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SYK > SEC Filings for SYK > Form 10-K on 13-Feb-2014All Recent SEC Filings

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Form 10-K for STRYKER CORP


13-Feb-2014

Annual Report


ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS.

NON-GAAP FINANCIAL MEASURES
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; percentage organic sales growth; adjusted gross profit; adjusted selling, general and administrative expenses; adjusted operating income; adjusted other income (expense); adjusted effective income tax rate; adjusted net earnings; and adjusted diluted net earnings per share. 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 percentage organic sales growth, we remove the impact of changes in foreign currency exchange rates and acquisitions that affect the comparability and trend of sales. Percentage organic sales growth is calculated by translating current year results at prior year average foreign currency exchange rates excluding the impact of acquisitions. 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, selling, general and administrative expenses, operating income, other income/(expense), 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 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 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. In general, we maintain separate 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 implant surgeries is generally lower during the summer months and sales of capital equipment are generally higher in the fourth quarter. Recent Business Developments
In December 2013 we announced our intent to acquire Patient Safety Technologies, Inc. (PST), for an aggregate purchase price of $120. PST conducts its business through its wholly owned subsidiary, SurgiCount Medical, Inc. Its proprietary Safety-Sponge® System and SurgiCount 360™ compliance software help prevent Retained Foreign Objects in the operating room. The System includes bar-coded surgical sponges and towels, an integrated bar-code scanner, and compliance tracking software. The transaction is subject to customary closing conditions and is expected to close in the first quarter of 2014.
In December 2013 we acquired MAKO Surgical Corp. (MAKO) for an aggregate purchase price of approximately $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.
In April 2013 William R. Jellison was named our Vice President and Chief Financial Officer. Mr. Jellison replaced Dean Bergy who was our Interim Chief Financial Officer.
In March 2013 we sold $600 of senior unsecured notes due 2018 (the 2018 Notes) and $400 of senior unsecured notes due 2043 (the 2043 Notes). The 2018 Notes bear interest at 1.3% per year and, unless previously redeemed, will mature in April 1, 2018. The 2043 Notes bear interest at 4.1% per year and, unless previously redeemed, will mature on April 1, 2043. We intend to use the net proceeds from the offering for working capital and other general

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


corporate purposes, including acquisitions, stock repurchases and other business opportunities.
In March 2013 we acquired Trauson Holdings Company Limited for a total consideration of $751. With this acquisition we expanded our presence in a key emerging market with a product portfolio

and pipeline that is targeted at the large and fast growing value segment of the Chinese orthopaedic market.
In 2013 we recorded charges for the Rejuvenate, ABG II and Neptune recalls of $460, net of tax, and other matters that are discussed more fully in Results of Operations below.

RESULTS OF OPERATIONS

Consolidated results of operations:                                      Percentage Change
                                       2013       2012       2011       2013/2012  2012/2011
Net Sales                               $9,021     $8,657     $8,307        4.2         4.2
Gross Profit                             6,044      5,876      5,496        2.9         6.9
Research, development & engineering
expenses                                   536        471        462       13.8         1.9
Selling, general & administrative
expenses                                 4,066      3,466      3,150       17.3        10.0
Intangibles amortization                   138        123        122       12.2         0.8
Restructuring charges                     48         75         76        (36.0 )      (1.3 )
Other income (expense)                    (44)       (36)        -         22.2           -
Income taxes                               206        407        341      (49.4 )      19.4
Net Earnings                            $1,006     $1,298     $1,345      (22.5 )      (3.5 )
Diluted Net Earnings per share           $2.63      $3.39      $3.45      (22.4 )      (1.7 )


Geographic and segment net sales:                                                       Percentage Change
                                                                                 2013/2012             2012/2011
                                            Year Ended December 31                     Constant               Constant
                                         2013         2012        2011      Reported   Currency   Reported    Currency
Geographic sales:
United States                         $   5,984     $ 5,658     $ 5,269          5.8        5.8       7.4          7.4
International                             3,037       2,999       3,038          1.3        6.0      (1.3 )        1.9
Total net sales                       $   9,021     $ 8,657     $ 8,307          4.2        5.9       4.2          5.4
Segment sales:
Reconstructive                        $   4,004     $ 3,823     $ 3,710          4.8        6.9       3.1          4.4
MedSurg                                   3,359       3,265       3,160          2.9        3.8       3.3          4.2
Neurotechnology and Spine                 1,658       1,569       1,437          5.6        7.7       9.2         10.5
Total net sales                       $   9,021     $ 8,657     $ 8,307          4.2        5.9       4.2          5.4

Net sales increased 4.2% in 2013 after increasing 4.2% in 2012. In 2013 net sales grew by 6.5% as a result of increased unit volume and changes in product mix and 0.8% due to acquisitions and were negatively impacted by 1.4% due to changes in price and 1.6% due to the unfavorable impact of foreign currency exchange rates on net sales. Excluding the impact of acquisitions, net sales increased 5.1% in constant currency. Net sales in 2012 increased 5.6% as a result of unit volume and changes in product mix and 1.2% due to acquisitions and were negatively impacted by 1.4% due to changes in price and 1.2% due to the unfavorable impact of foreign currency exchange rates on net sales. Excluding the impact of acquisitions, 2012 net sales increased 4.2% in constant currency.

Net sales in 2013 increased primarily due to higher shipments of trauma and extremities products, neurotechnology products, hips and endoscopy products. Net sales in 2012 increased primarily due to higher shipments of neurotechnology products, instruments products, trauma and extremities products, spine products and reprocessed and remanufactured medical devices; these gains were partially offset by slowness in the European markets. In the United States net sales increased 5.8% in 2013 after increasing 7.4% in 2012. In constant currency, International sales increased 6.0% in 2013 after increasing 1.9% in 2012.

Supplemental geographical sales growth information

                                                    Year Ended December 31, 2013                                                            Year Ended December 31, 2012
                                                                  Percentage Change                                                                      Percentage Change
                                                                        U.S.            International                                                          U.S.             International
                                                         Constant                                 Constant                                     Constant                                  Constant
                          2013    2012    As Reported    Currency    As Reported   As Reported    Currency      2012    2011    As Reported    Currency     As Reported   As Reported    Currency
Reconstructive
Knees                    1,371   1,356         1.1 %       2.6 %          3.4 %      (3.3 )%        1.1 %      1,356   1,316        3.0  %      4.0  %          6.0  %       (2.4 )%      0.4  %
Hips                     1,272   1,233         3.2 %       6.0 %          7.2 %      (1.4 )%        4.5 %      1,233   1,228        0.4  %      1.5  %          5.2  %       (4.5 )%     (2.3 )%
Trauma and Extremities   1,116     989        12.8 %      15.1 %         18.4 %       7.2  %       11.8 %        989     931        6.2  %      8.4  %         18.0  %       (3.5 )%      0.4  %
TOTAL RECONSTRUCTIVE     4,004   3,823         4.8 %       6.9 %          7.9 %       0.5  %        5.5 %      3,823   3,710        3.1  %      4.4  %          9.2  %       (4.3 )%     (1.4 )%
MedSurg
Instruments              1,269   1,261         0.6 %       1.9 %          0.7 %       0.6  %        5.1 %      1,261   1,187        6.2  %      7.3  %          9.1  %       (0.4 )%      3.1  %
Endoscopy                1,167   1,111         5.0 %       6.0 %          6.6 %       1.3  %        4.6 %      1,111   1,080        2.9  %      3.9  %          2.6  %        3.7  %      7.1  %
Medical                    710     691         2.8 %       3.1 %          3.4 %       0.3  %        2.0 %        691     722       (4.3 )%     (3.7 )%         (7.8 )%       11.1  %     14.8  %
TOTAL MEDSURG            3,359   3,265         2.9 %       3.8 %          3.6 %       0.8  %        4.3 %      3,265   3,160        3.3  %      4.2  %          3.4  %        3.0  %      6.5  %
Neurotechnology and
Spine
Neurotechnology            915     842         8.7 %      11.4 %         11.2 %       5.1  %       11.8 %        842     750       12.3  %     13.9  %         19.0  %        3.9  %      7.6  %
Spine                      743     727         2.1 %       3.4 %          1.8 %       2.9  %        7.2 %        727     687        5.8  %      6.9  %          9.2  %       (1.7 )%      1.7  %
TOTAL NEUROTECHNOLOGY
AND SPINE                1,658   1,569         5.6 %       7.7 %          6.4 %       4.3  %       10.0 %      1,569   1,437        9.2  %     10.5  %         13.8  %        1.7  %      5.3  %

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


Reconstructive Net Sales
Reconstructive net sales in 2013 increased 4.8%, primarily due to a 7.9% increase in unit volume and changes in product mix and 1.4% due to acquisitions. Net sales were negatively impacted by 2.4% due to changes in price and 2.1% due to the unfavorable impact of foreign currency exchange rates on net sales. Excluding the impact of acquisitions, net sales increased by 5.5% in constant currency in 2013, primarily due to increases in trauma and extremities products and hips. Net sales in 2012 increased 3.1%, primarily due to a 5.6% increase in unit volume and changes in product mix and 0.9% due to acquisitions. Net sales were negatively impacted by 2.2% due to changes in price and 1.3% due to the unfavorable impact of foreign currency exchange rates on net sales. In constant currency, net sales increased by 4.4% in 2012, primarily due to increases in trauma and extremities products and market share gains partially due to a competitor's product recall, partially offset by slowness in the European markets.
MedSurg Net Sales
MedSurg net sales in 2013 increased 2.9%, primarily due to a 3.8% increase in unit volume and changes in product mix and were negatively impacted by 0.9% due to the unfavorable impact of foreign currency exchange rates on net sales. The effect of pricing was not significant. In constant currency, net sales in 2013 increased 3.8%, led by higher shipments of endoscopy products. Net sales in 2012 increased 3.3%, primarily due to a 4.1% increase in unit volume and changes in product mix and 0.1% due to acquisitions, and were negatively impacted by 0.1% due to changes in price and 0.9% due to the unfavorable impact of foreign currency exchange rates on net sales. In constant currency, net sales in 2012 increased 4.2%, led by higher shipments of instruments products and reprocessed and remanufactured medical devices; these higher shipments were partially offset by challenging global market conditions for capital equipment. Neurotechnology and Spine Net Sales
Neurotechnology and Spine net sales in 2013 increased 5.6%, primarily due to an 8.8% increase in unit volume and changes in product mix and 0.9% due to acquisitions, and were negatively impacted by 2.0% due to changes in price and 2.1% due to the unfavorable impact of foreign currency exchange rates on net sales. Excluding the impact of acquisitions, net sales in 2013 increased 6.8% in constant currency, due to higher shipments of neurotechnology products. Net sales in 2012 increased 9.2%, primarily due to an 8.5% increase in unit volume and changes in product mix and 4.2% due to acquisitions, and were negatively impacted by 2.2% due to changes in price and 1.3% due to the unfavorable impact of foreign currency exchange rates on net sales. In constant currency net sales in 2012 increased 10.5%.
Consolidated Cost of Sales
Cost of sales increased 7.0% in 2013 to 33.0% of sales compared to 32.1% in 2012. The Medical Device Excise Tax was 0.9% of sales in the current year. Cost of sales as a percentage of sales was adversely impacted by changes in selling prices for our products and by the unfavorable effect of foreign currency exchange rates; these effects were offset by improvements in manufacturing productivity. Cost of sales in 2013 and 2012 includes an additional cost of $28 and $18, respectively, related to inventory that was

"stepped up" to fair value following acquisitions; $11 and $5, respectively in restructuring and restructuring related costs; and $7 in 2013 for disgorgement of profits associated with a legal settlement. Cost of sales decreased 1.1% in 2012 to 32.1% of sales compared to 33.8% in 2011. Cost of sales in 2012 and 2011 includes an additional cost of $18 and $143, respectively, related to inventory that was "stepped up" to fair value following acquisitions and $5 in 2012 in restructuring and related costs.
Research, Development and Engineering Expenses Research, development and engineering expenses represented 5.9% of sales in 2013 compared to 5.4% in 2012 and 5.6% in 2011. The increased spending level in 2013 was driven by the timing of projects and continued investment in new technologies. The spending level in 2012 decreased as a percentage of sales primarily due to the termination of all development of the OP-1 molecule in late 2011.
Selling, General and Administrative Expenses Selling, general and administrative expenses increased 17.3% in 2013 and represented 45.1% of sales compared to 40.0% in 2012 and 37.9% in 2011. These expenses included $70 and $37 in 2013 and 2012, respectively, of acquisition and integration related charges; $622 and $174, respectively, related to the Rejuvenate, ABG II and Neptune recalls; $62 and $33 in 2013 and 2012, respectively, related to regulatory and legal matters; $25 in 2013 representing a donation to an educational institution and $4 in 2013 in restructuring related charges. Excluding the impact of these charges, selling, general and administrative expenses were 36.4% of sales in 2013 compared to 37.2% in 2012. In 2011 general and administrative expenses included the payment of an intellectual property infringement claim, offset by a favorable resolution of a value added tax issue.
Restructuring Charges
In 2013, 2012 and 2011 we recorded $50 ($2 in cost of sales and $48 in selling, general and administrative expense), $75 and $76, respectively, in restructuring charges related to focused reductions of our global workforce and other restructuring initiatives. The targeted reductions and other restructuring activities were initiated to provide efficiencies and realign resources as well as to allow for continued investment in strategic areas and drive growth. Other Income (Expense)
Other expense increased by $8 in 2013 after increasing by $36 in 2012. Net expense in 2013 increased due to lower income from interest and marketable securities, offset by hedge gains and lower interest expense. The decrease in interest expense was due to favorable tax audit resolutions in multiple jurisdictions that resulted in interest expense credits, partially offset by higher interest expense on borrowings. The increase in 2012 was primarily due to reductions of accrued interest expense in 2011 resulting from settlements reached with the United States Internal Revenue Service (IRS).
In 2011 we reached a favorable settlement regarding an IRS proposed adjustment to our previously filed 2003 through 2007 income tax returns related to the income tax positions we had taken for our Irish cost sharing arrangements. We also reached a settlement with the IRS with respect to the allocation of income

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


with a wholly owned subsidiary operating in Puerto Rico for the years 2006 through 2009. The higher interest expense in 2012 due to the effect of the 2011 tax settlements was partially offset by higher interest income on our investments, due to higher cash and cash equivalents and marketable securities balances compared to 2011.
Income Taxes
Our effective income tax rate on earnings was 17.0%, 23.9% and 20.2% in 2013, 2012 and 2011, respectively. The effective income tax rate for 2013 includes income tax benefits relating to favorable audit resolutions in multiple jurisdictions. The effective income tax rate for 2012 includes the net impact of effective settlement of all tax matters through 2004 relating to two German subsidiaries, and adjustment of the estimate of foreign tax credits to the amount shown on the tax return as filed. The effective income tax rate for 2011 includes the net impact of the settlements with the IRS as described above. The American Taxpayer Relief Act of 2012 (the Act) was signed on January 2, 2013. The Act provided numerous tax provisions for corporations including an extension of the research tax credit and an extension of certain provisions for companies with significant international operations. The provisions originally expired at

December 31, 2011 but were retroactively extended through December 31, 2013. In 2013 we recorded tax benefits of $13 related to the 2012 research tax credit and other provision of the Act.
Net Earnings
Net earnings in 2013 decreased 22.5% to $1,006. Basic net earnings per share in 2013 decreased 22.0% to $2.66, and diluted net earnings per share in 2013 decreased 22.4% to $2.63. Net earnings in 2012 decreased 3.5% to $1,298. Basic net earnings per share in 2012 decreased 2.0% to $3.41, and diluted net earnings per share in 2012 decreased 1.7% to $3.39.
Reported net earnings in 2013 includes charges for the Rejuvenate, ABG II and Neptune recalls, acquisition and integration related charges related to the Neurovascular, Surpass, Trauson and MAKO acquisitions, additional cost of sales for inventory sold that was "stepped up" to fair value related to the Trauson and MAKO acquisitions, restructuring and related charges, certain charges related to legal and regulatory matters, a donation to an educational institution and benefits associated with the resolution of certain tax matters. Excluding the impact of these items, adjusted net earnings in 2013 increased 3.6% to $1,616 after increasing 7.7% in 2012. Adjusted diluted net earnings per share in 2013 increased 3.9% to $4.23 after increasing 9.4% in 2012.

Non-GAAP Financial Measures
The following reconciles the non-GAAP financial measures: adjusted gross profit;
adjusted selling, general and administrative expense; adjusted operating income;
adjusted other income/(expense); adjusted net earnings; adjusted effective tax
rate; and adjusted diluted net earnings per share; with the most directly
comparable GAAP financial measures:
                                                Selling, General and      Operating       Other Income                   Effective Tax
Year Ended December 31, 2013  Gross Profit    Administrative Expenses       Income         (Expense)       Net Earnings      Rate       Diluted EPS
AS REPORTED                  $       6,044   $            4,066         $      1,256   $        (44 )     $      1,006     17.0  %     $      2.63
 Acquisition and integration
related charges
  Inventory stepped up to
fair value                              28                    -                   28              -                 21      0.1               0.06
  Other acquisition and
integration related                      -                  (70 )                 70              -                 51      0.3               0.13
 Restructuring and related
charges                                 11                   (4 )                 63              -                 46      0.3               0.12
 Rejuvenate and recall
matters                                  -                 (622 )                622              -                460      2.0               1.20
 Regulatory and legal
matters                                  7                  (62 )                 69              2                 63     (0.6 )             0.17
 Donation                                -                  (25 )                 25              -                 15      0.3               0.04
 Tax matters                             -                    -                    -            (13 )              (46 )    2.9              (0.12 )
ADJUSTED                     $       6,090   $            3,283         $      2,133   $        (55 )     $      1,616     22.3  %     $      4.23


Year Ended December 31, 2012
AS REPORTED                  $ 5,876   $   3,466   $ 1,741   $   (36 ) $ 1,298     23.9  % $  3.39
 Acquisition and integration
related charges
  Inventory stepped up to
fair value                        18           -        18         -        13        -       0.03
  Other acquisition and
integration related                -         (37 )      37         -        24      0.3       0.06
 Restructuring and related
charges                            5           -        80         -        59      0.1       0.15
 Rejuvenate and recall
matters                            -        (174 )     174         -       133        -       0.35
 Regulatory and legal
matters                            -         (33 )      33         -        33     (0.5 )     0.09
ADJUSTED                     $ 5,899   $   3,222   $ 2,083   $   (36 ) $ 1,560     23.8  % $  4.07


Year Ended December 31, 2011
AS REPORTED                  $ 5,496   $   3,150   $ 1,686   $     -   $ 1,345     20.2  % $  3.45
 Acquisition and integration
related charges
  Inventory stepped up to
fair value                       143           -       143         -        97      0.6       0.25
  Other acquisition and
integration related                -         (66 )      66         -        45      0.3       0.12
 Restructuring and related
charges                            -           -        76         -        60     (0.2 )     0.16
 Regulatory and legal
matters                            -          (1 )       1         -         -        -          -
 Tax matters                       -           -         -       (27 )     (99 )    4.7      (0.26 )
ADJUSTED                     $ 5,639   $   3,083   $ 1,972   $   (27 ) $ 1,448     25.6  % $  3.72

The weighted-average basic and diluted shares outstanding used in the calculation of these non-GAAP financial measures are the same as the weighted-average shares outstanding used in the calculation of the reported per share amounts.

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


FINANCIAL CONDITION AND LIQUIDITY
Operating Activities
Operating cash flow was $1,886 in 2013, an increase of 13.8% and resulted primarily from net earnings adjusted for non-cash items (depreciation and amortization, share-based compensation, sale of inventory "stepped up" to fair value at acquisition and deferred income taxes), along with a decrease of $278 in cash paid for income taxes, associated with the timing of cash payments as . . .

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