SYK 10Q 9.30.2014


 

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
September 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: 378,320,513 shares of Common Stock, $0.10 par value, as of September 30, 2014.
 


STRYKER CORPORATION AND SUBSIDIARIES                   2014 Third Quarter Form 10-Q

PART I. - FINANCIAL INFORMATION
ITEM 1.
FINANCIAL STATEMENTS.

CONSOLIDATED STATEMENTS OF EARNINGS (Unaudited)
 
 
Three Months Ended September 30
 
Nine Months Ended September 30
 
 
2014
 
2013
 
2014
 
2013
Net sales
 
$
2,389

 
$
2,151

 
$
7,057

 
$
6,553

Cost of sales
 
822

 
682

 
2,399

 
2,125

Gross profit
 
1,567

 
1,469

 
4,658

 
4,428

Research, development and engineering expenses
 
153

 
136

 
461

 
397

Selling, general and administrative expenses
 
910

 
1,136

 
3,263

 
3,067

Intangible asset amortization
 
50

 
34

 
142

 
102

Restructuring charges
 
4

 
13

 
14

 
36

Total operating expenses
 
1,117

 
1,319

 
3,880

 
3,602

Operating income
 
450

 
150

 
778

 
826

Other income (expense), net
 
(25
)
 
(13
)
 
(79
)
 
(45
)
Earnings before income taxes
 
425

 
137

 
699

 
781

Income taxes
 
368

 
34

 
444

 
161

Net earnings
 
$
57

 
$
103

 
$
255

 
$
620

 
 
 
 

 
 
 
 
Net earnings per share of common stock:
 
 
 
 
 
 
 
 
  Basic net earnings per share of common stock
 
$
0.16

 
$
0.27

 
$
0.68

 
$
1.64

  Diluted net earnings per share of common stock
 
$
0.16

 
$
0.27

 
$
0.67

 
$
1.62

 
 
 
 
 
 
 
 
 
Weighted-average shares outstanding—in millions:
 
 
 
 
 
 
 
 
Basic
 
378.4

 
378.3

 
378.5

 
378.7

Net effect of dilutive employee stock options
 
4.1

 
3.4

 
4.2

 
3.1

Diluted
 
382.5

 
381.7

 
382.7

 
381.8

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

 

 

 
1.9



CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME (LOSS) (Unaudited)
 
 
 
Three Months Ended September 30
 
Nine Months Ended September 30
 
 
 
2014
 
2013
 
2014
 
2013
Net earnings
 
$
57

 
$
103

 
$
255

 
$
620

Other comprehensive income (loss), net of tax
 
 
 
 
 
 
 
 
 
Marketable Securities
 
(3
)
 
3

 
4

 
(3
)
 
Pension Plans
 
5

 
(3
)
 
5

 
(1
)
 
Hedges
 
5

 

 
(7
)
 

 
Financial Statement Translation
 
(312
)
 
115

 
(308
)
 
21

Total other comprehensive income (loss), net of tax
 
(305
)
 
115

 
(306
)
 
17

Comprehensive (loss) income
 
$
(248
)
 
$
218

 
$
(51
)
 
$
637


See accompanying notes to Consolidated Financial Statements.

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

STRYKER CORPORATION AND SUBSIDIARIES                   2014 Third Quarter Form 10-Q


CONSOLIDATED BALANCE SHEETS (Unaudited)
 
 
September 30
 
December 31
 
2014
 
2013
ASSETS
 
 
 
 
Current assets
 
 
 
 
Cash and cash equivalents
 
$
1,356

 
$
1,339

Marketable securities
 
3,321

 
2,641

Accounts receivable, less allowance of $66 ($72 in 2013)
 
1,529

 
1,518

Inventories
 
 
 
 
Materials and supplies
 
257

 
227

Work in process
 
106

 
85

Finished goods
 
1,303

 
1,110

Total inventories
 
1,666

 
1,422

Deferred income taxes
 
987

 
880

Prepaid expenses and other current assets
 
467

 
535

Total current assets
 
9,326

 
8,335

Property, plant and equipment
 
 
 
 
Land, buildings and improvements
 
676

 
686

Machinery and equipment
 
1,926

 
1,811

Total property, plant and equipment
 
2,602

 
2,497

Less allowance for depreciation
 
1,498

 
1,416

Net property, plant and equipment
 
1,104

 
1,081

Other assets
 
 
 
 
Goodwill
 
4,257

 
3,844

Other intangibles, net
 
2,108

 
1,989

Other
 
720

 
494

Total assets
 
$
17,515

 
$
15,743

 
 
 
 
 
LIABILITIES AND SHAREHOLDERS' EQUITY
 
 
 
 
Current liabilities
 
 
 
 
Accounts payable
 
$
335

 
$
314

Accrued compensation
 
485

 
535

Income taxes
 
374

 
131

Dividend payable
 
115

 
115

Accrued recall expenses
 
1,339

 
772

Accrued expenses and other liabilities
 
832

 
765

Current maturities of debt
 
731

 
25

Total current liabilities
 
4,211

 
2,657

Long-term debt, excluding current maturities
 
3,231

 
2,739

Other liabilities
 
1,449

 
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
 
1,230

 
1,160

Retained earnings
 
7,430

 
7,617

Accumulated other comprehensive income
 
(74
)
 
232

Total shareholders' equity
 
8,624

 
9,047

Total liabilities & shareholders' equity
 
$
17,515

 
$
15,743


See accompanying notes to Consolidated Financial Statements.


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

STRYKER CORPORATION AND SUBSIDIARIES                   2014 Third Quarter Form 10-Q


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
 
 
 
 
 
255

 
 
 
255

Other comprehensive loss
 
 
 
 
 
 
 
(306
)
 
(306
)
Issuance of 1.8 million shares of common stock under stock option and benefit plans, including $6 excess income tax benefit
 
 
 
16

 
 
 
 
 
16

Repurchase and retirement of 1.3 million shares of common stock
 
 
 
(4
)
 
(96
)
 
 
 
(100
)
Share-based compensation
 
 
 
58

 
 
 
 
 
58

Cash dividends declared of $0.915 per share of common stock
 
 
 
 
 
(346
)
 
 
 
(346
)
Balances at September 30, 2014
 
$
38

 
$
1,230

 
$
7,430

 
$
(74
)
 
$
8,624



CONSOLIDATED STATEMENTS OF CASH FLOWS (Unaudited)
 
 
Three Months Ended September 30
 
Nine Months Ended September 30
 
 
2014
 
2013
 
2014
 
2013
Operating activities
 
 
 
 
 
 
 
 
Net earnings
 
$
57

 
$
103

 
$
255

 
$
620

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

 
42

 
140

 
123

Amortization of intangible assets
 
50

 
34

 
142

 
102

Share-based compensation
 
17

 
19

 
58

 
57

Restructuring charges
 
4

 
14

 
14

 
38

Sale of inventory stepped up to fair value at acquisition
 
10

 
8

 
24

 
16

Recall accruals
 
29

 
313

 
649

 
523

Changes in operating assets and liabilities, net of effects of acquisitions:
 
 
 
 
 
 
 
 
Accounts receivable
 
(65
)
 
57

 
(12
)
 
46

Inventories
 
(97
)
 
(43
)
 
(217
)
 
(106
)
Accounts payable
 
4

 
(1
)
 
15

 
(31
)
Accrued expenses and other liabilities
 
179

 
68

 
37

 
15

Income taxes
 
306

 
34

 
169

 
(116
)
Other
 
(6
)
 
(26
)
 
(167
)
 
(73
)
Net cash provided by operating activities
 
535

 
622

 
1,107

 
1,214

 
 
 
 
 
 
 
 
 
Investing activities
 
 
 
 
 
 
 
 
Acquisitions, net of cash acquired
 
(368
)
 
(24
)
 
(825
)
 
(686
)
Purchases of marketable securities
 
(1,038
)
 
(1,160
)
 
(3,635
)
 
(3,777
)
Proceeds from sales of marketable securities
 
1,030

 
859

 
2,842

 
2,676

Purchases of property, plant and equipment
 
(48
)
 
(43
)
 
(172
)
 
(139
)
Net cash used in investing activities
 
(424
)
 
(368
)
 
(1,790
)
 
(1,926
)
 
 
 
 
 
 
 
 
 
Financing activities
 
 
 
 
 
 
 
 
Proceeds from borrowings
 
395

 
110

 
2,208

 
1,272

Payments on borrowings
 
(293
)
 
(107
)
 
(1,013
)
 
(258
)
Dividends paid
 
(115
)
 
(100
)
 
(346
)
 
(301
)
Repurchase and retirement of common stock
 
(40
)
 
(2
)
 
(100
)
 
(252
)
Other
 
(14
)
 
(6
)
 
(42
)
 
(8
)
Net cash (used in) provided by financing activities
 
(67
)
 
(105
)
 
707

 
453

 
 
 
 
 
 
 
 
 
Effect of exchange rate changes on cash and cash equivalents
 
(7
)
 
(10
)
 
(7
)
 
(26
)
Change in cash and cash equivalents
 
$
37

 
$
139

 
$
17

 
$
(285
)

See accompanying notes to Consolidated Financial Statements.



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

STRYKER CORPORATION AND SUBSIDIARIES                   2014 Third Quarter Form 10-Q

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Unaudited)
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 Consolidated Statements of Cash Flows and 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 - FAIR VALUE MEASUREMENTS
Assets and liabilities measured at fair value:
Total
 
Level 1
 
Level 2
 
Level 3
 
September
December
 
September
December
 
September
December
 
September
December
 
2014
2013
 
2014
2013
 
2014
2013
 
2014
2013
Cash and cash equivalents
$
1,356

$
1,339

 
$
1,356

$
1,339

 
$

$

 
$

$

Available-for-sale marketable securities
 
 
 
 
 
 
 
 
 
 
 
Corporate and asset-backed debt securities
1,614

1,177

 


 
1,614

1,177

 


Foreign government debt securities
828

845

 


 
828

845

 


United States agency debt securities
361

211

 


 
361

211

 


United States treasury debt securities
408

350

 


 
408

350

 


Certificates of deposit
103

53

 


 
103

53

 


Other
7

5

 


 
7

5

 


Total available-for-sale marketable securities
3,321

2,641

 


 
3,321

2,641

 


Trading marketable securities
77

72

 
77

72

 


 


Foreign currency exchange forward contracts
21

25

 


 
21

25

 


 
$
4,775

$
4,077

 
$
1,433

$
1,411

 
$
3,342

$
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

Interest rate swap
6


 


 
6


 


Foreign currency exchange forward contracts
23

2

 


 
23

2

 


 
$
151

$
133

 
$
77

$
72

 
$
29

$
2

 
$
45

$
59

Summary of marketable securities:
Amortized Cost
 
Gross Unrealized Gains
 
Gross Unrealized Losses
 
Estimated Fair Value
 
September
December
 
September
December
 
September
December
 
September
December
 
2014
2013
 
2014
2013
 
2014
2013
 
2014
2013
Available-for-sale marketable securities:
 
 
 
 
 
 
 
 
 
 
 
  Corporate and asset-backed debt securities
$
1,611

$
1,177

 
$
4

$
1

 
$
(1
)
$
(1
)
 
$
1,614

$
1,177

  Foreign government debt securities
826

846

 
2


 

(1
)
 
828

845

  United States agency debt securities
361

211

 


 


 
361

211

  United States treasury debt securities
408

350

 


 


 
408

350

  Certificates of deposit
103

53

 


 


 
103

53

  Other
7

5

 


 


 
7

5

Total available-for-sale marketable securities
$
3,316

$
2,642

 
$
6

$
1

 
$
(1
)
$
(2
)
 
3,321

2,641

Trading marketable securities
 
 
 
 
 
 
 
 
 
77

72

Total marketable securities
 
 
 
 
 
 
 
 
 
$
3,398

$
2,713

Reported as:
 
 
 
 
 
 
 
 
 
 
 
  Current assets-marketable securities
 
 
 
 
 
 
 
 
 
$
3,321

$
2,641

  Noncurrent assets-other
 
 
 
 
 
 
 
 
 
77

72

Available-for-sale marketable securities by contractual maturity:
 
 
 
 
 
 
 
 
 
  Due in one year or less
$
532

$
425

 
 
 
 
 
 
 
$
532

$
424

  Due after one year through three years
2,468

1,989

 
 
 
 
 
 
 
2,473

1,989

  Due after three years
316

228

 
 
 
 
 
 
 
316

228



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

STRYKER CORPORATION AND SUBSIDIARIES                   2014 Third Quarter Form 10-Q



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. Foreign currency exchange contracts and interest rate swaps are included in Level 2 as we use inputs other than quoted prices that are observable for the asset. The Level 2 derivative instruments are primarily valued using standard calculations and models that use readily observable market data as their basis. The fair value of our Level 3 liabilities represents 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 fair value from changes in probability of occurrence in general and administrative expense and the changes in time value of money in other income (expense). 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 level between December 31, 2013 and September 30, 2014.

The unrealized losses on available-for-sale marketable securities at September 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 September 30, 2014.

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 September 30, 2014 are:
 
Number of Investments
Fair Value
Unrealized Losses
Less than 12 months
 
 
 
     Corporate and Asset-Backed
225
$
397

$
1

     Foreign Government
45
100


     United States Agency
37
178


     Other
86
312


 
393
$
987

$
1

Total
 
 
 
     Corporate and Asset-Backed
233
$
397

$
1

     Foreign Government
52
194


     United States Agency
37
178


     Other
87
312


 
409
$
1,081

$
1

 
Upon the sale of a security classified as available-for-sale, the security’s specific unrealized gain (loss) is reclassified out of Accumulated Other Comprehensive Income (AOCI) into earnings based on the specific identification method.

The total of interest and marketable securities income was $10 and $7 for the three months ended September 30, 2014 and 2013, respectively, and $21 and $18 for the nine months ended September 30, 2014 and 2013, respectively, and is included in other income (expense).
NOTE 3 - DERIVATIVE INSTRUMENTS
We use operational and economic hedges as well as foreign currency exchange forward contracts and interest rate derivative instruments to manage the impact of currency exchange on earnings and cash flow.
Cash Flow Hedges
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, maximum term and gross fair value amounts of foreign exchange forward contract derivatives designated and non-designated as hedging instruments are:
 
 
Designated
 
Non-Designated
 
Total
September 30, 2014
 
 
 
 
 
 
Gross Notional Amount
 
$
219

 
$
3,155

 
$
3,374

Maximum term in days
 
 
 
 
 
546

Fair Value
 
 
 
 
 
 
     Other Current Assets
 
$
6

 
$
14

 
$
20

     Other Assets - Noncurrent
 
1

 

 
1

     Other Current Liabilities
 
1

 
22

 
23

 
 
$
6

 
$
(8
)
 
$
(2
)
December 31, 2013
 
 
 
 
 
 
Gross Notional Amount
 
$
344

 
$
2,000

 
$
2,344

Maximum term in days
 
 
 
 
 
546

Fair Value
 
 
 
 
 
 
     Other Current Assets
 
$
11

 
$
10

 
$
21

     Other Assets - Noncurrent
 
1

 
3

 
4

     Other Current Liabilities
 
1

 
1

 
2

 
 
$
11

 
$
12

 
$
23

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 net currency exchange rate gains (losses) for both designated and non-designated derivative instruments were:
 
 
Three Months
 
Nine Months
Recorded in:
 
2014
2013
 
2014
2013
Cost of goods sold
 
$
(1
)
$

 
$
4

$

Other income (expense)
 
(2
)

 
(11
)
(3
)
Total
 
$
(3
)
$

 
$
(7
)
$
(3
)
At September 30, 2014 and December 31, 2013, pretax gains on derivatives designated as hedges of $2 and $12, which are recorded in AOCI, are expected to be reclassified to earnings during the next


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

STRYKER CORPORATION AND SUBSIDIARIES                   2014 Third Quarter Form 10-Q

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.
Fair Value Hedges
Interest rate derivative instruments designated as fair value hedges are being used to manage the exposure to interest rate movements and to reduce borrowing costs by converting fixed-rate debt into floating-rate debt. Under these agreements, the Company agrees to exchange, at specified intervals, the difference between fixed and floating interest amounts calculated by reference to an agreed-upon notional principal amount.
As of  September 30, 2014, we had interest rate swaps in gross notional amounts of $500 designated as fair value hedges of underlying fixed rate obligations representing a portion of our $600 senior unsecured notes due in 2024.  The market value of outstanding interest rate swap agreements at September 30, 2014 was a realized loss of $6 which is recorded in other long-term liabilities with an offsetting realized gain of  $6 on the fair value of the underlying fixed rate obligation recorded in long-term debt in the consolidated balance sheet. No hedge ineffectiveness was recorded as a result of these fair value hedges for the three and nine months ended September 30, 2014.
NOTE 4 - 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 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 our future financial position, results of operations and cash flows. 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 $1,425 to $2,290 before third-party insurance recoveries that may potentially be recorded.  In the three months ended September 30, 2014, we recorded charges to earnings of $25 representing the excess of the $1,425 minimum of the range over the previously recorded reserves. No contingent gain for third-party insurance recoveries was recorded as of September 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


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

STRYKER CORPORATION AND SUBSIDIARIES                   2014 Third Quarter Form 10-Q

alleging infringement under United States patent laws with respect to certain patient handling equipment we manufactured and sold and seek damages and permanent injunctions.  The Wisconsin lawsuit was subsequently transferred to the United States District Court in Indiana and we have entered into an agreement settling that lawsuit on 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. 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. We filed a request with the United States Supreme Court asking that it vacate the Federal Court's decision. The district court has administratively closed the case until the Supreme Court resolves this request. 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 5 - ACQUISITIONS
During the quarter we completed our acquisition of assets of Small Bone Innovations, Inc. (SBi) for an aggregate purchase price of approximately $358. SBi products are designed and promoted for upper and lower extremity small bone indications, with a focus on small joint replacement. The acquisition of the assets of SBi enhances our product offerings within our Reconstructive segment. Intangible assets acquired with SBi will be amortized over a weighted-average life of 12 years.
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 enhances 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 enhances 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 SBi, 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
 
2013
 
 
SBi
 
Berchtold
 
PST
 
Other
 
MAKO
Purchase price paid
 
$
358

 
$
172

 
$
120

 
$
148

 
$
1,679

Tangible assets acquired:
 
 
 
 
 
 
 
 
 
 
Inventory
 
34

 
22

 
7

 
5

 
50

Other assets
 
4

 
38

 
19

 
25

 
174

Liabilities
 
(2
)
 
(45
)
 
(33
)
 
(32
)
 
(277
)
Intangible assets:
 
 
 
 
 
 
 
 
 
 
Customer relationship
 
19

 
11

 
33

 
4

 
91

 Trade name
 

 
7

 

 

 
24

Developed technology & patents
 
82

 
32

 
26

 
70

 
231

IPRD
 

 

 

 
2

 
169

Goodwill
 
221

 
107

 
68

 
74

 
1,217

 
 
$
358

 
$
172

 
$
120

 
$
148

 
$
1,679



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

STRYKER CORPORATION AND SUBSIDIARIES                   2014 Third Quarter Form 10-Q

NOTE 6 - LONG-TERM DEBT AND CREDIT FACILITIES
Our debt is as follows:
 
 
 
 
September 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
 
589

 

 
4.10%
April 1, 2043
 
395

 
394

 
4.375%
May 15, 2044
 
398

 

Commercial paper
 
199

 

Other
 
36

 
25

 
Total debt
 
3,962

 
2,764

 
Less current maturities
 
(731
)
 
(25
)
 
Total long-term debt
 
$
3,231

 
$
2,739

In August 2014, we amended and restated our Senior Unsecured Revolving Credit Facility. The principal changes were to increase the aggregate principal amount of the commitments to $1,250, to extend the maturity date to August 22, 2019 and to revise the definition of the consolidated Earnings Before Interest Taxes Depreciation and Amortization (EBITDA) calculation.

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 September 30, 2014, outstanding commercial paper totaled $199, the weighted average original maturity of the commercial paper outstanding was approximately 84 days and the weighted average interest rate was 0.24%.
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 September 30, 2014. We have lines of credit, issued by various financial institutions, available to fund our day-to-day operating needs. At September 30, 2014, we had $1,098 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 September 30, 2014.
At September 30, 2014, the total unamortized debt issuance costs incurred in connection with our outstanding notes were $22. The fair value of long-term debt (including current maturities and excluding the interest rate hedge) at September 30, 2014 and December 31, 2013 was $3,786 and $2,790, respectively, based on the quoted interest rates for similar types and amounts of borrowing agreements.
 
NOTE 7 - CAPITAL STOCK
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 1.3 million shares at a cost of $100 under the 2011 Repurchase Program. As of September 30, 2014, the maximum dollar value of shares that may yet be purchased under the 2011 Repurchase Program was $178 and we had not made any repurchases pursuant to the 2012 Repurchase Program. At September 30, 2014, the maximum dollar value of shares that may be purchased under the authorized Repurchase Programs was $583.
NOTE 8 - 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
 
14

 
6

 
8

Cash paid
 
(19
)
 
(9
)
 
(10
)
Other adjustments
 
5

 
(1
)
 
6

September 30 Balance
 
$
20

 
$
6

 
$
14

NOTE 9 - INCOME TAXES
Our effective tax rates for the three-month periods were 86.6% and 24.9%, respectively, and 63.5% and 20.7%, respectively, for the nine-month periods. The increase in the effective tax rate for the three-month and nine-month periods was primarily due to recording the tax impacts of the establishment of a European regional headquarters and a cash repatriation to the United States planned for the second half of 2015. The expirations of the United States federal research and development tax credit and certain United States tax code provisions related to the taxation of foreign earnings also increased the effective tax rates.


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



NOTE 10 - ACCUMULATED OTHER COMPREHENSIVE INCOME (LOSS) (AOCI)
Changes in and reclassifications out of AOCI in 2014 were as follows:
 
Marketable Securities
 
Pension Plans
 
Hedges
 
Financial Statement Translation
 
Total
 
Three Months
 
Nine Months
 
Three Months
 
Nine Months
 
Three Months
 
Nine Months
 
Three Months
 
Nine Months
 
Three Months
 
Nine Months
Beginning balance
$
7

 
$

 
$
(81
)
 
$
(81
)
 
$
(5
)
 
$
7

 
$
310

 
$
306

 
$
231

 
$
232

Other comprehensive income (loss) (OCI)

 
11

 
3

 

 
7

 
(9
)
 
(312
)
 
(308
)
 
(302
)
 
(306
)
Income tax expense on OCI

 
(1
)
 
1

 
1

 
(3
)
 
4

 

 

 
(2
)
 
4

Reclassifications out of AOCI into:


 


 


 


 


 


 


 


 


 


     Cost of sales

 

 
1

 
5

 
1

 
(4
)
 

 

 
2

 
1

     Other (income) expense
(4
)
 
(7
)
 

 

 

 

 

 

 
(4
)
 
(7
)
     Income tax expense (benefit)
1

 
1

 

 
(1
)
 

 
2

 

 

 
1

 
2

Total other comprehensive income (loss)
(3
)
 
4

 
5

 
5

 
5

 
(7
)
 
(312
)
 
(308
)
 
(305
)
 
(306
)
Balance at September 30
$
4

 
$
4

 
$
(76
)
 
$
(76
)
 
$

 
$

 
$
(2
)
 
$
(2
)
 
$
(74
)
 
$
(74
)
NOTE 11 - SEGMENT INFORMATION
Net sales and net earnings by business segment are as follows:
 
Reconstructive
 
MedSurg
 
Neurotechnology and Spine
 
Total
 
Three Months
 
Nine Months
 
Three Months
 
Nine Months
 
Three Months
 
Nine Months
 
Three Months
 
Nine Months
 
2014
2013
 
2014
2013
 
2014
2013
 
2014
2013
 
2014
2013
 
2014
2013
 
2014
2013
 
2014
2013
Net sales
$
1,016

$
936

 
$
3,043

$
2,858

 
$
936

$
805

 
$
2,727

$
2,474

 
$
437

$
410

 
$
1,287

$
1,221

 
$
2,389

$
2,151

 
$
7,057

$
6,553

Segment net earnings
259

254

 
735

718

 
163

130

 
459

452

 
108

79

 
273

230

 
$
530

$
463

 
$
1,467

$
1,400

Less: other (net of income taxes)
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Corporate and other
 
 
 
 
 
 
 
 
 
 
 
 
 
 
(91
)
(65
)
 
(209
)
(179
)
Acquisition and integration related charges
 
 
 
 
 
 
 
 
 
 
 
 
(17
)
(9
)
 
(47
)
(41
)
Amortization of intangible assets
 
 
 
 
 
 
 
 
 
 
 
 
 
 
(34
)
(25
)
 
(99
)
(74
)
Restructuring and related charges
 
 
 
 
 
 
 
 
 
 
 
 
 
 
(8
)
(15
)
 
(37
)
(36
)
Recall charges
 
 
 
 
 
 
 
 
 
 
 
 
 
 
(23
)
(245
)
 
(512
)
(397
)
Regulatory matter charges
 
 
 
 
 
 
 
 
 
 
 
 
 
 

(1
)
 

(53
)
Tax matters
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
(300
)

 
(308
)

Net earnings
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
$
57

$
103

 
$
255

$
620

Other than assets associated with the acquisitions that are discussed in greater detail in Note 5, 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 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 67.2% and 66.4% of total revenues in the first nine months of 2014 and 2013, respectively, and international revenues accounted for 32.8% and


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



33.6% of total revenues in the first nine months of 2014 and 2013, respectively.
During the third quarter we completed our acquisition of the assets of Small Bone Innovations, Inc. (SBi) for an aggregate purchase price of approximately $358. SBi products are designed and promoted for upper and lower extremity small bone indications, with a focus on small joint replacement. 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 2014 include the acquisition of Pivot Medical, Inc (Pivot).
In July 2014 we established a European regional headquarters in the Netherlands. We believe that this increased presence will strengthen our brand in Europe, support the growth of our global business, provide operational efficiencies and simplify our customers’ experience.




RESULTS OF OPERATIONS
 
 
Three Months
 
Nine Months
 
 
2014
2013
% Change
 
2014
2013
% Change
Net Sales
 
$
2,389

$
2,151

11.1

 
$
7,057

$
6,553

7.7

Gross profit
 
1,567
1,469
6.7

 
4,658
4,428
5.2

Research, development and engineering expenses
 
153

136
12.5

 
461
397
16.1

Selling, general and administrative expenses
 
910

1,136
(19.9
)
 
3,263
3,067
6.4

Amortization of intangible assets
 
50
34
47.1

 
142
102
39.2

Restructuring charges
 
4
13

(69.2
)
 
14
36

(61.1
)
Other income (expense)
 
(25)
(13)
92.3

 
(79)
(45)
75.6

Income taxes
 
368

34

982.4

 
444

161

175.8

Net earnings
 
$
57

$
103

(44.7
)
 
$
255

$
620

(58.9
)
Diluted net earnings per share
 
$
0.16

$
0.27

(40.7
)
 
$
0.67

$
1.62

(58.6
)

Geographic and segment net sales:
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Percentage Change
 
 
 
Percentage Change
 
 
Three Months
 
 
 
Constant
Currency
 
Nine Months
 
 
 
Constant
Currency
 
 
2014
 
2013
 
Reported
 
 
2014
 
2013
 
Reported
 
Geographic sales:
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
United States
 
$
1,628

 
$
1,449

 
12.4
 
12.4
 
$
4,740

 
$
4,348

 
9.0
 
9.0
International
 
761

 
702

 
8.3
 
9.0
 
2,317

 
2,205

 
5.1
 
6.5
Total net sales
 
$
2,389

 
$
2,151

 
11.1
 
11.3
 
$
7,057

 
$
6,553

 
7.7
 
8.2
Segment sales:
 
 
 
 
 
 
 
 
 

 
 
 
 
 
 
Reconstructive
 
$
1,016

 
$
936

 
8.5
 
8.6
 
$
3,043

 
$
2,858

 
6.5
 
6.9
MedSurg
 
936

 
805

 
16.3
 
16.6
 
2,727

 
2,474

 
10.2
 
10.7
Neurotechnology and Spine
 
437

 
410

 
6.5
 
6.9
 
1,287

 
1,221

 
5.4
 
5.9
Total net sales
 
$
2,389

 
$
2,151

 
11.1
 
11.3
 
$
7,057

 
$
6,553

 
7.7
 
8.2
Supplemental sales growth information:
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Three Months
 
Nine 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
$
335

$
315

6.4
6.4
6.8
5.4

5.3

 
$
1,033