
2013
 
2014
2013
 
2014
2013
Cash and cash equivalents
$
1,319

$
1,339

 
$
1,319

$
1,339

 
$

$

 
$

$

Available-for-sale marketable securities
 
 
 
 
 
 
 
 
 
 
 
Corporate and asset-backed debt securities
1,529

1,177

 


 
1,529

1,177

 


Foreign government debt securities
898

845

 


 
898

845

 


United States agency debt securities
402

211

 


 
402

211

 


United States treasury debt securities
491

350

 


 
491

350

 


Certificates of deposit
101

53

 


 
101

53

 


Other
5

5

 


 
5

5

 


Total available-for-sale marketable securities
3,426

2,641

 


 
3,426

2,641

 


Trading marketable securities
77

72

 
77

72

 


 


Foreign currency exchange forward contracts
13

25

 


 
13

25

 


 
$
4,835

$
4,077

 
$
1,396

$
1,411

 
$
3,439

$
2,666

 
$

$

Liabilities:
 
 
 
 
 
 
 
 
 
 
 
Deferred compensation arrangements
$
77

$
72

 
$
77

$
72

 
$

$

 
$

$

Contingent consideration
 
 
 
 
 
 
 
 
 
 
 
     Beginning Balance
 
 
 
 
 
 
 
 
 
59

103

     Losses included in earnings
 
 
 
 
 
 
 
 
 

(5
)
     Settlements
 
 
 
 
 
 
 
 
 
(14
)
(39
)
     Balance at the end of the period
45

59

 


 


 
45

59

Foreign currency exchange forward contracts
13

2

 


 
13

2

 


 
$
135

$
133

 
$
77

$
72

 
$
13

$
2

 
$
45

$
59

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 taking into account our credit risk and that of our counterparties. The fair value of our Level 3 liabilities represent milestone payments for acquisitions and is calculated as the net present value of expected cash flows (using a discounted cash flow technique) based on externally provided or obtained inputs, including our probability assessments of the occurrence of triggering events, appropriately discounted considering the uncertainties associated with the obligation. We remeasure this liability each reporting period and record the changes in the fair value in general and administrative expense (for probability of occurrence) and other income (expense) (for changes in time value of money) in earnings. During the period we evaluated but did not change our unobservable input assumptions and fair value techniques used in measuring the fair value of any financial assets or liabilities from those disclosed in our Annual Report on Form 10-K for the year ended December 31, 2013. There were no significant transfers into or out of any levels that occurred between December 31, 2013 and June 30, 2014.

Summary of marketable securities:
Amortized Cost
 
Gross Unrealized Gains
 
Gross Unrealized Losses
 
Estimated Fair Value
 
June
December
 
June
December
 
June
December
 
June
December
 
2014
2013
 
2014
2013
 
2014
2013
 
2014
2013
Available-for-sale marketable securities:
 
 
 
 
 
 
 
 
 
 
 
  Corporate and asset-backed debt securities
$
1,526

$
1,177

 
$
3

$
1

 
$

$
(1
)
 
$
1,529

$
1,177

  Foreign government debt securities
894

846

 
4


 

(1
)
 
898

845

  United States agency debt securities
402

211

 


 


 
402

211

  United States treasury debt securities
490

350

 
1


 


 
491

350

  Certificates of deposit
101

53

 


 


 
101

53

  Other
5

5

 


 


 
5

5

Total available-for-sale marketable securities
$
3,418

$
2,642

 
$
8

$
1

 
$

$
(2
)
 
3,426

2,641

Trading marketable securities
 
 
 
 
 
 
 
 
 
77

72

Total marketable securities
 
 
 
 
 
 
 
 
 
$
3,503

$
2,713

Reported as:
 
 
 
 
 
 
 
 
 
 
 
  Current assets-marketable securities
 
 
 
 
 
 
 
 
 
$
3,426

$
2,641

  Noncurrent assets-other
 
 
 
 
 
 
 
 
 
77

72

 
 
 
 
 
 
 
 
 
 
$
3,503

$
2,713

The unrealized losses on available-for-sale marketable securities at June 30, 2014 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). 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; accordingly, we do not consider these investments to be other-than-temporarily impaired at June 30, 2014.

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

STRYKER CORPORATION                                    2014 Second Quarter Form 10-Q

The cost and estimated fair value of available-for-sale marketable securities at June 30, 2014 by contractual maturity are: 
 
 
Cost
 
Estimated
Fair Value
Due in one year or less
 
$
500

 
$
500

Due after one year through three years
 
284

 
285

Due after three years
 
2,634

 
2,641

 
 
$
3,418

 
$
3,426

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, 2014 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
92

99

 
3

3

 
33

33

 
81

81

 
209

216

Fair value
$
200

$
203

 
$
14

$
14

 
$
312

$
312

 
$
21

$
21

 
$
547

$
550

Unrealized losses
$

$

 
$

$

 
$

$

 
$

$

 
$

$

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 $6 for the three months ended June 30, 2014 and 2013, respectively, and $11 for both the six months ended June 30, 2014 and 2013 and is included in other income (expense).

NOTE 5 - DERIVATIVE INSTRUMENTS AND HEDGING STRATEGIES
We use operational and economic hedges as well as foreign currency exchange forward contracts to manage the impact of currency exchange on earnings and cash flow. During the period we did not change our hedging strategies or objectives from those disclosed in our Annual Report on Form 10-K for the year ended December 31, 2013. The gross notional and gross fair value amounts of foreign exchange forward contract derivatives designated and non-designated as hedging instruments are:
 
June 30, 2014
 
December 31, 2013
 
 
 
Fair Value
 
 
 
Fair Value
 
Gross Notional
 
Other Current Assets
 
Other Assets – Noncurrent
 
Other Current Liabilities
 
Other Liabilities – Noncurrent
 
Gross Notional
 
Other Current Assets
 
Other Assets – Noncurrent
 
Other Current Liabilities
 
Other Liabilities – Noncurrent
Designated
$
420

 
$
1

 
$

 
$
7

 
$
1

 
$
344

 
$
11

 
$
1

 
$
1

 
$

Non-designated
2,353

 
12

 

 
4

 
1

 
2,000

 
10

 
3

 
1

 

 
$
2,773

 
$
13

 
$

 
$
11

 
$
2

 
$
2,344

 
$
21

 
$
4

 
$
2

 
$

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. The maximum term of the forward currency exchange contracts at June 30, 2014 and December 31, 2013 was 546 days for each period.
The net currency exchange rate gains (losses) for the three months ended June 30, 2014 was $0 comprised of gains of $3 recorded in cost of goods sold and losses of ($3) recorded in other income (expense). The net currency exchange rate gains (losses) for the six months ended June 30, 2014 was ($4) comprised of gains of $5 recorded in cost of goods sold and losses of ($9) recorded in other income (expense). The net currency exchange rate losses for both the three and six months ended June 30, 2013 were ($3) and ($4), respectively. These total gains (losses) represent the net impact for both designated and non-designated derivative instruments.
At June 30, 2014 and December 31, 2013, pretax gains on derivatives designated as hedges of $6 and $12, which are recorded in AOCI, are expected to be reclassified to earnings during the next twelve months. This reclassification is primarily due to the sale of inventory that includes previously hedged purchases. There have been no ineffective portions of derivatives that have resulted in gains or losses in any period.
NOTE 6 - CONTINGENCIES AND COMMITMENTS
We are involved in various ongoing proceedings, legal actions and claims arising in the normal course of business, including proceedings related to product, labor, intellectual property, and
 
other matters. The outcomes of these matters will generally not be known for prolonged periods of time. 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


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

STRYKER CORPORATION                                    2014 Second Quarter Form 10-Q

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 loss, 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. The 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. We are currently self-insured for product liability-related claims and expenses. The ultimate cost to us with respect to product liability claims could be materially different than the amount of the current estimates and accruals and could have a material adverse effect on our financial position, results of operations and cash flows.

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. We have recorded charges totaling $80 related to this matter.

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. The ultimate total cost with respect to this matter will depend on many factors that are difficult to predict 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, the actuarially determined range of probable loss to resolve this matter is estimated to be approximately $1,400 to $2,090 before third-party insurance recoveries.  In the three months ended June 30, 2014, we recorded charges to earnings of $270 representing the excess of the $1,400 minimum of the range over the previously recorded reserves. No contingent gain for third-party insurance recoveries was recorded as of June 30, 2014. 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.
 

In 2010 we filed a lawsuit in federal court against Zimmer Holdings, Inc. (Zimmer), alleging that a Zimmer product infringed three of our patents. In rulings issued in August and September 2013, the trial judge upheld the February 2013 jury verdict in our favor, issued a permanent injunction barring Zimmer from making or selling infringing products, and ordered Zimmer to pay us at least $228. Zimmer is appealing this ruling and the ultimate resolution of this matter may differ materially. Accordingly, we have not recorded a contingent gain related to this matter.

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. We have entered into an agreement settling the first lawsuit, with terms as previously disclosed. 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 that are currently under reexamination by the United States Patent Office. With respect to the three remaining patents, all of which have now expired, the Court of Appeals for the Federal Circuit reversed the trial court's grant of summary judgment in our favor and remanded the matter to the trial court for further proceedings. The ultimate resolution of the entire second suit may have no relation to the resolution of the first suit and cannot be predicted; however, the result 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 and 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.

NOTE 7 - ACQUISITIONS
In June 2014 we announced our intention to acquire the assets of Small Bone Innovations, Inc. (SBi) in an all cash transaction for up to $375. The net cost to Stryker after taking into account the present value of the tax benefits as a result of the asset purchase structure will be up to $285. SBi products are designed and promoted for upper and lower extremity small bone indications, with a focus on small joint replacement. The transaction is subject to customary closing conditions including the expiration or termination of the Hart-Scott-Rodino Antitrust Improvements Act waiting period and is expected to close in the third quarter of 2014.


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

STRYKER CORPORATION                                    2014 Second Quarter Form 10-Q

The acquisition of SBi is expected to enhance our product offerings within our Reconstructive segment.
In April 2014 we completed the acquisition of Berchtold Holding, AG (Berchtold) for an aggregate purchase price of approximately $172, net of cash acquired. Berchtold, a privately held business with operating facilities in Germany and the United States, sells surgical infrastructure equipment including surgical tables, equipment booms and surgical lighting systems. The acquisition of Berchtold is expected to enhance our product offerings within our MedSurg segment. Intangible assets acquired with Berchtold will be amortized over a weighted-average life of 8 years.
In March 2014 we completed our acquisition of Patient Safety Technologies, Inc. (PST) for an aggregate purchase price of $120. PST conducts its business through its wholly owned subsidiary, SurgiCount Medical, Inc. PST’s proprietary Safety-Sponge® System and SurgiCount 360™ compliance software help prevent Retained Foreign Objects in the operating room. The acquisition of PST is expected to enhance our product offerings within our MedSurg segment. Intangible assets acquired with PST will be amortized over a weighted-average life of 14 years.
The acquired net assets of other business acquisitions completed in 2014, including the previously announced acquisition of Pivot Medical, Inc. are in the "Other" column in the table below.
In December 2013 we acquired MAKO Surgical Corp. (MAKO) for an aggregate purchase price of $1,679. The acquisition of MAKO, combined with our strong history in joint reconstruction, capital equipment (operating room integration and surgical navigation) and surgical instruments, will help further advance the growth of robotic arm assisted surgery. Our combined expertise offers the potential to simplify joint reconstruction procedures, reduce variability and enhance the surgeon and patient experience. The acquisition of MAKO enhances our product offerings within our Reconstructive segment. Intangible assets acquired with MAKO will be amortized over a weighted-average life of 9 years, except for the trade name that is deemed to have an indefinite life. In-process research and development (IPRD) is considered to be an indefinite-lived intangible asset until such time as the research is completed (at which time it becomes a determinable-lived intangible asset) or determined to have no future use (at which time it is impaired).
The purchase price allocations for Berchtold, PST, MAKO and other smaller acquisitions are based upon preliminary valuations, and our estimates and assumptions are subject to change within the measurement period as the valuations are finalized. We are in the process of verifying data and finalizing information related to these acquisitions to finalize the recording of identifiable intangible assets, deferred income taxes and the corresponding effect on the value of goodwill.
 
The allocation of the purchase prices of each acquisition to the acquired net assets is as follows:
 
 
2014
 
2014
 
2014
 
2013
 
 
Berchtold
 
PST
 
Other
 
MAKO
Purchase price paid
 
$
172

 
$
120

 
$
148

 
$
1,679

Tangible assets acquired:
 
 
 
 
 
 
 
 
Inventory
 
22

 
7

 
5

 
50

Other assets
 
38

 
19

 
25

 
174

Liabilities
 
(45
)
 
(33
)
 
(32
)
 
(277
)
Intangible assets:
 
 
 
 
 
 
 
 
Customer relationship
 
11

 
33

 
4

 
91

 Trade name
 
7

 

 

 
24

Developed technology & patents
 
32

 
26

 
70

 
231

IPRD
 

 

 
2

 
169

Goodwill
 
107

 
68

 
74

 
1,217

 
 
$
172

 
$
120

 
$
148

 
$
1,679

NOTE 8 - LONG-TERM DEBT AND CREDIT FACILITIES
Our debt is as follows:
 
 
 
 
June 30
 
December 31
 
 
 
 
2014
 
2013
Senior unsecured notes:
 
 
 
 
 
Rate
Due
 
 
 
 
 
3.00%
January 15, 2015
 
$
500

 
$
500

 
2.00%
September 30, 2016
 
749

 
749

 
1.30%
April 1, 2018
 
598

 
598

 
4.375%
January 15, 2020
 
498

 
498

 
3.375%
May 15, 2024
 
595

 

 
4.10%
April 1, 2043
 
394

 
394

 
4.375%
May 15, 2044
 
398

 

Commercial paper
 
100

 

Other
 
35

 
25

 
Total debt
 
3,867

 
2,764

 
Less current maturities
 
(630
)
 
(25
)
 
Total long-term debt
 
$
3,237

 
$
2,739

During 2014 we issued commercial paper under the commercial paper program we established in July 2011. The program allows us to have a maximum of $500 in commercial paper outstanding, with maturities up to 397 days from the date of issuance. As of June 30, 2014, outstanding commercial paper totaled $100, the weighted average original maturity of the commercial paper outstanding was approximately 79 days and the weighted average interest rate was 0.27%.
In May 2014 we sold $600 in senior unsecured notes due 2024 (2024 Notes) and $400 of senior unsecured notes due 2044 (2044 Notes). The 2024 Notes will bear interest at 3.375% per year and, unless previously redeemed, will mature on May 15, 2024. The 2044 Notes will bear interest at 4.375% per year and, unless previously redeemed, will mature on May 15, 2044.
Certain of our credit facilities require us to comply with financial and other covenants. We were in compliance with all covenants at June 30, 2014. We have lines of credit, issued by various financial institutions, available to fund our day-to-day operating needs. At June 30, 2014, we had $949 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, 2014.


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

STRYKER CORPORATION                                    2014 Second Quarter Form 10-Q

At June 30, 2014, the total unamortized debt issuance costs incurred in connection with our outstanding notes were $23. The fair value of long-term debt (including current maturities) at June 30, 2014 and December 31, 2013 was $3,795 and $2,790, respectively, based on the quoted interest rates for similar types and amounts of borrowing agreements.
NOTE 9 - CAPITAL STOCK
In April 2014 we declared a quarterly dividend of $0.305 per share, payable July 31, 2014 to shareholders of record at the close of business on June 30, 2014. In July 2014 we declared a quarterly dividend of $0.305 per share payable October 31, 2014 to shareholders of record at the close of business on September 30, 2014.

In December of 2012 and 2011, we announced that our Board of Directors had authorized us to purchase up to $405 and $500, respectively, of our common stock (the 2012 and 2011 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 2014 we have repurchased 0.8 million shares at a cost of $60 under the 2011 Repurchase Program. As of June 30, 2014, the
 
maximum dollar value of shares that may yet be purchased under the 2011 Repurchase Program was $218 and we had not made any repurchases pursuant to the 2012 Repurchase Program. At June 30, 2014, the maximum dollar value of shares that may be purchased under the authorized Repurchase Programs was $623.

NOTE 10 - RESTRUCTURING CHARGES
In recent years, we have incurred an ongoing annual level of restructuring-type activities to maintain a competitive cost structure, including manufacturing and workforce optimization. The costs incurred under the ongoing program have generally ranged from $50 to $75 annually. The productivity and cost savings plan was designed to accelerate cost reductions by streamlining management decision making, manufacturing and other work processes to help fund our growth strategy.
A rollforward of our restructuring liability balance is as follows: 
 
 
Total
 
Severance and Related Costs
 
Contractual Obligations and Other
January 1 Balance
 
$
20

 
$
10

 
$
10

Charges to earnings
 
10

 
4

 
6

Cash paid
 
(15
)
 
(8
)
 
(7
)
June 30 Balance
 
$
15

 
$
6

 
$
9



NOTE 11 - SEGMENT INFORMATION
Net sales and net earnings by business segment are as follows:
 
Reconstructive
 
MedSurg
 
Neurotechnology and Spine
 
Total
 
Three Months
 
Six Months
 
Three Months
 
Six Months
 
Three Months
 
Six Months
 
Three Months
 
Six Months
 
2014
2013
 
2014
2013
 
2014
2013
 
2014
2013
 
2014
2013
 
2014
2013
 
2014
2013
 
2014
2013
Net sales
$
1,028

$
966

 
$
2,027

$
1,922

 
$
905

$
832

 
$
1,791

$
1,669

 
$
430

$
414

 
$
850

$
811

 
$
2,363

$
2,212

 
$
4,668

$
4,402

Segment net earnings
228

231

 
477

465

 
151

161

 
296

322

 
79

73

 
165

151

 
$
458

$
465

 
$
938

$
938

Less: other (net of income taxes)
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Other
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
(43
)
(59
)
 
(119
)
(115
)
Acquisition and integration related charges
 
 
 
 
 
 
 
 
 
 
 
 
(17
)
(15
)
 
(30
)
(32
)
Amortization of intangible assets
 
 
 
 
 
 
 
 
 
 
 
 
 
 
(33
)
(26
)
 
(64
)
(49
)
Restructuring and related charges
 
 
 
 
 
 
 
 
 
 
 
 
 
 
(20
)
(10
)
 
(30
)
(21
)
Recall charges
 
 
 
 
 
 
 
 
 
 
 
 
 
 
(217
)
(120
)
 
(489
)
(152
)
Regulatory matter charges
 
 
 
 
 
 
 
 
 
 
 
 
 
 

(22
)
 

(52
)
Tax matters
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 


 
(8
)

Net earnings
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
$
128

$
213

 
$
198

$
517

Other than assets associated with the acquisitions that are discussed in greater detail in Note 7, 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, 2013.
ITEM 2.
MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS.
ABOUT STRYKER
Stryker is one of the world's leading medical technology companies, with 2013 revenues of $9,021 and net earnings of $1,006. We are dedicated to helping healthcare professionals perform their jobs more efficiently while enhancing patient care. We offer a diverse array

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



of innovative medical technologies, including reconstructive, medical and surgical, and neurotechnology and spine products, to help people lead more active and more satisfying lives.
We segregate our operations into three reportable business segments: Reconstructive, MedSurg, and Neurotechnology and Spine. The Reconstructive segment includes orthopaedic reconstructive (hip and knee) and trauma implant systems as well as other related products. The MedSurg segment includes surgical equipment and surgical navigation systems (Instruments); endoscopic and communications systems (Endoscopy); patient handling and emergency medical equipment (Medical); and other related products. The Neurotechnology and Spine segment includes neurovascular products, spinal implant systems and other related products.
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 and sales of capital equipment are generally stronger in the fourth quarter.
Revenues in the United States accounted for 66.7% and 65.9% of total revenues in the first six months of 2014 and 2013, respectively, and international revenues accounted for 33.3% and 34.1% of total revenues in the first six months of 2014 and 2013, respectively.
Subsequent to the announcement of our second quarter 2014 operating results on July 17, 2014, we have updated our preliminary estimate of the probable loss to resolve the Rejuvenate and ABG II recall matter based on all information received to date which
resulted in a $110 increase to the actuarially determined range of probable loss to resolve the matter to approximately $1,400 to $2,090 before third-party recoveries. Our results for the three months ended June 30, 2014 now include charges to earnings totaling $270, representing the excess of the $1,400 minimum of the range over the previously recorded reserves.

In June 2014 we announced our intention to acquire assets of Small Bone Innovations, Inc. (SBi) in an all cash transaction for up to $375. The net cost to Stryker after taking into account the present value of the tax benefits as a result of the asset purchase structure will be up to $285. SBi products are designed and promoted for upper and lower extremity small bone indications, with a focus on small joint replacement. The transaction is subject to customary closing conditions including the expiration or termination of the Hart-Scott-Rodino Antitrust Improvements Act waiting period and is expected to close in the third quarter of 2014.

In April 2014 we completed the acquisition of Berchtold Holding, AG (Berchtold), a privately-held business with operations in Germany and the United States, for an aggregate purchase price of approximately $172. Berchtold sells surgical infrastructure equipment. In March 2014 we completed our acquisition of Patient Safety Technologies, Inc. (PST), for an aggregate purchase price of $120. PST conducts its business through its wholly owned subsidiary, SurgiCount Medical, Inc. PST’s proprietary Safety-Sponge® System and SurgiCount 360™ compliance software help prevent Retained Foreign Objects in the operating room. Other business acquisitions completed in the six months ended June 30, 2014 include the acquisition of Pivot Medical, Inc (Pivot).



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

STRYKER CORPORATION                                    2014 Second Quarter Form 10-Q


RESULTS OF OPERATIONS
Consolidated results of operations for the three and six months ended June 30, 2014 and 2013 were:
 
 
Three Months
 
Six Months
 
 
2014
2013
% Change
 
2014
2013
% Change
Net Sales
 
$
2,363

$
2,212

6.8

 
$
4,668

$
4,402

6.0

Gross profit
 
1,555
1,482
4.9

 
3,091
2,959
4.5

Research, development and engineering expenses
 
158

132
19.7

 
308
261
18.0

Selling, general and administrative expenses
 
1,148
1,015
13.1

 
2,353
1,931
21.9

Amortization of intangible assets
 
47
36
30.6

 
92
68
35.3

Restructuring charges
 
5
9

(44.4
)
 
10
23

(56.5
)
Other income (expense)
 
(30)
(21)
42.9

 
(54)
(32)
68.8

Income taxes
 
39
56
(30.4
)
 
76
127
(40.2
)
Net earnings
 
$
128

$
213

(39.9
)
 
$
198

$
517

(61.7
)
Diluted net earnings per share
 
$
0.33

$
0.56

(41.1
)
 
$
0.51

$
1.35

(62.2
)
Geographic and segment net sales were:
 
 
 
 
Percentage Change
 
 
 
Percentage Change
 
 
Three Months
 
 
 
Constant
Currency
 
Six Months
 
 
 
Constant
Currency
 
 
2014
 
2013
 
Reported
 
 
2014
 
2013
 
Reported
 
Geographic sales:
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
United States
 
$
1,569

 
$
1,458

 
7.6
 
7.6
 
$
3,111

 
$
2,899

 
7.3
 
7.3
International
 
794

 
754

 
5.4
 
5.4
 
1,557

 
1,503

 
3.6
 
5.3
Total net sales
 
$
2,363

 
$
2,212

 
6.8
 
6.9
 
$
4,668

 
$
4,402

 
6.1
 
6.7
Segment sales:
 
 
 
 
 
 
 
 
 

 
 
 
 
 
 
Reconstructive
 
$
1,028

 
$
966

 
6.5
 
6.3
 
$
2,027

 
$
1,922

 
5.5
 
6.1
MedSurg
 
905

 
832

 
8.8
 
9.0
 
1,791

 
1,669

 
7.3
 
7.9
Neurotechnology and Spine
 
430

 
414

 
3.8
 
3.9
 
850

 
811

 
4.8
 
5.4
Total net sales
 
$
2,363

 
$
2,212

 
6.8
 
6.9
 
$
4,668

 
$
4,402

 
6.1
 
6.7
Net sales increased 6.8% for the three-month period ended June 30, 2014 from 2013. Net sales grew 6.8% as a result of increased unit volume and changes in product mix and 2.1% due to acquisitions. Net sales were unfavorably impacted by 2.0% due to changes in price. and 0.1% due to the unfavorable impact of foreign currency exchange rates. Excluding the impact of acquisitions, net sales increased by 4.8% in constant currency. The increase was primarily due to higher shipments of trauma and extremities products, neurotechnology products, instruments and endoscopy products.
Net sales increased 6.1% for the six-month period ended June 30, 2014 from 2013. Net sales grew 6.8% as a result of increased unit volume and changes in product mix and 1.8% due to acquisitions. Net sales were unfavorably impacted by 1.9% due to changes in price and 0.6% due to the unfavorable impact of foreign currency exchange rates on net sales. Excluding the impact of acquisitions, net sales increased by 4.9% in constant currency. The increase was primarily due to higher shipments of trauma and extremities products, neurotechnology products, instruments and endoscopy products.
Supplemental sales growth information:
 
Three Months
 
Six Months
 
 
 
% Change
 
 
 
% Change
 
 
 
 
 
U.S.
International
 
 
 
 
 
U.S.
International
 
2014
2013
As Reported
Constant Currency
As Reported
As Reported
Constant Currency
 
2014
2013
As Reported
Constant Currency
As Reported
As Reported
Constant Currency
Knees
$
350

$
340

2.7

2.7

7.1

(5.6
)
(5.6
)
 
$
698

$
685

1.9

2.5

5.7

(5.5
)
(3.7
)
Hips
326

319

2.3

2.2

6.3

(2.6
)
(2.7
)
 
644

627

2.7

3.5

6.1

(1.5
)
0.5

Trauma and Extremities
298

266

11.8

11.3

13.2

10.3

9.2

 
586

532

10.1

10.3

12.4

7.6

8.1

RECONSTRUCTIVE
1,028

966

6.5

6.3

10.7

0.5

0.2

 
2,027

1,922

5.5

6.1

9.3


1.5

Instruments
340

315

7.6

7.5

7.0

9.4

8.9

 
683

627

8.9

9.2

9.8

6.3

7.7

Endoscopy
336

287

17.3

17.6

16.8

18.5

19.7

 
648

578

12.1

12.8

11.3

13.9

16.5

Medical