10-K 1 syk10k12312013.htm 10-K SYK 10K 12.31.2013

 
UNITED STATES SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
_______________________________________________________________________
FORM 10-K
_______________________________________________________________________
ý
ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
For the fiscal year ended December 31, 2013
OR
¨
TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
Commission file number: 000-09165
_______________________________________________________________________
 
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)
Registrant’s telephone number, including area code: (269) 385-2600
_______________________________________________________________________
 Securities registered pursuant to Section 12(b) of the Act:
Title of each class
 
Name of each exchange on which registered
Common Stock, $.10 par value
 
New York Stock Exchange
Securities registered pursuant to Section 12(g) of the Act: None
Indicate by check mark if the registrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities Act.    YES  ý      NO  o
Indicate by check mark if the registrant is not required to file reports pursuant to Section 13 or 15(d) of the Act.    YES  o       NO  ý
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 and 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  ý       NO  o
Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Website, 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  ý       NO  o
Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K (§229.405 of this chapter) is not contained herein, and will not be contained, to the best of registrant’s knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K.  o
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 definitions of large “accelerated filer,” “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act.
Large accelerated filer  ý
  
Accelerated filer  o
Non-accelerated filer  o
  
Smaller reporting company  o
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Act).    YES  o       NO  ý
Based on the closing sales price of June 30, 2013, the aggregate market value of the voting stock held by non-affiliates of the registrant was approximately $22,463,504,679. The number of shares outstanding of the registrant’s common stock, $.10 par value, was 377,870,936 at January 31, 2014.

DOCUMENTS INCORPORATED BY REFERENCE
Portions of the proxy statement to be filed with the U.S. Securities and Exchange Commission relating to the 2014 Annual Meeting of Shareholders (the 2014 proxy statement) are incorporated by reference into Part III.
 






TABLE OF CONTENTS
 
 
 
 
PART I
 
Item 1.
Business
1

Item 1A.
Risk Factors
4

Item 1B.
Unresolved Staff Comments
7

Item 2.
Properties
7

Item 3.
Legal Proceedings
7

Item 4.
Mine Safety
7

 
 
PART II
 
Item 5.
Market for the Registrant’s Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities
7

Item 6.
Selected Financial Data
9

Item 7.
Management’s Discussion and Analysis of Financial Condition and Results of Operations
10

Item 7A.
Quantitative and Qualitative Disclosures About Market Risk
18

Item 8.
Financial Statements and Supplementary Data
19

 
Report of Independent Registered Public Accounting Firm on Consolidated Financial Statements
19

 
Consolidated Statements of Earnings
20

 
Consolidated Statements of Comprehensive Income
20

 
Consolidated Balance Sheets
21

 
Consolidated Statements of Shareholders’ Equity
22

 
Consolidated Statements of Cash Flows
23

 
Notes to Consolidated Financial Statements
24

Item 9.
Changes in and Disagreements With Accountants on Accounting and Financial Disclosure
41

Item 9A.
Controls and Procedures
41

Item 9B.
Other Information
42

 
 
PART III
 
Item 10.
Directors, Executive Officers and Corporate Governance
42

Item 11.
Executive Compensation
43

Item 12.
Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters
43

Item 13.
Certain Relationships and Related Transactions, and Director Independence
43

Item 14.
Principal Accounting Fees and Services
43

 
 
PART IV
 
Item 15.
Exhibits, Financial Statement Schedules
44

 












PART I

ITEM 1.
BUSINESS.

General

Stryker Corporation is one of the world's leading medical technology companies with 2013 revenues of $9,021 and net earnings of $1,006. Stryker's products include implants used in joint replacement and trauma surgeries; surgical equipment and surgical navigation systems; endoscopic and communications systems; patient handling and emergency medical equipment; neurosurgical, neurovascular and spinal devices; as well as other medical device products used in a variety of medical specialties.

Stryker was incorporated in Michigan in 1946 as the successor company to a business founded in 1941 by Dr. Homer H. Stryker, a prominent orthopaedic surgeon and the inventor of several orthopaedic products. In the United States, most of our products are marketed directly to doctors, hospitals and other healthcare facilities. Internationally, our products are sold in over 100 countries through company-owned sales subsidiaries and branches as well as third-party dealers and distributors.

As used herein, and except where the context otherwise requires, "Stryker," "we," "us," and "our" refer to Stryker Corporation and its consolidated subsidiaries.

Business Segments and Geographic Information

We segregate our reporting into three reportable business segments: Reconstructive, MedSurg, and Neurotechnology and Spine. Financial information regarding our reportable business segments and certain geographic information is included under "Results of Operations" in Item 7 of this report and Note 13 to the Consolidated Financial Statements in Item 8 of this report.

The net sales for each reportable segment over the last three years was:
 
2013
 
2012
 
2011
Reconstructive
$
4,004

44
%
 
$
3,823

44
%
 
$
3,710

45
%
MedSurg
3,359

37
%
 
3,265

38
%
 
3,160

38
%
Neurotechnology and Spine
1,658

19
%
 
1,569

18
%
 
1,437

17
%
Total
$
9,021

100
%
 
$
8,657

100
%
 
$
8,307

100
%

Reconstructive

Reconstructive products consist primarily of implants used in hip and knee joint replacements and trauma and extremities surgeries. We bring patients and physicians advanced implant designs and specialized instrumentation that make orthopaedic surgery and recovery simpler, faster and more effective. We support surgeons with the technology and services they need as they develop new surgical techniques.


 
The composition of net sales of Reconstructive products over the last three years was:
 
2013
 
2012
 
2011
Knees
$
1,371

34
%
 
$
1,356

35
%
 
$
1,316

35
%
Hips
1,272

32
%
 
1,233

32
%
 
1,228

33
%
Trauma and Extremities
1,116

28
%
 
989

26
%
 
931

25
%
Other
245

6
%
 
245

7
%
 
235

7
%
Total
$
4,004

100
%
 
$
3,823

100
%
 
$
3,710

100
%

In December 2013 we acquired MAKO Surgical Corp. (MAKO). 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 March 2013 we acquired Trauson Holdings Company Limited (Trauson). The acquisition of Trauson will enhance our product offerings, primarily within our Reconstructive segment, broaden our presence in China and enable us to expand into the fast growing value segment of the emerging markets.
In 2013 we launched the Tritanium Cementless Baseplate for our Triathlon Knee System (TKA), which combines biologic fixation with Triathlon’s ideal kinematics to provide surgeons with a superior option for cementless TKA. We also launched the Secur-Fit Advanced Femoral Hip Stem aimed at accurately restoring biomechanics by leveraging our new and unique Stryker Orthopaedics Modeling and Analytics system.

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. We continue to work with the medical community to evaluate the data and further understand this matter and the associated costs as more fully described in Note 7 to the Consolidated Financial Statements in Item 8 of this report; this information is incorporated herein by reference.

In 2012 we launched Accolade II, the first hip stem with a Morphometric Wedge design, an evolution of the tapered wedge stem.

In 2011 we acquired Memometal Technologies, which develops, manufactures and markets products for extremity (hand and foot) indications that enhance the offerings in our trauma and extremities product line.

Stryker is one of five leading competitors in the United States for joint replacement and trauma products; the other four are Zimmer Holdings, Inc. (Zimmer), DePuy Synthes Company (DePuy Synthes, a subsidiary of Johnson & Johnson), Biomet, Inc. and


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


Smith & Nephew plc. We are also a leading player in the international markets, with these same companies as our principal competitors.

MedSurg

MedSurg products include surgical equipment and surgical navigation systems (Instruments); endoscopic and communications systems (Endoscopy); patient handling and emergency medical equipment (Medical); and reprocessed and remanufactured medical devices as well as other medical device products used in a variety of medical specialties.

The composition of net sales of MedSurg products over the last three years was:
 
2013
 
2012
 
2011
Instruments
$
1,269

38
%
 
$
1,261

39
%
 
$
1,187

38
%
Endoscopy
1,167

35
%
 
1,111

34
%
 
1,080

34
%
Medical
710

21
%
 
691

21
%
 
722

23
%
Other
213

6
%
 
202

6
%
 
171

5
%
Total
$
3,359

100
%
 
$
3,265

100
%
 
$
3,160

100
%

In December 2013 we announced our intent to acquire Patient Safety Technologies, Inc. (PST). PST's proprietary Safety-Sponge® System and SurgiCount 360™ compliance software help prevent Retained Foreign Objects in the operating room. The transaction is subject to customary closing conditions and is expected to close in the first quarter of 2014.
In March 2013 we received a warning letter from the United States Food and Drug Administration (FDA) concerning quality system observations made during an inspection and citing us for failing to notify the FDA of a product recall and for marketing devices, including certain of our Neptune Waste Management Systems, without a required 510(k) clearance. We were notified in January 2014 that the actions taken to address issues raised in the warning letter are sufficient and no further corrective actions related to the warning letter are required.

In December 2013 we received 510(k) clearance to market a modified Neptune 2 Waste Management System. The Neptune 2 Waste Management System mitigates risk to healthcare workers by eliminating harmful exposure to fluids and smoke in the operating room. This constantly closed system collects surgical waste and disposes of it without exposing the operator to contact with infectious fluids and surgical plumes.

In 2012 we launched System 7, the next generation of heavy duty surgical power tools. These tools are used in total joint procedures, such as hip and knee replacements, and offer the latest in advanced cutting technology. We also launched the 1488 HD 3-Chip Endoscopic Camera System, which utilizes advanced CMOS technology and premium optics to provide a clear bright image designed to enhance patient outcomes. In addition, we launched Power-LOADTM, our cot fastener system that lifts and lowers the cot into and out of ambulances, thereby reducing spinal loads and the risk of cumulative trauma injuries to emergency responders.

 
Stryker is one of four market leaders in Instruments, competing principally with Zimmer, Medtronic, Inc. and Conmed Linvatec, Inc. (a subsidiary of CONMED Corporation) globally; internationally, we also compete with Aesculap-Werke AG (a division of B. Braun Melsungen AG). In Endoscopy, we compete with Smith & Nephew Endoscopy (a division of Smith & Nephew plc), ConMed Linvatec, Inc., Arthrex, Inc., Karl Storz GmbH & Co. and Olympus Optical Co. Ltd. Our primary competitors in Medical are Hill-Rom Holdings, Inc. and Kinetic Concepts, Inc.

Neurotechnology and Spine

Our Neurotechnology and Spine products include both neurosurgical and neurovascular devices. Our neurotechnology offering includes products used for minimally invasive endovascular techniques; a comprehensive line of products for traditional brain and open skull base surgical procedures; orthobiologic and biosurgery products, including synthetic bone grafts and vertebral augmentation products; and minimally invasive products for the treatment of acute ischemic and hemorrhagic stroke. We also develop, manufacture and market spinal implant products including cervical, thoracolumbar and interbody systems used in spinal injury, deformity and degenerative therapies.

The composition of net sales of Neurotechnology and Spine products over the last three years was:
 
2013
 
2012
 
2011
Neurotechnology
$
915

55
%
 
$
842

54
%
 
$
750

52
%
Spine
743

45
%
 
727

46
%
 
687

48
%
Total
$
1,658

100
%
 
$
1,569

100
%
 
$
1,437

100
%

In 2012 we received 510(k) clearance to market the Trevo® Pro Retriever, our next generation clot removal technology that utilizes proprietary Stentriever® Technology for optimized clot integration and retrieval in patients experiencing acute ischemic stroke. In addition, we received 510(k) clearance to market our Trevo® ProVEUTM Retriever, the first clot removal device fully visible during the procedure for precise positioning within the clot and optimized clot retrieval in patients experiencing acute ischemic stroke.

In 2012 we acquired Surpass Medical, Ltd. (Surpass). Surpass is developing and commercializing next-generation flow diversion stent technology to treat brain aneurysms using a unique mesh design and delivery system. The acquisition of Surpass enhances our product offerings in Neurotechnology.

In 2011 we acquired the assets of the Neurovascular division of Boston Scientific Corporation (Neurovascular), as well as Concentric Medical, Inc., a manufacturer of minimally invasive products for the treatment of acute ischemic stroke. These acquisitions significantly expanded our product offerings in Neurotechnology. In addition, we acquired Orthovita, Inc. (Orthovita), a developer of orthobiologic and biosurgery products, including synthetic bone grafts and vertebral augmentation


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


products. The acquisition of Orthovita complements our existing product offerings, primarily in Spine.

Our primary competitors in Neurotechnology are Micrus Endovascular, LLC and DePuy Synthes (subsidiaries of Johnson & Johnson), Covidien and Medtronic. We are one of five market leaders in Spine, along with Medtronic Sofamor Danek, Inc. (a subsidiary of Medtronic, Inc.), DePuy Synthes, Nuvasive, Inc. and Globus Medical.

Geographic Areas

In 2013 approximately 66.3% of our revenues were generated from customers in the United States. Internationally our products are sold in over 100 countries through local dealers and direct sales efforts. Additional geographic information is included under "Results of Operations" in Item 7 of this report and Note 13 to the Consolidated Financial Statements in Item 8 of this report.

Raw Materials and Inventory

Raw materials essential to our business are generally readily available from multiple sources. Substantially all products we manufacture are stocked in inventory, while certain MedSurg products are assembled to order. The dollar amount of backlog orders at any given time is not considered material to an understanding of our business taken as a whole.

Patents and Trademarks

Patents and trademarks are significant to our business to the extent that a product or an attribute of a product represents a unique design or process. Patent protection of such products restricts competitors from duplicating these unique designs and features. We seek to obtain patent protection on our products whenever appropriate for protecting our competitive advantage. As of December 31, 2013 we owned approximately 1,783 United States patents and 3,420 international patents.

Seasonality

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 stronger in the fourth quarter.

Competition

In all of our product lines we compete with local and global companies located throughout the world. Competition exists in all product lines without regard to the number and size of the competing companies involved. The development of new and innovative products is important to our success in all areas of our business and competition in research, involving the development and the improvement of new and existing products and processes, is particularly significant. The competitive environment requires substantial investments in continuing research and in maintaining sales forces.
 
The principal factors that we believe differentiate us in the highly competitive product categories in which we operate and enable us to compete effectively include our commitment to innovation and quality, service and reputation. We believe that our competitive position in the future will depend to a large degree on our ability to develop new products and make improvements to existing products.

Product Development

Most of our products and product improvements have been developed internally at research facilities in the United States, Ireland, Puerto Rico, Germany, Switzerland, India and France. We also invest through acquisitions in technologies developed by third parties that have the potential to expand the markets in which we operate. We maintain close working relationships with physicians and medical personnel in hospitals and universities who assist us in product development efforts. The total costs of worldwide company-sponsored research, development and engineering activities relating to the development of new products, improvement of existing products, technical support of products and compliance with governmental regulations for the protection of customers and patients were $536, $471 and $462 in 2013, 2012 and 2011, respectively. Research, development and engineering expenses as a percentage of sales were 5.9%, 5.4% and 5.6% in 2013, 2012 and 2011, respectively. The spending level in 2013 increased due to the timing of projects and continued investment in new technologies. The spending level in 2012 as a percentage of sales decreased primarily due to the termination of all development of the OP-1 molecule in late 2011.

Regulation

Our businesses are subject to varying degrees of governmental regulation in the countries in which we operate, and the general trend is toward increasingly stringent regulation.

In the United States, the Medical Device Amendments of 1976 to the Federal Food, Drug and Cosmetic Act and its subsequent amendments, and the regulations issued or proposed thereunder, provide for regulation by the FDA of the design, manufacture and marketing of medical devices, including most of our products. Many of our new products fall into FDA classifications that require notification of and review by the FDA before we begin marketing them, submitted as a 510(k). Certain of our products require extensive clinical testing, consisting of safety and efficacy studies, followed by pre-market approval (PMA) applications for specific surgical indications.

The FDA's Quality System regulations set forth standards for our product design and manufacturing processes, require the maintenance of certain records and provide for inspections of our facilities by the FDA. There are also certain requirements of state, local and foreign governments that must be complied with in the manufacture and marketing of our products.

The member states of the European Union (EU) have adopted the European Medical Device Directives that form a single set of


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


medical device regulations for all EU member countries. These regulations require companies that wish to manufacture and distribute medical devices in EU member countries to meet certain quality system requirements and obtain CE marking for their products. We have authorization to apply the CE marking to substantially all of our products. In addition, we comply with the unique regulatory requirements of each of the countries in which we market our products.

Initiatives sponsored by government agencies, legislative bodies and the private sector to limit the growth of healthcare expenses generally and hospital costs in particular, including price regulation and competitive pricing, are ongoing in markets where we do business. It is not possible to predict at this time the long-term impact of such cost containment measures on our future business. In addition, business practices in the healthcare industry have come under increased scrutiny, particularly in the United States, by government agencies and state attorneys general, and resulting investigations and prosecutions carry the risk of significant civil and criminal penalties.

Employees

At December 31, 2013, we had approximately 25,000 employees worldwide. Certain international employees are covered by collective bargaining agreements. We believe that we maintain positive relationships with our employees worldwide.

Executive Officers of the Registrant

Information regarding our executive officers appears under the caption "Directors, Executive Officers and Corporate Governance" in Item 10 of this Report.    

Available Information

Our main corporate website address is www.stryker.com. Copies of our Quarterly Reports on Form 10-Q, Annual Reports on Form 10-K and Current Reports on Form 8-K filed or furnished to the United States Securities and Exchange Commission (SEC) will be provided without charge to any shareholder submitting a written request to our Corporate Secretary at our principal executive offices. All of our SEC filings are also available free of charge on our website within the "For Investors - SEC Filings & Ownership Reports" link as soon as reasonably practicable after having been electronically filed or furnished to the SEC. All SEC filings are also available at the SEC's website at www.sec.gov.
ITEM 1A.
RISK FACTORS.

This report contains statements referring to us that are not historical facts and are considered "forward-looking statements" within the meaning of the Private Securities Litigation Reform Act of 1995. These statements, which are intended to take advantage of the "safe harbor" provisions of the Reform Act, are based on current projections about operations, industry conditions, financial condition and liquidity. Words that identify forward-looking statements include words such as "may," "could," "will," "should,"
 
"possible," "plan," "predict," "forecast," "potential," "anticipate," "estimate," "expect," "project," "intend," "believe," "may impact," "on track," and words and terms of similar substance used in connection with any discussion of future operating or financial performance, an acquisition or our businesses. In addition, any statements that refer to expectations, projections or other characterizations of future events or circumstances, including any underlying assumptions, are forward-looking statements. Those statements are not guarantees and are subject to risks, uncertainties and assumptions that are difficult to predict. Therefore, actual results could differ materially and adversely from these forward-looking statements. Some important factors that could cause our actual results to differ from our expectations in any forward-looking statements include the risks discussed below.

Our operations and financial results are subject to various risks and uncertainties that could adversely affect our business, cash flows, financial condition and results of operations. Additional risks and uncertainties not currently known to us or that we currently deem to be immaterial may also materially and adversely affect our business, cash flows, financial condition or results of operations.

LEGAL AND REGULATORY RISKS

The impact of United States healthcare reform legislation on our business remains uncertain. In 2010 federal legislation to reform the United States healthcare system was enacted into law. The legislation is far-reaching and is intended to expand access to health insurance coverage, improve the quality and reduce the costs of healthcare over time. Its provisions become effective at various dates and there are many programs and requirements for which the details have not been determined. We expect the law will have a significant impact upon various aspects of our business operations. Among other things, the law imposes a 2.3 percent excise tax on Class I, II and III medical devices that applies to United States sales of a majority of our medical device products. Other provisions of this legislation, including Medicare provisions aimed at improving quality and decreasing costs, comparative effectiveness research, an independent payment advisory board, and pilot programs to evaluate alternative payment methodologies, could meaningfully change the way healthcare is developed and delivered. Further, we cannot predict what other healthcare programs and regulations will be ultimately implemented at the federal or state level or the effect of any future legislation or regulation in the United States. However, any change that lowers reimbursements for our products or reduces medical procedure volumes could adversely affect our business and results of operations.

Cost containment measures in the United States and other countries resulting in pricing pressures could have a negative impact on our future operating results. Initiatives sponsored by government agencies, legislative bodies and the private sector to limit the growth of healthcare costs, including price regulation and competitive pricing, are ongoing in markets where we do business. Pricing pressure has also increased in our markets due to continued consolidation among healthcare providers, trends toward managed care, the shift towards governments becoming the primary payers of healthcare expenses, and government laws and regulations


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


relating to sales and promotion, reimbursement and pricing generally. Reductions in reimbursement levels or coverage or other cost containment measures could unfavorably affect our future operating results.

We may be adversely affected by product liability claims, unfavorable court decisions or legal settlements. Our business exposes us to potential product liability risks that are inherent in the design, manufacture and marketing of medical devices, many of which are intended to be implanted in the human body for long periods of time or indefinitely. We are currently defendants in a number of product liability matters, including those relating to the voluntary recall in 2012 of our Rejuvenate and ABGII modular neck hip stems discussed in "Other Information-Legal and Regulatory Matters" in Item 7 of this report and Note 7 to the Consolidated Financial Statements in Item 8 of this report. These matters are subject to many uncertainties and outcomes are not predictable. In addition, we may incur significant legal expenses regardless of whether we are found to be liable. The Company is 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.
  
Intellectual property litigation and infringement claims could cause us to incur significant expenses or prevent us from selling certain of our products.  The medical device industry is characterized by extensive intellectual property litigation and, from time to time, we are the subject of claims by third parties of potential infringement or misappropriation.  Regardless of outcome, such claims are expensive to defend and divert the time and effort of management and operating personnel from other business issues.  A successful claim or claims of patent or other intellectual property infringement against us could result in our payment of significant monetary damages and/or royalty payments or negatively impact our ability to sell current or future products in the affected category.

Dependence on patent and other proprietary rights and failing to protect such rights or to be successful in litigation related to such rights may impact offerings in our product portfolios. Our long-term success largely depends on our ability to market technologically competitive products. If we fail to obtain or maintain adequate intellectual property protection, such a failure could allow others to sell products that compete with offerings in our product portfolio. Also, our issued patents are subject to claims concerning priority, scope and other issues, and currently pending or future patent applications may not result in issued patents.

We are subject to extensive governmental regulations relating to the manufacturing, labeling and marketing of our products. Substantially all of our products are subject to regulation by the FDA and other governmental authorities in the United States and internationally. The process of obtaining regulatory approvals to market a medical device can be costly and time consuming and approvals might not be granted for future products on a timely basis, if at all. We have ongoing responsibilities under FDA regulations with respect to our products and facilities and are
 
subject to periodic inspections by the FDA to determine compliance with the quality system and medical device reporting regulations and other requirements. If we fail to fully comply with applicable regulatory requirements, we may be subject to a range of sanctions, including warning letters, product recalls, the suspension of product manufacturing, monetary fines and criminal prosecution.

We are subject to federal, state and foreign healthcare regulations, including fraud and abuse laws, as well as anti-bribery laws, and could face substantial penalties if we fail to fully comply with such regulations and laws. Our relationship with healthcare professionals, such as physicians, hospitals and those that may market our products, are subject to scrutiny under various state and federal laws often referred to collectively as healthcare fraud and abuse laws. In addition, the United States and foreign government regulators have increased the enforcement of the Foreign Corrupt Practices Act and other anti-bribery laws. These laws are broad in scope and are subject to evolving interpretation, which could require us to incur substantial costs to monitor compliance or to alter our practices if we are found not to be in compliance. We also must comply with a variety of other laws which protect the privacy of individually identifiable healthcare information and impose extensive tracking and reporting related to all transfers of value provided to certain healthcare professionals. Violations of these laws may be punishable by criminal or civil sanctions, including substantial fines, imprisonment and exclusion from participation in governmental healthcare programs.

MARKET RISKS

Macroeconomic developments, such as the recent recessions in Europe and the debt crises in certain countries in the European Union, could negatively affect our ability to conduct business in those geographies. The continuing debt crises in certain European Union countries could cause the value of the euro to deteriorate, reducing the purchasing power of our European Union customers. Financial difficulties experienced by our suppliers and customers, including distributors, could result in product delays and inventory issues; risks to accounts receivable could also include delays in collection and greater bad debt expense.

Exposure to exchange rate fluctuations on cross border transactions and translation of local currency results into United States dollars. Cross border transactions, both with external parties and intercompany relationships, result in increased exposure to foreign exchange effects. In addition, our sales are translated into United States dollars for reporting purposes. The strengthening or weakening of the United States dollar results in favorable or unfavorable translation effects as the results of our foreign locations are translated into United States dollars.

BUSINESS AND OPERATIONAL RISKS

We may be unable to effectively develop and market products against the products of our competitors in a highly competitive industry. Our present or future products could be rendered obsolete or uneconomical by technological advances by our competitors. Competitive factors include price, customer service,


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


technology, innovation, quality, reputation and reliability. Our competition may respond more quickly to new or emerging technologies, undertake more extensive marketing campaigns, have greater financial, marketing and other resources than us or be more successful in attracting potential customers, employees and strategic partners. Given these factors, we cannot guarantee that we will be able to continue our level of success in the industry.

Competition in research, involving the development and improvement of new and existing products, is particularly significant and results from time to time in product obsolescence. The markets in which we operate are highly competitive, and new products and surgical procedures are introduced on an ongoing basis. Such marketplace changes may cause some of our products to become obsolete. If actual product life cycles, product demand or acceptance of new product introductions are less favorable than projected by management, a higher level of inventory write downs may result.

We may be unable to maintain adequate working relationships with healthcare professionals. We seek to maintain close working relationships with respected physicians and medical personnel in hospitals and universities who assist in product research and development. We rely on these professionals to assist us in the development of proprietary products and product improvements to complement and expand our existing product lines. If we are unable to maintain these relationships, our ability to develop, market and sell new and improved products could decrease.

We are subject to additional risks associated with our extensive international operations. We develop, manufacture and distribute our products throughout the world. Our international operations are subject to a number of additional risks and potential costs, including changes in foreign medical reimbursement policies and programs, unexpected changes in foreign regulatory requirements, differing local product preferences and product requirements, diminished protection of intellectual property in some countries, trade protection measures and import or export licensing requirements, difficulty in staffing and managing foreign operations, political and economic instability. Our results of operations and/or financial condition could be adversely impacted if we are unable to successfully manage these and other risks of international operations in an increasingly volatile environment.

We may be unable to capitalize on previous or future acquisitions. In addition to internally developed products, we rely upon investment in new technologies through acquisitions. Investments in medical technology are inherently risky, and we cannot guarantee that any acquisition will be successful or will not have a material unfavorable impact on us. These risks include the activities required by us to integrate new businesses, which may result in the need to allocate more resources to integration and product development activities than originally anticipated, diversion of management's time, which could adversely affect management's ability to focus on other projects, the inability to realize the expected benefits, savings or synergies from the acquisition, the loss of key personnel of the acquired company, and exposure to unexpected liabilities of the acquired company. In
 
addition, we cannot be certain that the businesses we acquire will become profitable or remain so, which may result in unexpected impairment charges.

We may record future goodwill impairment charges related to one or more of our business units, which could materially adversely impact our results of operations. We perform our annual impairment test for goodwill in the fourth quarter of each year, or more frequently if indicators are present or changes in circumstances suggest that impairment may exist. In evaluating the potential for impairment we make assumptions regarding revenue projections, growth rates, cash flows, tax rates, and discount rates. These assumptions are uncertain and by nature may vary from actual results. A significant reduction in the estimated fair values could result in impairment charges that could materially affect our results of operations.

Our results of operations could be negatively impacted by future changes in the allocation of income to each of the income tax jurisdictions in which we operate. We operate in multiple income tax jurisdictions both in the United States and internationally. Accordingly, our management must determine the appropriate allocation of income to each jurisdiction based on current interpretations of complex income tax regulations. Income tax authorities regularly perform audits of our income tax filings. Income tax audits associated with the allocation of income and other complex issues, including inventory transfer pricing and cost sharing, product royalty and foreign branch arrangements, may require an extended period of time to resolve and may result in significant income tax adjustments. If changes to the income allocation are required between jurisdictions with different income tax rates, the related adjustments could have a material unfavorable impact on our results of operations.

Failure of a key information technology system, process or site could have a material adverse impact on our business. We rely extensively on information technology systems to conduct business. These systems include, but are not limited to, ordering and managing materials from suppliers, converting materials to finished products, shipping products to customers, processing transactions, summarizing and reporting results of operations, complying with regulatory, legal or tax requirements, providing data security and other processes necessary to manage our business. If our systems are damaged or cease to function properly due to any number of causes, ranging from catastrophic events to power outages to security breaches, and our business continuity plans do not effectively compensate on a timely basis, we may suffer interruptions in our operations.

We may be unable to attract and retain key employees. Our sales, technical and other key personnel play an integral role in the development, marketing and selling of new and existing products. If we are unable to recruit, hire, develop and retain a talented, competitive work force, we may not be able to meet our strategic business objectives.
ITEM 1B.
UNRESOLVED STAFF COMMENTS.
None.


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


ITEM 2.
PROPERTIES.

The following are our principal manufacturing locations as of December 31, 2013
Location
 
Segment
 
Square
Feet
 
Owned/
Leased
Portage, Michigan
 
M
 
1,034,000

 
Owned
Changzhou, China
 
R, NS
 
736,000

 
Owned
Mahwah, New Jersey
 
R
 
531,000

 
Owned
Arroyo, Puerto Rico
 
M
 
220,000

 
Leased
Kiel, Germany
 
R
 
173,000

 
Owned
Suzhou, China
 
R, NS
 
158,000

 
Owned
San Jose, California
 
M
 
185,000

 
Leased
Selzach, Switzerland
 
R
 
137,000

 
Owned
Lakeland, Florida
 
M
 
125,000

 
Leased
Freiburg, Germany
 
R
 
123,000

 
Owned
Limerick, Ireland
 
R
 
121,000

 
Owned
Flower Mound, Texas
 
M
 
114,000

 
Leased
Carrigtwohill, Ireland
 
R, NS
 
110,000

 
Leased
Phoenix, Arizona
 
M
 
100,000

 
Leased
Cestas, France
 
NS
 
91,000

 
Owned
Neuchâtel, Switzerland
 
NS
 
88,000

 
Owned
Ft. Lauderdale, Florida
 
R
 
83,000

 
Leased
Carrigtwohill, Ireland
 
R
 
72,000

 
Owned
Malvern, Pennsylvania
 
R
 
65,000

 
Leased
Mountain View, California
 
NS
 
62,000

 
Leased
Fremont, California
 
NS
 
52,000

 
Leased
Guayama, Puerto Rico
 
M
 
46,000

 
Leased
Cestas, France
 
NS
 
35,000

 
Leased
Freiburg, Germany
 
R, M
 
34,000

 
Leased
Stetten, Germany
 
R
 
33,000

 
Owned
Rennes, France
 
R
 
31,000

 
Leased
West Valley, Utah
 
NS
 
29,000

 
Leased
 
 
 
 
 
 
 
R = Reconstructive M = MedSurg NS = Neurotechnology and Spine

Our corporate headquarters are located in Kalamazoo, Michigan, in a 75,000 square foot owned facility. In addition, we maintain administrative and sales offices and warehousing and distribution facilities in multiple countries. We believe that our properties are suitable and adequate for the manufacture and distribution of our products.
ITEM 3.
LEGAL PROCEEDINGS.

We are involved in various proceedings, legal actions and claims arising in the normal course of business, including proceedings related to product, labor and intellectual property, and other matters that are more fully described in Note 7 to the Consolidated Financial Statements in Item 8 of this report; this information is incorporated herein by reference.
ITEM 4.
MINE SAFETY.

Not applicable.
 

PART II
ITEM 5.
MARKET FOR THE REGISTRANT’S COMMON EQUITY, RELATED STOCKHOLDER MATTERS AND ISSUER PURCHASES OF EQUITY SECURITIES.

Our common stock is traded on the New York Stock Exchange under the symbol SYK. Quarterly stock price and dividend information for the years ended December 31, 2013 and 2012 were as follows:
2013 Quarter Ended
 
Mar. 31
 
June 30
 
Sept. 30
 
Dec. 31
Dividends declared per share of common stock
 
$
0.265

 
$
0.265

 
$
0.265

 
$
0.305

Market price of common stock:
 
 
 
 
 
 
 
 
High
 
66.92

 
70.00

 
71.94

 
75.55

Low
 
55.24

 
63.35

 
63.71

 
66.93

2012 Quarter Ended
 
Mar. 31
 
June 30
 
Sept. 30
 
Dec. 31
Dividends declared per share of common stock
 
$
0.2125

 
$
0.2125

 
$
0.2125

 
$
0.265

Market price of common stock:
 
 
 
 
 
 
 
 
High
 
55.90

 
57.14

 
56.79

 
56.75

Low
 
50.41

 
49.43

 
50.05

 
51.60


Our Board of Directors considers payment of cash dividends at each of its quarterly meetings. On January 31, 2014, there were 3,556 shareholders of record of our common stock.

In December of 2012, 2011 and 2010, we announced that our Board of Directors had authorized us to purchase up to $405, $500 and $500, respectively, of our common stock (the 2012, 2011 and 2010 Repurchase Programs, respectively). The manner, timing and amount of purchases is determined by management based on an evaluation of market conditions, stock price and other factors and is subject to regulatory considerations. Purchases are to be made from time to time in the open market, in privately negotiated transactions or otherwise.

During the year ended December 31, 2013 we repurchased 1.4 million shares at a cost of $95 under the 2010 Repurchase Program and 3.4 million shares at a cost of $222 under the 2011 Repurchase Program. As of December 31, 2013, the 2010 Repurchase Program was complete and the maximum dollar value of shares that may yet be purchased under the 2011 Repurchase Program was $278. We had made no repurchases pursuant to the 2012 Repurchase Program at December 31, 2013.

Shares repurchased under the share repurchase programs are available for general corporate purposes, including offsetting dilution associated with stock option and other equity-based employee benefit plans.  At December 31, 2013, the maximum
dollar value of shares that may be purchased under the authorized Repurchase Programs was $683.

The activity pursuant to the 2011 Repurchase Program for the three months ended December 31, 2013 is summarized as follows:


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


Period
Total
Number
of Shares
Purchased
Average Price
Paid
Per Share
Total 
Number of
Shares 
Purchased as
Part of Publicly
Announced Plan
Maximum Dollar Value of Shares that may yet be Purchased Under the Plan
10/1/2013-10/31/2013

$


$
343

11/1/2013-11/30/2013



343

12/1/2013-12/31/2013
0.91

71.70

0.91

278

Total
0.91

$
71.70

0.91

 
The following graph compares our total returns (including reinvestments of dividends) against the Standard & Poor’s (S&P) 500 Index and the S&P 500 Health Care Index. The graph assumes $100 (not in millions) invested on December 31, 2008 in our Common Stock and each of the indices.
Company / Index
2008
2009
2010
2011
2012
2013
Stryker Corporation
100.00
126.71
136.71
128.35
143.87
200.40
S&P 500 Index
100.00
126.46
145.51
148.59
172.37
228.19
S&P 500 Health Care Index
100.00
119.70
123.17
138.85
163.69
231.55


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


ITEM 6.
SELECTED FINANCIAL DATA.

Selected financial data for each of the five years in the period ended December 31, 2013 is as follows: 
CONSOLIDATED OPERATIONS
 
2013
 
2012
 
2011
 
2010
 
2009
Net sales
 
$
9,021

 
$
8,657

 
$
8,307

 
$
7,320

 
$
6,723

Cost of sales
 
2,977

 
2,781

 
2,811

 
2,286

 
2,184

Gross profit
 
6,044

 
5,876

 
5,496

 
5,034

 
4,539

Research, development and engineering expenses
 
536

 
471

 
462

 
394

 
336

Selling, general and administrative expenses
 
4,066

 
3,466

 
3,150

 
2,707

 
2,506

Intangibles amortization
 
138

 
123

 
122

 
58

 
36

Other (a)
 
48

 
75

 
76

 
124

 
67

 
 
4,788

 
4,135

 
3,810

 
3,283

 
2,945

Operating income
 
1,256

 
1,741

 
1,686

 
1,751

 
1,594

Other income (expense)
 
(44
)
 
(36
)
 

 
(22
)
 
30

Earnings before income taxes
 
1,212

 
1,705

 
1,686

 
1,729

 
1,624

Income taxes
 
206

 
407

 
341

 
456

 
517

Net earnings
 
$
1,006

 
$
1,298

 
$
1,345

 
$
1,273

 
$
1,107

 
 
 
 
 
 
 
 
 
 
 
PER SHARE DATA
 
 
 
 
 
 
 
 
 
 
Net earnings per share of common stock:
 
 
 
 
 
 
 
 
 
 
Basic
 
$
2.66

 
$
3.41

 
$
3.48

 
$
3.21

 
$
2.79

Diluted
 
$
2.63

 
$
3.39

 
$
3.45

 
$
3.19

 
$
2.77

Dividends per share of common stock:
 
 
 
 
 
 
 
 
 
 
Declared
 
$
1.10

 
$
0.9025

 
$
0.7525

 
$
0.63

 
$
0.25

Paid
 
$
1.06

 
$
0.85

 
$
0.72

 
$
0.60

 
$
0.50

Average number of shares outstanding—in millions:
 
 
 
 
 
 
 
 
 
 
Basic
 
378.6

 
380.6

 
386.5

 
396.4

 
397.4

Diluted
 
382.1

 
383.0

 
389.5

 
399.5

 
399.4

 
 
 
 
 
 
 
 
 
 
 
CONSOLIDATED FINANCIAL POSITION
 
 
 
 
 
 
 
 
 
 
Cash, cash equivalents and current marketable securities
 
$
3,980

 
$
4,285

 
$
3,418

 
$
4,380

 
$
2,955

Accounts receivable—net
 
1,518

 
1,430

 
1,417

 
1,252

 
1,147

Inventory—net
 
1,422

 
1,265

 
1,283

 
1,057

 
943

Property, plant and equipment—net
 
1,081

 
948

 
888

 
798

 
948

Capital expenditures
 
195

 
210

 
226

 
182

 
131

Depreciation and amortization
 
511

 
486

 
481

 
410

 
385

Total assets
 
15,743

 
13,206

 
12,146

 
10,895

 
9,071

Accounts payable—net
 
314

 
288

 
345

 
292

 
200

Total debt
 
2,764

 
1,762

 
1,768

 
1,021

 
18

Shareholders’ equity
 
9,047

 
8,597

 
7,683

 
7,174

 
6,595

Net cash provided by operating activities
 
1,886

 
1,657

 
1,434

 
1,547

 
1,461

 
 
 
 
 
 
 
 
 
 
 
OTHER DATA
 
 
 
 
 
 
 
 
 
 
Number of shareholders of record
 
3,612

 
4,258

 
4,508

 
4,586

 
4,607

Approximate number of employees
 
25,000

 
22,000

 
21,000

 
20,000

 
19,000


(a) Includes restructuring and asset impairment charges.



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


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


10
 
Dollar amounts in millions except per share 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
Currency
 
 
 
Constant
Currency
 
 
2013
 
2012
 
2011
 
Reported
 
 
Reported
 
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
 
2013
2012
As Reported
Constant Currency
As Reported
As Reported
Constant Currency
 
2012

2011

As Reported
Constant Currency
As Reported
As Reported
Constant 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
 %

11
 
Dollar amounts in millions except per share 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


12
 
Dollar amounts in millions except per share 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:
Year Ended December 31, 2013
Gross Profit
Selling, General and Administrative Expenses
Operating Income
Other Income (Expense)
Net Earnings
Effective Tax 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.

13
 
Dollar amounts in millions except per share 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 well as favorable tax audit resolutions in multiple jurisdictions. These increases were partially offset by higher levels of inventory and accounts receivable. The net of accounts receivable, inventory and accounts payable resulted in the consumption of $165 of cash in 2013. Inventory days on hand improved by 1 day due to continued focus on improved inventory management; accounts receivable days sales outstanding remained consistent with 2012.
Operating cash flow was $1,657 in 2012, an increase of 15.6%, 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). The net of accounts receivable, inventory and accounts payable consumed $50 of cash in 2012. Inventory reductions contributed $18 of cash as inventory days on hand decreased by 5 days, due to lower inventory levels driven primarily by improved inventory management. Accounts receivable increases from business growth resulted in the consumption of $20 of cash, while accounts receivable days sales outstanding decreased by 3 days due to timing of sales.
Investing Activities
Net investing activities resulted in cash consumption of $2,217, $736 and $2,135 in 2013, 2012 and 2011, respectively, primarily due to acquisitions and capital spending.
Acquisitions. Acquisitions resulted in cash consumption of $2,320 in 2013 and $154 in 2012. In 2013 the cash consumed was primarily for Trauson and MAKO. In 2012 cash consumed was primarily for Surpass for $99 as well as for milestone payments related to previous acquisitions. Cash consumed in 2011 of $2,066 was primarily for the acquisitions of Neurovascular for $1,450; Orthovita for $316; Memometal for $150; and Concentric for $135.
Capital Spending. We manage capital spending to support our business growth. Capital expenditures, primarily to support integration of acquisitions, information technology infrastructure upgrades, capacity expansion, new product introductions, innovation and cost savings, were $195, $210 and $226 in 2013, 2012 and 2011, respectively.
Proceeds from Asset Sales. Proceeds from asset sales contributed $67 of cash in 2011, primarily due to the sale of certain assets related to the OP-1 product family.
Financing Activities
Dividend Payments. Dividends paid per common share increased 24.7% to $1.06 per share in 2013, and increased 18.1% to $0.85 per share in 2012. As a result of the annual increase in dividends paid per share, total dividend payments to common shareholders were $401, $324 and $279 in 2013, 2012 and 2011, respectively.
 
Short-term and Long-Term Debt. We maintain debt levels we consider appropriate after evaluating a number of factors, including cash flow expectations, cash requirements for ongoing operations, investment and financing plans (including acquisitions and share repurchase activities) and overall cost of capital.
In March 2013 we sold $600 million of senior unsecured notes due 2018 (the 2018 Notes) and $400 million of senior unsecured notes due 2043 (the 2043 Notes). The 2018 Notes bear interest at 1.3% per year and mature in April 1, 2018. The 2043 Notes bear interest at 4.1% per year and mature on April 1, 2043. We intend to use the net proceeds from the offering for working capital and other general corporate purposes, including acquisitions, stock repurchases and other business opportunities.
Total debt was $2,764 and $1,762 in 2013 and 2012, respectively.
Share Repurchases. The total use of cash for share repurchases was $317, $108 and $622 in 2013, 2012 and 2011, respectively.
Liquidity
Our cash, cash equivalents and marketable securities were $3,980 and $4,285 at December 31, 2013 and 2012, respectively, and our current assets exceeded current liabilities by $5,678 and $6,272 at December 31, 2013 and 2012, respectively. We anticipate being able to support our short-term liquidity and operating needs, including settlements related to the Rejuvenate and ABG II recalls, from a variety of sources, including cash from operations, commercial paper and existing credit lines. In the past we have also raised funds in the capital markets and may continue to do so from time to time in the future. We have strong short-term and long-term debt ratings that we believe should enable us to refinance our debt as it becomes due.
In August 2012 we refinanced our credit facility with a new $1,000 Unsecured Revolving Credit Facility due August 2017 (2012 Facility). The 2012 Facility replaced the previously outstanding $1,000 Unsecured Credit Facility that would have become due in August 2013. The 2012 Facility includes an increase option permitting us to increase the size of the facility up to an additional $500, a $500 multicurrency sublimit (with no sublimit for euro borrowings) and a $100 letter of credit sublimit. The 2012 Facility has an annual facility fee ranging from 5 to 22.5 basis points and bears interest at LIBOR, as defined in the 2012 Facility agreement, plus an applicable margin ranging from 57.5 to 127.5 basis points, both of which are dependent on our credit ratings.
Should additional funds be required we had approximately $1,052 of borrowing capacity available under all of our existing credit facilities at December 31, 2013, including the 2012 Facility.
At December 31, 2013, approximately 78% of our consolidated cash, cash equivalents and marketable securities were held outside of the United States. These funds are considered indefinitely reinvested to be used to expand operations either organically or through acquisitions outside the United States.
We continually evaluate our receivables, particularly in Spain, Portugal, Italy and Greece (the Southern European Region). The total net receivables from the Southern European Region were approximately $199 and $198 at December 31, 2013 and 2012, respectively, including approximately $103 of sovereign


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


receivables in both years. We believe that our current reserves related to receivables are adequate and any additional credit risk associated with the Southern European Region is not expected to have a material adverse impact on our financial position or liquidity. We currently do not have any investments in the sovereign debt instruments of the Southern European Region.  Any non-sovereign exposure in these countries in our investment portfolio is considered immaterial. 
Guarantees and Other Off-Balance Sheet Arrangements
We do not have guarantees or other off-balance sheet financing arrangements, including variable interest entities, of a magnitude that we believe could have a material impact on our financial condition or liquidity.
CONTRACTUAL OBLIGATIONS AND FORWARD-LOOKING CASH REQUIREMENTS
As further described in Note 7 to the Consolidated Financial Statements, as of December 31, 2013 we have recorded charges to earnings totaling $790 representing the minimum of the range of probable loss to resolve the Rejuvenate and ABG II recalls. Based on the information that has been received, the actuarially determined range of probable loss to resolve this matter is estimated to be approximately $790 to $1,235, before third-party insurance recoveries.  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 could have a material adverse effect on our financial position, results of operations and cash flows. We are not able to reasonably estimate the future periods in which payments will be made.
As further described in Note 12 to the Consolidated Financial Statements, as of December 31, 2013 our defined benefit pension plans were underfunded by $175, of which approximately $174 related to plans outside the United States. Due to the rules affecting tax-deductible contributions in the jurisdictions in which the plans are offered and the impact of future plan asset performance, changes in interest rates and the potential for changes in legislation in the United States and other foreign jurisdictions, we are not able to reasonably estimate, beyond 2013, the amounts that may be required to fund defined benefit pension plans.
As further described in Note 11 to the Consolidated Financial Statements, as of December 31, 2013 we have recorded a liability for uncertain income tax positions of $204. Due to uncertainties regarding the ultimate resolution of income tax audits, we are not able to reasonably estimate the future periods in which income tax payments to settle these uncertain income tax positions will be made.







 
Our future contractual obligations for agreements with initial terms greater than one year, including agreements to purchase materials in the normal course of business, are:
 
Payment Period
 
2014
 
2015
 
2016
 
2017
 
2018
 
After 2018
 
Total
Short-term and long-term debt
$
25

 
$
500

 
$
750

 
$

 
$
600

 
$
900

 
$
2,775

Unconditional purchase obligations
479

 
136

 
11

 
6

 
33

 
3

 
668

Operating leases
51

 
53

 
33

 
26

 
21

 
38

 
222

Contributions to defined benefit plans
20

 

 

 

 

 

 
20

Other
5

 
5

 
5

 
3

 
2

 
55

 
75

 
$
580

 
$
694

 
$
799

 
$
35

 
$
656

 
$
996

 
$
3,760

CRITICAL ACCOUNTING POLICIES AND ESTIMATES

In preparing our financial statements in accordance with GAAP, there are certain accounting policies that may require a choice between acceptable accounting methods or may require substantial judgment or estimation in their application. These include allowance for doubtful accounts, inventory reserves, income taxes, acquisitions, goodwill and intangible assets, and legal and other contingencies. We believe these accounting policies and the others set forth in Note 1 to the Consolidated Financial Statements should be reviewed as they are integral to understanding our results of operations and financial condition.

Allowance for Doubtful Accounts

We maintain an allowance for doubtful accounts for estimated losses in the collection of accounts receivable. We make estimates regarding the future ability of our customers to make required payments based on historical credit experience and expected future trends. If actual customer financial conditions are less favorable than projected by management, additional accounts receivable write offs may be necessary, which could unfavorably affect future operating results.

Inventory Reserves

We maintain reserves for excess and obsolete inventory resulting from the potential inability to sell certain products at prices in excess of current carrying costs. We make estimates regarding the future recoverability of the costs of these products and record provisions based on historical experience, expiration of sterilization dates and expected future trends. If actual product life cycles, product demand or acceptance of new product introductions are less favorable than projected by management, additional inventory write downs may be required, which could unfavorably affect future operating results.

Income Taxes

Our annual tax rate is determined based on our income, statutory tax rates and the tax impacts of items treated differently for tax purposes than for financial reporting purposes. Tax law requires certain items be included in the tax return at different times than the items are reflected in the financial statements. Some of these differences are permanent, such as expenses that are not deductible


15
 
Dollar amounts in millions except per share amounts or as otherwise specified


in our tax return, and some differences are temporary and reverse over time, such as depreciation expense. These temporary differences create deferred tax assets and liabilities.

Deferred tax assets generally represent the tax effect of items that can be used as a tax deduction or credit in future years for which we have already recorded the tax benefit in our income statement. Deferred tax liabilities generally represent tax expense recognized in our financial statements for which payment has been deferred, the tax effect of expenditures for which a deduction has already been taken in our tax return but has not yet been recognized in our financial statements or assets recorded at fair value in business combinations for which there was no corresponding tax basis adjustment.

Inherent in determining our annual tax rate are judgments regarding business plans, tax planning opportunities and expectations about future outcomes. Realization of certain deferred tax assets is dependent upon generating sufficient taxable income in the appropriate jurisdiction prior to the expiration of the carryforward periods. Although realization is not assured, management believes it is more likely than not that our deferred tax assets, net of valuation allowances, will be realized.

We operate in multiple jurisdictions with complex tax policy and regulatory environments. In certain of these jurisdictions, we may take tax positions that management believes are supportable but are potentially subject to successful challenge by the applicable taxing authority. These differences of interpretation with the respective governmental taxing authorities can be impacted by the local economic and fiscal environment. We evaluate our tax positions and establish liabilities in accordance with the applicable accounting guidance on uncertainty in income taxes. We review these tax uncertainties in light of changing facts and circumstances, such as the progress of tax audits, and adjust them accordingly. We have a number of audits in process in various jurisdictions. Although the resolution of these tax positions is uncertain, based on currently available information, we believe that it is more likely than not that the ultimate outcomes will not have a material adverse effect on our financial position, results of operations or cash flows.

Because there are a number of estimates and assumptions inherent in calculating the various components of our tax provision, certain changes or future events, such as changes in tax legislation, geographic mix of earnings, completion of tax audits or earnings repatriation plans, could have an impact on those estimates and our effective tax rate.

Acquisitions, Goodwill and Intangibles, and Long-Lived Assets

We account for acquired businesses using the purchase method of accounting. Under the purchase method, our financial statements include the operations of an acquired business starting from the completion of the acquisition. In addition, the assets acquired and liabilities assumed are recorded at the date of acquisition at their respective estimated fair values, with any excess of the purchase price over the estimated fair values of the net assets acquired recorded as goodwill.
 
Significant judgment is required in estimating the fair value of intangible assets and in assigning their respective useful lives. Accordingly, we typically obtain the assistance of third-party valuation specialists for significant items. The fair value estimates are based on available historical information and on future expectations and assumptions deemed reasonable by management but are inherently uncertain.

We typically use an income method to estimate the fair value of intangible assets, which is based on forecasts of the expected future cash flows attributable to the respective assets. Significant estimates and assumptions inherent in the valuations reflect a consideration of other marketplace participants and include the amount and timing of future cash flows (including expected growth rates and profitability), the underlying product or technology life cycles, the economic barriers to entry and the discount rate applied to the cash flows. Unanticipated market or macroeconomic events and circumstances may occur that could affect the accuracy or validity of the estimates and assumptions.

Determining the useful life of an intangible asset also requires judgment. With the exception of certain trade names, the majority of our acquired intangible assets (e.g., certain trademarks or brands, customer and distributor relationships, patents and technologies) are expected to have determinable useful lives. Our assessment as to the useful lives of these intangible assets is based on a number of factors including competitive environment, market share, trademark and/or brand history, underlying product life cycles, operating plans and the macroeconomic environment of the countries in which the trademarks or brands are sold. Our estimates of the useful lives of determinable-lived intangibles are primarily based on these same factors. Determinable-lived intangible assets are amortized to expense over their estimated useful life.

In certain of our acquisitions, we acquire in-process research and development (IPRD) intangible assets. 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 value of indefinite-lived intangible assets and goodwill is not amortized but is tested at least annually for impairment. Our impairment testing for goodwill is performed separately from our impairment testing of indefinite-lived intangibles. We perform our annual impairment test for goodwill in the fourth quarter of each year. We have adopted the provisions of Accounting Standards Update (ASU) No. 2011-08, Intangibles - Goodwill and Other: Testing Goodwill for Impairment, which permits us to consider qualitative indicators of the fair value of a reporting unit when it is unlikely that a reporting unit has impaired goodwill. In certain circumstances, we may also utilize a discounted cash flow analysis that requires certain assumptions and estimates be made regarding market conditions and our future profitability. In those circumstances we test goodwill for impairment by reviewing the book value compared to the fair value at the reporting unit level. We test individual indefinite-lived intangibles by reviewing the individual book values compared to the fair value.


16
 
Dollar amounts in millions except per share amounts or as otherwise specified


We determine the fair value of our reporting units and indefinite-lived intangible assets based on the income approach. Under the income approach, we calculate the fair value of our reporting units and indefinite-lived intangible assets based on the present value of estimated future cash flows. Considerable management judgment is necessary to evaluate the impact of operating and macroeconomic changes and to estimate future cash flows to measure fair value. Assumptions used in our impairment evaluations, such as forecasted growth rates and cost of capital, are consistent with internal projections and operating plans. We believe such assumptions and estimates are also comparable to those that would be used by other marketplace participants.

We did not recognize any material impairment charges for goodwill during the years presented, as our annual impairment testing indicated that all reporting unit goodwill fair values exceeded their respective recorded values. Future changes in the judgments, assumptions and estimates that are used in our impairment testing for goodwill and indefinite-lived intangible assets, including discount and tax rates or future cash flow projections, could result in significantly different estimates of the fair values. A significant reduction in the estimated fair values could result in impairment charges that could materially affect our financial statements.

We review our other long-lived assets for indicators of impairment whenever events or changes in circumstances indicate that the carrying amount may not be recoverable. The evaluation is performed at the lowest level of identifiable cash flows, which is at the individual asset level or the asset group level. The undiscounted cash flows expected to be generated by the related assets are estimated over their useful life based on updated projections. If the evaluation indicates that the carrying amount of the assets may not be recoverable, any potential impairment is measured based upon the fair value of the related assets or asset group as determined by an appropriate market appraisal or other valuation technique. Assets classified as held for sale, if any, are recorded at the lower of carrying amount or fair value less costs to sell.

Legal and Other Contingencies

We are involved in various ongoing proceedings, legal actions and claims arising in the normal course of business, including proceedings related to product, labor and intellectual property, and other matters that are more fully described in "Other Information" below and in Note 7 to the Consolidated Financial Statements. 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 future operating results. The Company is 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.
NEW ACCOUNTING PRONOUNCEMENTS
No accounting pronouncements that were issued or became effective during the year have had or are expected to have a material impact on our Consolidated Financial Statements.
OTHER INFORMATION
Hedging and Derivative Financial Instruments
We sell our products throughout the world. As a result, our financial results could be significantly affected by factors such as weak economic conditions or changes in foreign currency exchange rates. Our operating results are primarily exposed to changes in exchange rates among the United States dollar; European currencies, in particular the euro, Swiss franc and the British pound; the Japanese yen; the Australian dollar; and the Canadian dollar. We develop and manufacture products in the United States, China, France, Germany, Ireland, Puerto Rico and Switzerland and incur costs in the applicable local currencies. This worldwide deployment of facilities serves to partially mitigate the impact of currency exchange rate changes on our cost of sales.
We enter into designated and non-designated forward currency exchange contracts to mitigate the impact of currency fluctuations on transactions denominated in nonfunctional currencies, thereby limiting risk that would otherwise result from changes in exchange rates. These nonfunctional currency exposures principally relate to intercompany receivables and payables arising from intercompany purchases of manufactured products. The periods of the forward currency exchange contracts correspond to the periods of the exposed transactions, with realized gains and losses included in the measurement and recording of transactions denominated in the nonfunctional currencies. All forward currency exchange contracts are recorded at their fair value each period, with resulting gains (losses) for non-designated forward contracts and any ineffectiveness measured on designated forward currency exchange contracts included in our Consolidated Statements of Earnings. For derivative instruments that are designated and qualify as a cash flow hedge, the effective portion of the gain or loss on the derivative is reported as a component of accumulated other comprehensive income, and reclassified into earnings in the same period during which the hedged transaction affects earnings.
The estimated fair value of forward currency exchange contracts represents the measurement of the contracts at month-end spot rates as adjusted by current forward points. A hypothetical 10% change in foreign currencies relative to the United States dollar would change the December 31, 2013 fair value by approximately $6. We are exposed to credit loss in the event of nonperformance by counterparties on our outstanding forward currency exchange


17
 
Dollar amounts in millions except per share amounts or as otherwise specified


contracts, but we do not anticipate nonperformance by any of our counterparties.
We have certain investments in net assets in international locations that are not hedged. These investments are subject to translation gains and losses due to changes in foreign currency exchange rates. For 2013 the strengthening of foreign currencies relative to the United States dollar increased the value of these investments in net assets and the related foreign currency translation adjustment gain in shareholders' equity by $80 to $306, from $226 as of December 31, 2012.
Legal and Regulatory Matters
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 the above matter, including $47 in the year ended December 31, 2013.

In June 2012 we voluntarily recalled our Rejuvenate and ABG II modular-neck hip stems and terminated global distribution of these hip products. We notified healthcare professionals and regulatory bodies of this recall, which was taken due to potential risks associated with fretting and/or corrosion that may lead to adverse local tissue reactions. Product liability lawsuits relating to this voluntary recall have been filed against us. As previously announced, we intend to reimburse implanted patients for reasonable and customary costs of testing and treatment services, including any necessary revision surgeries. We continue to work with the medical community to evaluate the data and further understand this matter and the associated costs. The ultimate total cost with respect to this matter will depend on many factors that are difficult to predict with the information received to date and may vary materially based on the number of and actual costs of patients seeking testing and treatment services, the number of and actual costs of patients requiring revision surgeries, the number of and actual costs to settle lawsuits filed against us, and the amount of third-party insurance recoveries.  Based on the information that has been received, the actuarially determined range of probable loss to resolve this matter is estimated to be approximately $790 to $1,235, before third-party insurance recoveries.  In the year ended December 31, 2013, we recorded charges to earnings of $600 representing the excess of the $790 minimum of the range over the previously recorded reserves. No contingent gain for third-party insurance recoveries was recorded as of December 31, 2013. As noted above, the final outcome of this matter is dependent on many variables that are difficult to predict.  The ultimate cost to entirely resolve this matter may be materially different than the amount of the current estimate and accruals and could have a material adverse effect on our financial position, results of operations and cash flows.
In 2010 we filed a lawsuit in federal court against Zimmer Holdings, Inc. (Zimmer), alleging that a Zimmer product infringed three of our patents. In rulings issued in August and September
 
2013, the trial judge upheld the February 2013 jury verdict in our favor, issued a permanent injunction barring Zimmer from making or selling infringing products, and ordered Zimmer to pay us at least $228. Zimmer is appealing this ruling and the ultimate resolution of this matter may differ materially. Accordingly, we have not recorded a contingent gain related to this matter.

For each of the following legal matters the final outcome is dependent on many variables and cannot be predicted. Accordingly, it is not possible at this time for us to estimate any material loss or range of losses. However, the ultimate cost to resolve these matters could have a material adverse effect on our financial position, results of operations and cash flows.

In April 2011 lawsuits brought by Hill-Rom Company, Inc. and affiliated entities (Hill-Rom) against us were filed in the United States District Court for the Western District of Wisconsin and the United States District Court for the Southern District of Indiana.  The Wisconsin lawsuit was subsequently transferred to the United States District Court in Indiana. The suits allege infringement under United States patent laws with respect to certain patient handling equipment we manufactured and sold and seek damages and permanent injunctions. We have entered into an agreement settling the first lawsuit, with terms as previously disclosed. The second lawsuit involves nine patents related to electrical network communications for hospital beds. The case has been stayed with respect to six of the patents, which are currently under reexamination by the United States Patent Office. With respect to the three remaining patents, Hill-Rom is appealing the trial court's grant of summary judgment in our favor and the ultimate resolution of this particular part of the suit may differ. 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 ultimate 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, 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.
ITEM 7A.
QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
We consider our material area of market risk exposure to be exchange rate risk. Quantitative and qualitative disclosures about exchange rate risk are included in the "Other Information" section of Management's Discussion and Analysis of Financial Condition in Item 7, under the caption Other Information - "Hedging and Derivative Financial Instruments".



18
 
Dollar amounts in millions except per share amounts or as otherwise specified


ITEM 8.
FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA.
REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM ON CONSOLIDATED FINANCIAL STATEMENTS
The Board of Directors and Shareholders of Stryker Corporation:

We have audited the accompanying consolidated balance sheets of Stryker Corporation and subsidiaries as of December 31, 2013 and 2012, and the related consolidated statements of earnings and comprehensive income, shareholders' equity, and cash flows for each of the three years in the period ended December 31, 2013. Our audits also included the financial statement schedule listed in the Index at Item 15(a). These financial statements and schedule are the responsibility of the Company's management. Our responsibility is to express an opinion on these financial statements and schedule based on our audits.

We conducted our audits in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.

In our opinion, the financial statements referred to above present fairly, in all material respects, the consolidated financial position of Stryker Corporation and subsidiaries at December 31, 2013 and 2012, and the consolidated results of their operations and their cash flows for each of the three years in the period ended December 31, 2013, in conformity with U.S. generally accepted accounting principles. Also, in our opinion, the related financial statement schedule, when considered in relation to the basic financial statements taken as a whole, presents fairly in all material respects the information set forth therein.

We also have audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States), Stryker Corporation's internal control over financial reporting as of December 31, 2013, based on criteria established in Internal Control-Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission (1992 framework) and our report dated February 13, 2014 expressed an unqualified opinion thereon.


/s/    ERNST & YOUNG LLP
Grand Rapids, Michigan
February 13, 2014



19
 
Dollar amounts in millions except per share amounts or as otherwise specified


Stryker Corporation and Subsidiaries

CONSOLIDATED STATEMENTS OF EARNINGS
 
 
Years Ended December 31
 
 
2013
 
2012
 
2011
Net sales
 
$
9,021

 
$
8,657

 
$
8,307

Cost of sales
 
2,977

 
2,781

 
2,811

Gross profit
 
6,044

 
5,876

 
5,496

Research, development and engineering expenses
 
536

 
471

 
462

Selling, general and administrative expenses
 
4,066

 
3,466

 
3,150

Intangible asset amortization
 
138

 
123

 
122

Restructuring charges
 
48

 
75

 
76

Total operating expenses
 
4,788

 
4,135

 
3,810

Operating income
 
1,256

 
1,741

 
1,686

Other income (expense), net
 
(44
)
 
(36
)
 

Earnings before income taxes
 
1,212

 
1,705

 
1,686

Income taxes
 
206

 
407

 
341

Net earnings
 
$
1,006

 
$
1,298

 
$
1,345

 
 
 
 
 
 
 
Net earnings per share of common stock:
 
 
 
 
 
 
  Basic net earnings per share of common stock
 
$
2.66

 
$
3.41

 
$
3.48

  Diluted net earnings per share of common stock
 
$
2.63

 
$
3.39

 
$
3.45

 
 
 
 
 
 
 
Weighted-average shares outstanding—in millions:
 
 
 
 
 
 
Basic
 
378.6

 
380.6

 
386.5

Net effect of dilutive employee stock options
 
3.5

 
2.4

 
3.0

Diluted
 
382.1

 
383.0

 
389.5

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

 
6.4

 
7.8


CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME
 
 
Years Ended December 31
 
 
2013
 
2012
 
2011
Net earnings
 
$
1,006

 
$
1,298

 
$
1,345

Unrealized gains (losses) on securities, net of tax (expense) benefit of $1, ($1) and $1, respectively
 
(4
)
 
4

 
(2
)
Unfunded pension gains (losses), net of tax (expense) benefit of ($15), $25 and ($8), respectively
 
20

 
(69
)
 
12

Unrealized gains on designated hedges, net of tax expense of $4, $0 and $0, respectively
 
7

 

 

Foreign currency translation adjustments
 
80

 
50

 
(20
)
Total other comprehensive income (loss)
 
103

 
(15
)
 
(10
)
Comprehensive income
 
$
1,109

 
$
1,283

 
$
1,335


See accompanying notes to Consolidated Financial Statements.

20
 
Dollar amounts in millions except per share amounts or as otherwise specified


Stryker Corporation and Subsidiaries

CONSOLIDATED BALANCE SHEETS
 
 
December 31
 
2013
 
2012
ASSETS
 
 
 
 
Current assets
 
 
 
 
Cash and cash equivalents
 
$
1,339

 
$
1,395

Marketable securities
 
2,641

 
2,890

Accounts receivable, less allowance of $72 ($58 in 2012)
 
1,518

 
1,430

Inventories
 
 
 
 
Materials and supplies
 
227

 
202

Work in process
 
85

 
71

Finished goods
 
1,110

 
992

Total inventories
 
1,422

 
1,265

Deferred income taxes
 
880

 
811

Prepaid expenses and other current assets
 
535

 
357

Total current assets
 
8,335

 
8,148

Property, plant and equipment
 
 
 
 
Land, buildings and improvements
 
686

 
625

Machinery and equipment
 
1,811

 
1,607

Total property, plant and equipment
 
2,497

 
2,232

Less allowance for depreciation
 
1,416

 
1,284

Net property, plant and equipment
 
1,081

 
948

Other assets
 
 
 
 
Goodwill
 
3,844

 
2,142

Other intangibles, net
 
1,989

 
1,424

Other
 
494

 
544

Total assets
 
$
15,743

 
$
13,206

 
 
 
 
 
LIABILITIES AND SHAREHOLDERS' EQUITY
 
 
 
 
Current liabilities
 
 
 
 
Accounts payable
 
314

 
288

Accrued compensation

535

 
467

Income taxes

131

 
70

Dividend payable

115

 
101

Accrued expenses and other liabilities

1,537

 
934

Current maturities of debt

25

 
16

Total current liabilities

2,657

 
1,876

Long-term debt, excluding current maturities
 
2,739

 
1,746

Other liabilities

1,300

 
987

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

 
38

Additional paid-in capital
 
1,160

 
1,098

Retained earnings
 
7,617

 
7,332

Accumulated other comprehensive income
 
232

 
129

Total shareholders' equity
 
9,047

 
8,597

Total liabilities & shareholders' equity
 
$
15,743

 
$
13,206


See accompanying notes to Consolidated Financial Statements.

21
 
Dollar amounts in millions except per share amounts or as otherwise specified


Stryker Corporation and Subsidiaries

CONSOLIDATED STATEMENTS OF SHAREHOLDERS’ EQUITY
 
 
Common
Stock
 
Additional
Paid-In
Capital
 
Retained
Earnings
 
Accumulated
Other
Comprehensive
Income
 
Total
Balances at January 1, 2011
 
$
39

 
$
964

 
$
6,017

 
$
154

 
$
7,174

Net earnings