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SYK > SEC Filings for SYK > Form 10-Q on 24-Jul-2014All Recent SEC Filings

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Form 10-Q for STRYKER CORP


24-Jul-2014

Quarterly Report


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

Dollar amounts in millions except per share
10 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).

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


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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        Six Months                    Constant
                               2014         2013      Reported   Currency     2014        2013      Reported   Currency
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
                                                           Constant                                Constant                                       Constant                                Constant
                            2014    2013    As Reported    Currency    As Reported  As Reported    Currency       2014     2013    As Reported    Currency    As Reported  As Reported    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                      177     172         3.3         3.8            2.5           6.3        8.6           358      354         1.3         2.1            2.2          (1.7 )      1.8
MEDSURG                      905     832         8.8         9.0            7.6          12.5       13.2         1,791    1,669         7.3         7.9            7.1           7.9       10.1
Neurotechnology              245     227         8.3         8.3            8.3           8.3        8.3           488      448         9.1         9.9            9.8           8.2       10.1
Spine                        185     187        (1.6 )      (1.5 )         (6.1 )         9.5        9.8           362      363        (0.5 )      (0.1 )         (2.9 )         5.7        7.0
NEUROTECHNOLOGY AND SPINE    430     414         3.8         3.9            1.1           8.7        8.9           850      811         4.8         5.4            3.5           7.3        9.0




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


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STRYKER CORPORATION                    2014 Second Quarter Form 10-Q

Reconstructive Net Sales
Reconstructive net sales in the three-month period in 2014 increased 6.5% from 2013 primarily due to a 6.5% increase in unit volume and changes in product mix, 2.8% due to acquisitions and 0.1% due to the favorable impact of foreign currency exchange rates on net sales. Net sales were unfavorably impacted by 2.9% due to changes in price. Excluding the impact of acquisitions, net sales increased 3.6% in constant currency, primarily due to higher shipments of trauma and extremities products worldwide.
Reconstructive net sales for the six-month period in 2014 increased 5.5% from 2013 primarily due to a 5.9% increase in unit volume and changes in product mix and 2.9% due to acquisitions. Net sales were unfavorably impacted by 2.6% 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 3.3% in constant currency primarily due to higher shipments of trauma and extremities products worldwide.
MedSurg Net Sales
MedSurg net sales in the three-month period in 2014 increased 8.8% from 2013, primarily due to a 7.8% increase in unit volume and changes in product mix and 2.3% due to acquisitions. Net sales were unfavorably impacted by 1.1% due to changes in price and 0.2% due to the unfavorable impact of foreign currency exchange rates on net sales. Excluding the impact of acquisitions, net sales increased 6.7% in constant currency, primarily due to higher shipments of instruments and endoscopy products.
MedSurg net sales in the six-month period in 2014 increased 7.3% from 2013 primarily due to a 7.8% increase in unit volume and changes in product mix and 1.2% due to acquisitions. Net sales were unfavorably impacted by 1.2% 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 6.7% in constant currency, primarily due to higher shipments of instruments and endoscopy products.
Neurotechnology and Spine Net Sales
Neurotechnology and Spine net sales in the three-month period in 2014 increased 3.8% from 2013 primarily due to a 5.5% increase in unit volume and changes in product mix and 0.2% due to acquisitions. Net sales were unfavorably impacted by 1.9% due to changes in price and 0.1% due to the unfavorable impact of foreign currency exchange rates on net sales. Excluding the impact of acquisitions, net sales increased 3.7% in constant currency, led by higher shipments of neurotechnology products partially offset by lower shipments and continued pricing pressures in spinal implant products Neurotechnology and Spine net sales in the six-month period in 2014 increased 4.8% from 2013 primarily due to a 7.0% increase in unit volume and changes in product mix and 0.4% from 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 5.1% in constant currency,

primarily due to higher shipments of neurotechnology products partially offset by lower shipments and continued pricing pressures in spinal implant products. Cost of Sales
Cost of sales increased 10.7% in the three-month period in 2014 to 34.2% of sales compared to 33.0% of sales in 2013. The impact of our recent acquisitions and product mix contributed to the increase in cost of sales, as sales growth for capital equipment in our MedSurg businesses outpaced sales growth in the Reconstructive segment. Cost of sales in 2014 and 2013 also includes $9 and $8, respectively, related to inventory that was "stepped up" to fair value following acquisitions. Cost of sales in 2013 also includes $7 in restructuring and restructuring-related costs. Excluding the impact of the acquisition and restructuring costs described above, cost of sales was 33.8% of sales compared to 32.3% in 2013.
Cost of sales increased 9.3% in the six-month period in 2014 to 33.8% of sales compared to 32.8% of sales in 2013. The impact of our recent acquisitions and product mix contributed to the increase in cost of sales as sales of capital equipment in our MedSurg businesses. Cost of sales in 2014 and 2013 also includes $14 and $8, respectively, related to inventory that was "stepped up" to fair value following acquisitions and $1 and $7, respectively, in restructuring and restructuring-related costs. Excluding the impact of the acquisition and restructuring costs described above, cost of sales was 33.5% of sales as compared to 32.4% in 2013.
Research, Development and Engineering Expenses Research, development and engineering expenses increased 19.7% to $158, representing 6.7% of sales for the three-month period in 2014 compared to 6.0% in 2013 and increased 18.0% to $308 in the six-month period in 2014, representing 6.6% of sales in the period compared to 5.9% in 2013. The timing of projects for anticipated future products, the impact of acquisitions 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 13.1% to $1,148, representing 48.6% of sales for the three-month period in 2014 compared to 45.9% in 2013. The three-month periods included $16 and $10, respectively, in acquisition and integration related charges; $15 and $3, respectively, in restructuring related charges; $276 and $170, respectively, related to the previously disclosed voluntary recall of the Rejuvenate and ABG II modular-neck hip stems and the recall of the Neptune Waste Management System; and $19 in 2013 related to two previously disclosed United States regulatory matters. Excluding the impact of these charges, selling, general and administrative expenses were 35.6% of sales in 2014 compared to 36.8% in 2013, primarily due to improved control over general and administrative spending.
Selling, general and administrative expenses in the six-month period increased by 21.9% to $2,353, representing 50.4% of sales compared to 43.9% in 2013. The six-month periods included $32

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


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STRYKER CORPORATION                    2014 Second Quarter Form 10-Q

in 2014 and 2013, respectively, in acquisition and integration related charges; $24 and $3 in 2014 and 2013, respectively, in restructuring related charges; $620 and $210 in 2014 and 2013, respectively, related to the previously disclosed voluntary recall of the Rejuvenate and ABG II modular-neck hip stems and the recall of the Neptune Waste Management System; and $59 in 2013 related to two previously disclosed United States regulatory matters. Excluding the impact of these charges, selling, general and administrative expenses were 35.9% of sales in 2014 compared to 37.0% in 2013, primarily due to improved control over general and administrative spending. Restructuring Charges
Restructuring charges of $5 and $9 were recorded in the three-month periods in 2014 and 2013, respectively, and $10 and $23 in the six-month periods in 2014 and 2013, respectively. These restructuring charges are the result of our ongoing level of restructuring type activities to maintain a competitive cost structure, including manufacturing and workforce optimization. Our productivity and cost savings plans are designed to accelerate cost reductions by streamlining management decision making, manufacturing and other work processes to help fund our growth strategy.
Other Income (Expense)
Other expense in the three-and six-month periods increased $9 and $22, respectively, compared to 2013, primarily due to increased interest expense associated with our public offering of notes in May 2014 and March 2013 and in the six-month period due to losses on foreign currency exchange transactions. Income Taxes
Our effective income tax rate on earnings was 23.5% and 20.8% in the three-month periods in 2014 and 2013, respectively, and 27.8% and 19.7% in the six-month periods in 2014 and 2013, respectively. In 2013 we recorded retroactive net 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 extension of numerous tax provisions, including an extension of the research tax credit and other provisions for companies with significant international operations. These same tax provisions expired at the end of 2013. Net Earnings
Net earnings in the three-month period in 2014 decreased to $128 or $0.33 per diluted share compared to $213 or $0.56 per diluted share in 2013. Reported net earnings includes restructuring and restructuring-related charges of $20 and $10 in 2014 and 2013, respectively; acquisition and integration related charges of $17 and $15 in 2014 and 2013, respectively; amortization of purchased intangible assets of $33 and $26 in 2014 and 2013, respectively; charges related to the previously disclosed voluntary recall of the Rejuvenate and ABG II modular-neck hip stems and the recall of the Neptune Waste Management System of $217 and $120 in 2014 and 2013, respectively; and charges related to two previously disclosed United States regulatory matters of $22 in 2013. The

impact of foreign currency exchange rates on net earnings reduced diluted net earnings per share by approximately $0.03.
Net earnings in the six-month period in 2014 decreased to $198 or $0.51 per diluted share compared to $517 or $1.35 per diluted share in 2013. Reported net earnings includes restructuring and restructuring-related charges of $30 and $21 in 2014 and 2013, respectively; acquisition and integration related charges of $30 and $32 in 2014 and 2013, respectively; amortization of purchased intangible assets of $64 and $49 in 2014 and 2013, respectively; charges related to the previously disclosed voluntary recall of the Rejuvenate and ABG II modular-neck hip stems and the recall of the Neptune Waste Management System of $489 and $152 in 2014 and 2013, respectively; tax expense related to certain discrete tax items of $8 in 2014 and charges related to two previously disclosed United States regulatory matters of $52 in 2013. The impact of foreign currency exchange rates on net earnings reduced diluted net earnings per share by approximately $0.07.
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; cost of sales excluding specified items; adjusted selling, general and administrative expenses; adjusted amortization of intangible assets; 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 investors and 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. These adjustments are

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


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STRYKER CORPORATION                    2014 Second Quarter Form 10-Q

irregular in timing, may not be indicative of our past and future performance and are therefore excluded to allow investors to better understand underlying operating trends. Adjustments may include, but are not limited to, the following:
1. Acquisition and integration related costs. These adjustments include costs related to integrating recently acquired businesses and specific costs related to the consummation of the acquisition process.

2. Amortization of intangible assets. These adjustments represent the periodic amortization expense related to purchased intangible assets.

3. Restructuring and related charges. These adjustments include costs associated with focused workforce reductions and other restructuring activities.

4. Rejuvenate and recall matters. These adjustments are our best estimate of the minimum of the range of probable loss to resolve certain product recalls, including the recall of Rejuvenate / ABG II modular-neck hip stems and certain matters pertaining to the recall of the Neptune Waste Management System.

5. Regulatory and legal matters. These adjustments represent our best estimate of the minimum of the range of probable

loss to resolve certain regulatory matters and other legal settlements.

6. Tax matters. These adjustments represent certain discrete tax items and adjustments to interest expense related to the settlement of certain tax matters.

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, amortization of intangible assets, 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.

The following reconciles the non-GAAP financial measures of adjusted gross profit; adjusted selling, general and administrative expense; adjusted amortization of intangible assets; 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,                    Selling, General &         Intangible                                          Effective Tax
2014                         Gross Profit   Administrative Expenses      Amortization      Operating Income    Net Earnings       Rate        Diluted EPS
AS REPORTED                 $       1,555   $           1,148        $          47        $             197   $         128     23.5  %     $        0.33
 Acquisition and
integration related charges
. . .
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