10-Q 1 syk10q06302015.htm 10-Q SYK 10Q 6.30.15


 

UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
___________________________

FORM 10-Q
(Mark one)
 
[X]
QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the quarterly period ended June 30, 2015

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)
 
 
 
(269)-385-2600
(Registrant’s telephone number, including area code)

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.                          YES [X]          NO [   ]

Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).                 YES [X]         NO [   ]

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company. See the definitions of "large accelerated filer," "accelerated filer" and "smaller reporting company" in Rule 12b-2 of the Exchange Act.

Large accelerated filer
[X]
 
Accelerated filer
[ ]
 
 
 
 
 
Non-accelerated filer
[ ]
 
Small reporting company
[ ]

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).    YES [   ]        NO [X]

Number of shares outstanding of each of the issuer’s classes of common stock, as of the latest practicable date: 376,558,214 shares of Common Stock, $0.10 par value, as of June 30, 2015.
 


STRYKER CORPORATION
 
2015 Second Quarter Form 10-Q

PART I. - FINANCIAL INFORMATION
ITEM 1.
FINANCIAL STATEMENTS.
Stryker Corporation and Subsidiaries

CONSOLIDATED STATEMENTS OF EARNINGS (Unaudited)
 
 
Three Months
 
Six Months

 
2015
 
2014
 
2015
 
2014
Net sales
 
$
2,432

 
$
2,363

 
$
4,811

 
$
4,668

Cost of sales
 
827

 
815

 
1,653

 
1,591

Gross profit
 
1,605

 
1,548

 
3,158

 
3,077

Research, development and engineering expenses
 
154

 
158

 
306

 
308

Selling, general and administrative expenses
 
861

 
870

 
1,753

 
1,729

Recall charges
 
112

 
276

 
166

 
620

Intangible asset amortization
 
49

 
47

 
98

 
92

Total operating expenses
 
1,176

 
1,351

 
2,323

 
2,749

Operating income
 
429

 
197

 
835

 
328

Other income (expense), net
 
(28
)
 
(30
)
 
(57
)
 
(54
)
Earnings before income taxes
 
401

 
167

 
778

 
274

Income taxes
 
9

 
39

 
162

 
76

Net earnings
 
$
392

 
$
128

 
$
616

 
$
198

 
 
 
 
 
 
 
 
 
Net earnings per share of common stock:
 
 
 
 
 
 
 
 
Basic net earnings per share of common stock
 
$1.04
 
$0.34
 
$1.63
 
$0.52
Diluted net earnings per share of common stock
 
$1.03
 
$0.33
 
$1.61
 
$0.51
 
 
 
 
 
 
 
 
 
Weighted-average shares outstanding - in millions:
 
 
 
 
 
 
 
 
Basic
 
377.0

 
378.8

 
377.9

 
378.5

Net effect of dilutive employee stock options
 
4.1

 
3.9

 
4.3

 
4.2

Diluted
 
381.1

 
382.7

 
382.2

 
382.7

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

 

 

 
2.5



CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME (Unaudited)
 
 
Three Months
 
Six Months
 
 
2015
 
2014
 
2015
 
2014
Net earnings
 
$
392

 
$
128

 
$
616

 
$
198

Other comprehensive income, net of tax
 
 
 
 
 
 
 
 
Marketable securities
 
(4
)
 
4

 
(3
)
 
7

Pension plans
 
(3
)
 
1

 
10

 

Unrealized gains on designated hedges
 
10

 
(9
)
 
11

 
(12
)
Financial statement translation
 
87

 
(33
)
 
(195
)
 
4

Total other comprehensive (loss) income, net of tax
 
90

 
(37
)
 
(177
)
 
(1
)
Comprehensive income
 
$
482

 
$
91

 
$
439

 
$
197


See accompanying notes to Consolidated Financial Statements.

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

STRYKER CORPORATION
 
2015 Second Quarter Form 10-Q

Stryker Corporation and Subsidiaries

CONSOLIDATED BALANCE SHEETS
 
 
June 30
 
December 31
 
2015
 
2014
 
 
Unaudited
 
 
ASSETS
 
 
 
 
Current assets
 
 
 
 
Cash and cash equivalents
 
$
3,626

 
$
1,795

Marketable securities
 
651

 
3,205

Accounts receivable, less allowance of $62 ($59 in 2014)
 
1,500

 
1,572

Inventories
 
 
 
 
Materials and supplies
 
270

 
248

Work in Process
 
104

 
88

Finished Goods
 
1,245

 
1,252

Total inventories
 
1,619

 
1,588

Deferred income taxes
 
955

 
989

Prepaid expenses and other current assets
 
585

 
524

Total current assets
 
8,936

 
9,673

Property, plant and equipment
 
 
 
 
Land, buildings and improvements
 
680

 
678

Machinery and equipment
 
1,924

 
1,919

Total property, plant and equipment
 
2,604

 
2,597

Less allowance for depreciation
 
1,502

 
1,499

Net property, plant and equipment
 
1,102

 
1,098

Other assets
 
 
 
 
Goodwill
 
4,125

 
4,186

Other intangibles, net
 
1,925

 
2,018

Other
 
731

 
738

Total assets
 
$
16,819

 
$
17,713

 
 
 
 
 
LIABILITIES AND SHAREHOLDERS' EQUITY
 
 
 
 
Current liabilities
 
 
 
 
Accounts payable
 
$
342

 
$
329

Accrued compensation
 
440

 
597

Income taxes
 
157

 
333

Dividend payable
 
130

 
131

Accrued recall expenses
 
1,688

 
1,593

Accrued expenses and other liabilities
 
739

 
754

Current maturities of debt
 
227

 
727

Total current liabilities
 
3,723

 
4,464

Long-term debt, excluding current maturities
 
3,242

 
3,246

Other liabilities
 
1,349

 
1,408

Shareholders' equity
 
 
 
 
Common stock, $0.10 par value:
 
 
 
 
Authorized: 1 billion shares, outstanding: 377 million shares (378 million in 2014)
 
38

 
38

Additional paid-in capital
 
1,298

 
1,252

Retained earnings
 
7,600

 
7,559

Accumulated other comprehensive income
 
(431
)
 
(254
)
Total shareholders' equity
 
8,505

 
8,595

Total liabilities & shareholders' equity
 
$
16,819

 
$
17,713


See accompanying notes to Consolidated Financial Statements.


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

STRYKER CORPORATION
 
2015 Second Quarter Form 10-Q

Stryker Corporation and Subsidiaries

CONSOLIDATED STATEMENT OF SHAREHOLDERS’ EQUITY (Unaudited)
 
 
Common
Stock
 
Additional
Paid-In
Capital
 
Retained
Earnings
 
Accumulated
Other
Comprehensive
Loss
 
Total
Balances at December 31, 2014
 
$
38

 
$
1,252

 
$
7,559

 
$
(254
)
 
$
8,595

Net earnings
 

 

 
616

 

 
616

Other comprehensive loss
 

 

 

 
(177
)
 
(177
)
Issuance of 1.5 million shares of common stock under stock option and benefit plans, including $46 excess income tax benefit
 


 
14

 

 

 
14

Repurchase and retirement of 3.5 million shares of common stock
 

 
(12
)
 
(312
)
 

 
(324
)
Share-based compensation
 

 
44

 

 

 
44

Cash dividends declared of $0.69 per share of common stock
 

 

 
(263
)
 

 
(263
)
Balances at June 30, 2015
 
$
38

 
$
1,298

 
$
7,600

 
$
(431
)
 
$
8,505



CONSOLIDATED STATEMENTS OF CASH FLOWS (Unaudited)
 
Six Months
 
2015
 
2014
Operating activities
 
 
 
Net earnings
$
616

 
$
198

Adjustments to reconcile net earnings to net cash provided by operating activities:
 
 
 
Depreciation
90

 
93

Amortization of intangible assets
98

 
92

Share-based compensation
44

 
41

Gross recall charges
166

 
620

Sale of inventory stepped up to fair value at acquisition
13

 
14

Changes in operating assets and liabilities, net of effects of acquisitions:
 
 
 
Accounts receivable
39

 
53

Inventories
(67
)
 
(120
)
Accounts payable
17

 
11

Accrued expenses and other liabilities
(125
)
 
(134
)
Recall-related payments
(31
)
 
(36
)
Income taxes
(251
)
 
(137
)
Other
128

 
(116
)
Net cash provided by operating activities
737

 
579

Investing activities
 
 
 
Acquisitions, net of cash acquired
(92
)
 
(457
)
Purchases of marketable securities
(1,137
)
 
(2,597
)
Proceeds from sales of marketable securities
3,569

 
1,812

Purchases of property, plant and equipment
(114
)
 
(124
)
Net cash provided by (used in) investing activities
2,226

 
(1,366
)
Financing activities
 
 
 
Proceeds from borrowings
1,014

 
1,813

Payments on borrowings
(1,512
)
 
(720
)
Dividends paid
(261
)
 
(231
)
Repurchase and retirement of common stock
(324
)
 
(60
)
Other financing
32

 
(35
)
Net cash (used in) provided by financing activities
(1,051
)
 
767

Effect of exchange rate changes on cash and cash equivalents
(81
)
 

Change in cash and cash equivalents
1,831

 
(20
)
Cash and cash equivalents at beginning of year
1,795

 
1,339

Cash and cash equivalents at end of year
$
3,626

 
$
1,319


See accompanying notes to Consolidated Financial Statements.

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

STRYKER CORPORATION
 
2015 Second Quarter Form 10-Q


NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Unaudited)

NOTE 1 - BASIS OF PRESENTATION
General Information
These statements should be read in conjunction with our Annual Report on Form 10-K for 2014. Management believes that the accompanying unaudited Consolidated Financial Statements include all adjustments, including normal recurring items, considered necessary for a fair presentation of the interim periods. However, the results of operations included in such financial statements may not necessarily be indicative of annual results.
To conform with the current year presentation, certain immaterial
amounts previously reported as selling, general and administrative
expenses have been reclassified to cost of sales. In addition, certain prior year amounts have been reclassified to conform to the current year presentation of our segment information in Note 10.
New Accounting Pronouncements Not Yet Adopted
In May 2014 the FASB issued ASU 2014-09, Revenue from Contracts with Customers. This guidance outlines a single, comprehensive model for accounting for revenue from contracts with customers. We will adopt the standard on January 1, 2018. We are still evaluating the impact, if any, that the standard will have on our financial statements.
In April 2015 the FASB issued ASU 2015-03, Interest - Imputation of Interest: Simplifying the Presentation of Debt Issuance Costs. This update requires an entity to present debt issuance costs related to a recognized debt liability as a direct deduction from the carrying amount of that debt liability consistent with debt discounts and is effective for financial statements issued for fiscal years beginning after December 15, 2015 and interim periods within those fiscal years. We plan to adopt this standard on January 1, 2016 and do not expect it to have a material impact on the Consolidated Financial Statements.
No other new accounting pronouncement issued or effective during the period had or is expected to have a material impact on the Consolidated Financial Statements.
NOTE 2 - FAIR VALUE MEASUREMENTS
Financial assets and liabilities carried at fair value are classified and disclosed in one of the following three categories:
Level 1
Quoted market prices in active markets for identical assets or liabilities.
Level 2
Observable market-based inputs or unobservable inputs that are corroborated by market data.
Level 3
Unobservable inputs reflecting our assumptions or external inputs from active markets.
When applying fair value principles in the valuation of assets and liabilities, we are required to maximize the use of quoted market prices and minimize the use of unobservable inputs. We calculate the fair value of our Level 1 and Level 2 instruments based on the exchange traded price of similar or identical instruments, where available, or based on other observable inputs taking into account our credit risk and that of our counterparties. Foreign currency exchange contracts and interest rate hedges are included in Level 2 as we use inputs other than quoted prices that are observable for the asset or liability. The Level 2 derivative instruments are primarily valued using standard calculations and models that use readily observable market data as their basis. Our Level 3 liabilities represent milestone payments for acquisitions and the fair value is calculated based on the net present value of expected cash flows
 
utilizing a discounted cash flow technique based on externally provided or obtained inputs, including our probability assessments of the occurrence of triggering events, appropriately discounted considering the uncertainties associated with the obligation. There were no significant transfers into or out of any level between December 31, 2014 and June 30, 2015.
We remeasure our assets and liabilities each reporting period and record the changes in fair value from changes in probability of occurrence in selling, general and administrative expense and the changes in time value of money in other income (expense). During the period we evaluated but did not change our unobservable input assumptions and fair value techniques used in measuring the fair value of our financial assets or liabilities from those disclosed in our Annual Report on Form 10-K for 2014.
Our valuation of our assets and liabilities measured at fair value is:
 
June
December
 
2015
2014
Cash and cash equivalents
$
3,626

$
1,795

Trading marketable securities
80

80

Level 1 - Assets
$
3,706

$
1,875

Available-for-sale marketable securities
 
 
Corporate and asset-backed debt securities
264

1,525

Foreign government debt securities
101

726

United States agency debt securities
185

382

United States treasury debt securities
72

474

Certificates of deposit
28

110

Other
4

12

Total available-for-sale marketable securities
654

3,229

Foreign currency exchange forward contracts
25

32

Interest rate swap asset
15

10

Level 2 - Assets
694

3,271

Total assets measured at fair value
$
4,400

$
5,146

 
 
 
Deferred compensation arrangements
80

80

Level 1 - Liabilities
80

80

Foreign currency exchange forward contracts
10

12

Level 2 - Liabilities
10

12

Contingent consideration
 
 
     Beginning Balance
48

59

     Losses included in earnings
2

4

     Settlements
(3
)
(15
)
     Balance at the end of the period
47

48

Level 3 - Liabilities
47

48

Total liabilities measured at fair value
$
137

$
140

The cost and estimated fair value of available-for-sale marketable securities at June 30, 2015 by contractual maturity are:
 
Cost
Estimated
Fair Value
Due in one year or less
$
489

$
489

Due after one year through three years
161

161

Due after three years
4

4

Less than 1% of our investments in available-for-sale securities had a credit quality rating of less than A2 (Moody's), A (Standard & Poors) and A (Fitch). We do not intend to sell the investments and it is not more likely than not that we will be required to sell the investments before recovery of their amortized cost basis, which may be maturity; accordingly, we do not consider investments with cost in excess of fair value to be other-than-temporarily impaired at June 30, 2015.
Upon the sale of a security classified as available-for-sale, the security’s specific unrealized gain (loss) is reclassified out of


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

STRYKER CORPORATION
 
2015 Second Quarter Form 10-Q

accumulated other comprehensive income (AOCI) into earnings based on the specific identification method. In the 2015 three months we sold a portion of our marketable securities in preparation for recall-related payments and other cash management activity in July 2015. See Note 5 for more information.
The total of interest and marketable securities income was $5 for the 2015 and 2014 three months, and $11 for the 2015 and 2014 six months. The amounts are included in other income (expense).
Summary of marketable securities:

June
December
 
2015
2014
Available for Sale Securities:
Amortized Cost
  Corporate and asset-backed debt securities
$
264

$
1,523

  Foreign government debt securities
101

725

  United States agency debt securities
185

382

  United States treasury debt securities
72

474

  Certificates of deposit
28

110

  Other
4

12

 
Gross Unrealized Gains
  Corporate and asset-backed debt securities
$

$
3

  Foreign government debt securities

2

 
Gross Unrealized Losses
  Corporate and asset-backed debt securities
$

$
(1
)
  Foreign government debt securities

(1
)
 
Estimated Fair Value
  Corporate and asset-backed debt securities
$
264

$
1,525

  Foreign government debt securities
101

726

  United States agency debt securities
185

382

  United States treasury debt securities
72

474

  Certificates of deposit
28

110

  Other
4

12

Total available-for-sale marketable securities
$
654

$
3,229

Trading marketable securities
80

80

Total marketable securities
$
734

$
3,309

Reported as:
 
 
Current assets - marketable securities
$
651

$
3,205

Current assets - prepaid expenses and other
3

24

Noncurrent assets - other
80

80

At June 30, 2015, the fair value and gross unrealized losses of our investments with unrealized losses that are not deemed to be other-than-temporarily impaired, aggregated by investment category and length of time that the individual securities have been in a continuous unrealized loss position are:
 
Number of Investments
Fair Value
Unrealized Losses
   Corporate and asset-backed
73
$
111

$

   Foreign Government
6
27


   United States Agency
7
14


   United States Debt
2
19


   Certificate of deposit
5
17


Less than 12 months
93
$
188

$

 
 
 
 
   Corporate and asset-backed
73
$
111

$

   Foreign Government
7
28


   United States Agency
7
14


United States Debt
2
19


Certificate of Deposit
5
17


Total
94
$
189

$

NOTE 3 - DERIVATIVE INSTRUMENTS
We use operational and economic hedges as well as foreign currency exchange forward contracts and interest rate derivative instruments to manage the impact of currency exchange on earnings and cash flow.
 
Foreign Exchange Forward Contract Derivatives
We have not changed our hedging strategies or objectives from those disclosed in our Annual Report on Form 10-K for 2014.
The gross notional, maximum term and gross fair value amounts of foreign exchange forward contract derivatives designated and non-designated as hedging instruments are:
 
 
Designated
 
Non-Designated
 
Total
June 30, 2015
 
 
 
 
 
 
Gross Notional Amount
 
$
567

 
$
3,307

 
$
3,874

Maximum term in days
 
 
 
 
 
546

Fair Value
 
 
 
 
 
 
     Other Current Assets
 
$
18

 
$
6

 
$
24

     Other Noncurrent Assets
 
1

 

 
1

     Other Current Liabilities
 
(2
)
 
(8
)
 
(10
)
 
 
$
17

 
$
(2
)
 
$
15

December 31, 2014
 
 
 
 
 
 
Gross Notional Amount
 
$
357

 
$
2,085

 
$
2,442

Maximum term in days
 
 
 
 
 
546

Fair Value
 
 
 
 
 
 
     Other Current Assets
 
$
18

 
$
12

 
$
30

     Other Noncurrent Assets
 
2

 

 
2

     Other Current Liabilities
 

 
(12
)
 
(12
)
 
 
$
20

 
$

 
$
20

The net currency exchange rate gains (losses) for both designated and non-designated derivative instruments and the underlying amounts are:
 
 
Three Months
 
Six Months
Recorded In:
 
2015
2014
 
2015
2014
Cost of goods sold
 
$
5

$
3

 
$
5

$
5

Other income (expense)
 
(7
)
(3
)
 
(11
)
(9
)
Total
 
$
(2
)
$

 
$
(6
)
$
(4
)
Pretax gains on derivatives designated as hedges that are expected to be reclassified from AOCI into earnings within the next twelve months is $21. This reclassification is primarily due to the sale of inventory that includes previously hedged purchases. There have been no ineffective portions of derivatives that have resulted in gains or losses in any of the periods presented.
Interest Rate Risk on Refinancing of 2016 Debt Maturity
Forward starting interest rate derivative instruments designated as cash flow hedges are used to manage the exposure to interest rate volatility with regard to future refinancing of debt. The effective portion of the gains or losses on the forward starting interest rate derivative instrument that is designated and qualifies as a cash flow hedge is reported as a component of AOCI. Beginning in the period in which the planned debt refinancing occurs and the related derivative instrument is terminated, the effective portion of the gains or losses is then reclassified into interest expense, net over the term of the related debt.
At June 30, 2015 we had interest rate swaps with a notional amount of $375 designated as forward starting interest rate swaps in anticipation of refinancing $750 of senior unsecured notes maturing on September 30, 2016. The market value of outstanding interest rate swap agreements at June 30, 2015 was $11, which is recorded in other long-term assets with an offsetting amount recorded in AOCI in the consolidated balance sheet. There was no hedge ineffectiveness recorded as a result of these cash flow hedges.
Fair Value Hedges
Interest rate derivative instruments designated as fair value hedges are used to manage the exposure to interest rate movements and to reduce borrowing costs by converting fixed-rate debt into floating-rate debt. Under these agreements we agree to exchange, at


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

STRYKER CORPORATION
 
2015 Second Quarter Form 10-Q

specified intervals, the difference between fixed and floating interest amounts calculated by reference to an agreed-upon notional principal amount.
At June 30, 2015 we had interest rate swaps in gross notional amounts of $500 designated as fair value hedges of underlying fixed rate obligations representing a portion of our $600 senior unsecured notes due in 2024. There was no hedge ineffectiveness recorded as a result of these fair value hedges.
Certain amounts related to our fair value hedge instrument are:
 
 
June 2015
 
December 2014
Gross Notional Amount
 
$
500

 
$
500

Fair Value
 
 
 
 
     Other Noncurrent Assets
 
4

 
10

     Other Noncurrent Liabilities
 
(4
)
 
(10
)
 
 
$

 
$

We are exposed to credit loss in the event of nonperformance by counterparties on our outstanding derivative instruments but do not anticipate nonperformance by any of our counterparties. Should a counterparty default, our maximum exposure to loss is the asset balance of the instrument.
NOTE 4 - ACQUISITIONS
In January 2015 we completed the acquisition of certain assets of CHG Hospital Beds, Inc. (CHG) in an all cash transaction. CHG designs, manufactures and markets a series of low-height hospital beds and related accessories. This acquisition enhances our product offerings within our MedSurg segment. The acquisition is included in the "Other" column in the table below.
In 2014 we completed the acquisition of certain assets of Small Bone Innovations, Inc. (SBi) for an aggregate purchase price of approximately $365, the acquisition of Berchtold Holding, AG (Berchtold) for an aggregate purchase price of approximately $184 and the acquisition of Patient Safety Technologies, Inc. (PST) for an aggregate purchase price of $120. The acquired net assets of other business acquisitions completed in 2014 are in the "Other" column in the table below.
The allocation of the purchase prices of each acquisition to the acquired net assets is as follows:
 
2015
 
2014
 
Other
 
SBi
Berchtold
PST
Other
Purchase price paid
$
80

 
$
365

$
184

$
120

$
216

Contingent consideration
5

 
$




Total purchase consideration
$
85

 
$
365

$
184

$
120

$
216

Tangible assets:


 
 
 
 
 
Cash

 

12



Inventory
5

 
34

22

7

5

Other assets
12

 
4

44

19

25

Liabilities
(4
)
 
(2
)
(45
)
(31
)
(29
)
Intangible assets:

 
 
 
 
 
Customer relationship
9

 
19

11

33

5

Trade name
1

 

7



Developed technology & patents
36

 
82

32

26

115

Non-compete agreements
2

 




IPRD

 



2

Goodwill
24

 
228

101

66

93

 
$
85

 
$
365

$
184

$
120

$
216

Weighted-average life of intangible assets
9

 
12

8

14

12

The measurement periods for Berchtold, PST and certain other acquisitions in 2014 have been completed. Revisions to the original purchase price allocation were not material. The purchase price
 
allocations for CHG, SBi and certain other acquisitions are based upon preliminary valuations, and our estimates and assumptions are subject to change within the measurement period as the valuations are finalized. We are in the process of verifying data and information related to these acquisitions to finalize the recording of identifiable intangible assets, deferred income taxes and goodwill. Goodwill acquired associated with the SBi and CHG acquisitions is deductible for tax purposes.
The effects of all the acquisitions described above are included in our Consolidated Financial Statements prospectively from the close of the respective acquisition. Pro forma consolidated results of operations for the three or six months 2015 and 2014 would not differ significantly as a result of these acquisitions.
The estimated amortization expense for our amortizable intangible assets for the next five years is:
 
Remainder of 2015
2016
2017
2018
2019
Amortization expense
$
100

$
170

$
168

$
152

$
135

NOTE 5 - CONTINGENCIES AND COMMITMENTS
We are involved in various ongoing proceedings, legal actions and claims arising in the normal course of business, including proceedings related to product, labor, intellectual property and other matters that are more fully described below. 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, 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 estimated by management, additional expense may be incurred, which could unfavorably affect future operating results. We are currently self-insured for product liability-related claims and expenses. The ultimate cost to us with respect to product liability claims could be materially different than the amount of the current estimates and accruals and could have a material adverse effect on our financial position, results of operations and cash flows.
In June 2012 we voluntarily recalled our Rejuvenate and ABG II Modular-Neck hip stems and terminated global distribution of these hip products. Product liability lawsuits relating to this voluntary recall have been filed against us. On November 3, 2014 we announced that we had entered into a settlement agreement to compensate eligible United States patients who had revision surgery to replace their Rejuvenate and/or ABG II Modular-Neck hip stem prior to that date. We continue to offer support for recall-related care and reimburse patients who are not eligible to enroll in the settlement program for testing and treatment services, including any necessary revision surgeries. In addition, some lawsuits will remain and we will continue to defend against them. Based on the information that has been received, the actuarially determined range of probable loss to resolve this matter on a global basis is estimated to be approximately $1,699 ($1,878 before $179 of third-party insurance recoveries) to $2,539.  In the 2015 three months, we recorded charges to earnings of $112 representing the excess of the minimum of the range over the previously recorded reserves. In July 2015 we made initial payments totaling $1,078 to eligible United States patients who had revision surgery to replace their Rejuvenate and/


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

STRYKER CORPORATION
 
2015 Second Quarter Form 10-Q

or ABG II Modular-Neck hip stem as part of the settlement agreement. The final outcome of this matter is dependent on many factors that are difficult to predict including the number of enrollees in the settlement program and the total awards to them, the number and costs of patients not eligible for the settlement program who seek testing and treatment services and require revision surgery and the number and actual costs to resolve the remaining lawsuits. Accordingly, the ultimate cost to resolve this entire matter globally 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 2013 following a jury trial favorable to us, the trial judge entered a final judgment that among other things, awarded us damages of $76 and ordered Zimmer to pay us enhanced damages. Zimmer appealed this ruling. In December 2014 the Federal Circuit affirmed the damages awarded to us, reversed the order for enhanced damages and remanded the issue of attorney fees to the trial court. The Federal Circuit denied our petition for a rehearing en banc on the issue of enhanced damages, and we have filed a petition for writ of certiorari with the Supreme Court to review this issue. In May 2015 the trial court entered a stipulated final judgment that, among other things, required Zimmer to pay us the base amount of damages and interest by July 15, 2015, while the issues of enhanced damages and attorney fees continue to be pursued. We concluded that all of the contingencies associated with this payment were resolved when the judgment was entered. Accordingly, we recorded a gain of $54, net of legal costs, to selling, general and administrative expenses in the 2015 three months. On July 15, 2015 we received the payment from Zimmer.
In April 2011 Hill-Rom Company, Inc. and affiliated entities (Hill-Rom) brought a lawsuit against us alleging infringement under United States patent laws with respect to nine patents related to electrical network communications for hospital beds.  On March 31, 2015, the court granted the parties’  joint motion to dismiss with prejudice the claims and counterclaims associated with three of these patents.  The case has been stayed with respect to the remaining six patents, which currently are under reexamination by the United States Patent Office.  The ultimate resolution of this matter cannot be predicted and it is not possible at this time for us to estimate any probable loss or range of probable losses.  However, the ultimate result could have a material adverse effect on our financial position, results of operations and cash flows.
NOTE 6 - DEBT AND CREDIT FACILITIES
During the 2015 six months, we repaid $500 of all our senior unsecured notes that were due on January 15, 2015. Our commercial paper program allows us to have a maximum of $1,250 in commercial paper outstanding, with maturities up to 397 days from the date of issuance. At June 30, 2015 outstanding commercial paper totaled $200, the weighted-average original maturity of the commercial paper outstanding was approximately 78 days and the weighted average interest rate of short-term debt was approximately 1.3%.
Certain of our credit facilities require us to comply with financial and other covenants. We were in compliance with all covenants at June 30, 2015. We have lines of credit, issued by various financial institutions, available to fund our day-to-day operating needs. At June 30, 2015 we had $1,248 of borrowing capacity available under all of our existing credit facilities.
At June 30, 2015 the total unamortized debt issuance costs incurred in connection with our outstanding notes were $19. The fair value of long-term debt (excluding the interest rate hedge) at June 30,
 
2015 and December 31, 2014 was $3,254 and $3,811, respectively, based on the quoted interest rates for similar types and amounts of borrowings.
NOTE 7 - CAPITAL STOCK
In February 2015 we declared a quarterly dividend of $0.345 per share, payable April 30, 2015 to shareholders of record at the close of business on March 31, 2015. In April 2015 we declared a quarterly dividend of $0.345 per share, payable July 31, 2015 to shareholders of record at the close of business on June 30, 2015.
In March 2015 we announced that our Board of Directors had authorized us to purchase up to $2,000 of our common stock (the 2015 Repurchase Program). In 2012 and 2011, we announced that our Board of Directors had authorized us to purchase up to $405 and $500, respectively, of our common stock (the 2012 and 2011 Repurchase Programs, respectively). The manner, timing and amount of purchases is determined by management based on an evaluation of market conditions, stock price and other factors and is subject to regulatory considerations. Purchases are to be made from time to time in the open market, in privately negotiated transactions or otherwise.
In the 2015 three months we repurchased 0.5 million shares at a cost of $48 under the 2011 Repurchase Program and 1.6 million shares at a cost of $146 under the 2012 Repurchase Program. At June 30, 2015 the maximum dollar value of shares that may yet be purchased was $2,000 under the 2015 Repurchase Program and $259 under the 2012 Repurchase Program. There are no amounts remaining under the 2011 Repurchase Program.
NOTE 8 - ACCUMULATED OTHER COMPREHENSIVE INCOME
Changes in AOCI for the three months:
 
Marketable Securities
Pension Plans
Hedges
Financial Statement Translation
Total
Beginning
$
4

$
(123
)
$
14

$
(416
)
$
(521
)
OCI before reclassifications
(3
)
(6
)
22

87

100

Tax (benefit) expense on OCI

1

(8
)

(7
)
Reclassifications out of AOCI
(1
)
2

(4
)

(3
)
Net current period OCI
(4
)
(3
)
10

87

90

Ending
$

$
(126
)
$
24

$
(329
)
$
(431
)
Changes in AOCI for the six months:
 
Marketable Securities
Pension Plans
Hedges
Financial Statement Translation
Total
Beginning
3

(136
)
13

(134
)
(254
)
OCI before reclassifications
1

9

21

(195
)
(164
)
Tax (benefit) expense on OCI
(1
)
(2
)
(6
)

(9
)
Reclassifications out of AOCI
(3
)
3

(4
)

(4
)
Net current period OCI
(3
)
10

11

(195
)
(177
)
Ending

(126
)
24

(329
)
(431
)


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

STRYKER CORPORATION
 
2015 Second Quarter Form 10-Q

Reclassifications out of AOCI for the three and six months:
 
Three Months
 
Six Months
 
2015
2014
 
2015
2014
Marketable Securities
 
 
 
 
 
  Other (income) expense
$
(2
)
$
(2
)
 
$
(4
)
$
(4
)
  Tax expense (benefit)
1


 
1

1

  Net of tax
(1
)
(2
)
 
(3
)
(3
)
Pension Plans
 
 
 
 
 
  Cost of Sales
2

2

 
4

4

  Tax expense (benefit)

(1
)
 
(1
)
(1
)
  Net of tax
2

1

 
3

3

Hedges
 
 
 
 
 
  Cost of Sales
(6
)
(3
)
 
(6
)
(5
)
  Tax expense (benefit)
2

1

 
2

2

  Net of tax
(4
)
(2
)
 
(4
)
(3
)
Total, net of tax
$
(3
)
$
(3
)
 
$
(4
)
$
(3
)

NOTE 9 - INCOME TAXES
Our effective tax rates for the 2015 and 2014 three months were 2.2% and 23.5%, respectively. Our effective tax rates for the 2015 and 2014 six months were 20.8% and 27.8%, respectively. The decrease in the effective tax rate for the 2015 three and six months was primarily due to the tax jurisdiction applicable to the recall-related charges. The operating impact of the European regional headquarters and certain discrete tax matters are also included in the 2015 six-month rate.
 
NOTE 10 - SEGMENT INFORMATION
Net sales and net earnings by business segment were:
 
Three Months
 
Six Months
 
2015
2014
 
2015
2014
Orthopaedics
$
1,035

$
1,028

 
$
2,058

$
2,027

MedSurg
939

905

 
1,866

1,791

Neurotechnology and Spine
458

430

 
887

850

Net sales
$
2,432

$
2,363

 
$
4,811

$
4,668

Orthopaedics
269

261

 
539

493

MedSurg
151

136

 
291

286

Neurotechnology and Spine
111

81

 
202

171

Segment net earnings
$
531

$
478

 
$
1,032

$
950

Less: other (net of income taxes)
 
 
 
 
 
Corporate and other
(73
)
(63
)
 
(150
)
(131
)
Acquisition and integration-related charges
(8
)
(17
)
 
(21
)
(30
)
Amortization of intangible assets
(34
)
(33
)
 
(69
)
(64
)
Restructuring and related charges
(24
)
(20
)
 
(43
)
(30
)
Recall charges
(46
)
(217
)
 
(95
)
(489
)
Legal Matters
46


 
46


Tax matters


 
(84
)
(8
)
Net earnings
$
392

$
128

 
$
616

$
198

Other than assets associated with the acquisitions that are discussed in greater detail in Note 4, there were no significant changes to total assets by segment from information provided in our Annual Report on Form 10-K for 2014.


ITEM 2.
MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS.
ABOUT STRYKER
Stryker is one of the world's leading medical technology companies. We offer a diverse array of innovative medical technologies, including reconstructive, medical and surgical, and neurotechnology and spine products, to help people lead more active and more satisfying lives.
We segregate our operations into three reportable business segments: Orthopaedics, MedSurg, and Neurotechnology and Spine. The Orthopaedics segment primarily consists of implants used in hip and knee joint replacements and trauma and extremities surgeries. The MedSurg segment includes 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 (Sustainability) as well as other medical device products used in a variety of medical specialties. The Neurotechnology and Spine segment includes both neurosurgical and neurovascular devices.
 

In the United States, most of our products are marketed directly to doctors, hospitals and other healthcare facilities. In general, we maintain separate and dedicated sales forces for each of our principal product lines to provide focus and a high level of expertise to each medical specialty served. Internationally, our products are sold in over 100 countries through company-owned sales subsidiaries and branches as well as third-party dealers and distributors. Our business is generally not seasonal in nature; however, the number of reconstructive surgeries is generally lower during the summer months and sales of capital equipment are generally stronger in the fourth quarter.
In January 2015 we completed the acquisition of certain assets of CHG Hospital Beds, Inc. (CHG) in an all cash transaction. CHG designs, manufactures and markets a series of low-height hospital beds and related accessories.



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

STRYKER CORPORATION
 
2015 Second Quarter Form 10-Q

RESULTS OF OPERATIONS
 
Three Months

Six Months
 
 
2015
% Net Sales
2014
% Net Sales
% Change
 
2015
% Net Sales
2014
% Net Sales
% Change
Net sales
 
$
2,432

100.0%
$
2,363

100.0%
2.9
 %
 
$
4,811

100.0%
$
4,668

100.0%
3.1
 %
Gross profit
 
1,605

66.0
1,548

65.5
3.7

 
3,158
65.6
3,077
65.9
2.6

Research, development and engineering expenses
 
154

6.3
158

6.7
(2.5
)
 
306

6.4
308
6.6
(0.6
)
Selling, general and administrative expenses
 
861

35.4
870

36.8
(1.0
)
 
1,753

36.4
1,729
37.0
1.4

Recall charges
 
112

4.6
276

11.7
(59.4
)
 
166
3.5
620

13.3
(73.2
)
Intangible amortization
 
49

2.0
47

2.0
4.3

 
98
2.0
92

2.0
6.5

Other income (expense), net
 
(28
)
(1.2)
(30
)
(1.3)
(6.7
)
 
(57
)
(1.2)
(54
)
(1.2)
5.6

Income taxes
 
9


39


(76.9
)
 
162
 
76

 
113.2

Net earnings
 
$
392

16.1
$
128

5.4
206.3

 
$
616

12.8
$
198

4.2
211.1

Diluted net earnings per share
 
$
1.03

 
$
0.33

 
212.1

 
$
1.61

 
$
0.51

 
215.7

Adjusted diluted net earnings per share
 
$
1.20

 
$
1.08

 
11.1

 
$
2.31

 
$
2.14

 
7.9

For a discussion of non-GAAP financial measures used in this report see "Non-GAAP Financial Measures".
Geographic and segment net sales:
 
Three Months
 
% Change
 
Six Months
 
% Change
 
 
2015
 
2014
 
Reported
 
Constant Currency
 
2015
 
2014
 
Reported
 
Constant
Currency
Geographic sales:
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
United States
 
$
1,716

 
$
1,569

 
9.4
 %
 
9.4
%
 
$
3,389

 
$
3,111

 
8.9
 %
 
8.9
%
International
 
716

 
794

 
(9.9
)
 
4.1

 
1,422

 
1,557

 
(8.7
)
 
4.7

Total net sales
 
$
2,432

 
$
2,363

 
2.9

 
7.6

 
$
4,811

 
$
4,668

 
3.1

 
7.5

Segment sales:
 
 
 
 
 
 
 
 
 


 
 
 
 
 
 
Orthopaedics
 
$
1,035

 
$
1,028

 
0.6

 
6.2

 
$
2,058

 
$
2,027

 
1.5

 
6.9

MedSurg
 
939

 
905

 
3.9

 
7.4

 
1,866

 
1,791

 
4.2

 
7.6

Neurotechnology and Spine
 
458

 
430

 
6.4

 
11.5

 
887

 
850

 
4.3

 
9.1

Total net sales
 
$
2,432

 
$
2,363

 
2.9

 
7.6

 
$
4,811

 
$
4,668

 
3.1

 
7.5

Supplemental sales growth information:
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Three Months
 
Six Months
 
 
 
 
 
Percentage Change
 
 
 
 
Percentage Change
 
 
 
 
 
 
 
 
U.S.
 
International
 
 
 
 
 
 
 
U.S.
 
International
 
 
2015
2014
 
As Reported
Constant Currency
 
As Reported
 
As Reported
Constant Currency
 
2015
2014
 
As Reported
Constant Currency
 
As Reported
 
As Reported
Constant Currency
Knees
 
$
346

$
350

 
(1.0)%
3.6%
 
2.8%
 
(9.3)%
5.3%
 
$
691

$
698

 
(1.0)%
3.3%
 
2.6%
 
(8.8)%
4.9%
Hips
 
320

326

 
(2.1)
3.7
 
5.7
 
(12.4)
1.1
 
632

644

 
(1.9)
3.7
 
6.6
 
(12.8)
(0.1)
Trauma and Extremities
 
309

298

 
4.0
10.8
 
17.8
 
(12.0)
2.7
 
622

586

 
6.2
12.9
 
18.1
 
(7.9)
6.7
Other
 
60

54

 
8.9
12.9
 
15.1
 
(8.9)
6.5
 
113

99

 
13.4
16.9
 
23.1
 
(13.6)
(0.3)
ORTHOPAEDICS
 
$
1,035

$
1,028

 
0.6
6.2
 
8.3
 
(11.3)
3.0
 
$
2,058

$
2,027

 
1.5
6.9
 
9.0
 
(10.1)
3.6
Instruments
 
354

340

 
4.3
8.5
 
10.1
 
(10.8)
4.2
 
700

683

 
2.5
6.4
 
6.5
 
(7.9)
6.3
Endoscopy
 
335

336

 
(0.2)
3.2
 
4.9
 
(12.3)
(0.8)
 
656

648

 
1.2
4.7
 
6.4
 
(10.9)
0.7
Medical
 
197

177

 
11.0
14.3
 
12.9
 
4.0
19.7
 
402

358

 
12.3
15.2
 
14.9
 
2.5
16.5
Sustainability
 
53

52

 
4.0
4.1
 
4.0
 
(2.2)
10.5
 
108

102

 
6.6
6.6
 
6.6
 
(5.3)
6.7
MEDSURG
 
$
939

$
905

 
3.9
7.4
 
8.4
 
(9.1)
4.5
 
$
1,866

$
1,791

 
4.2
7.6
 
8.2
 
(7.5)
5.6
Neurotechnology
 
272

245

 
10.5
17.0
 
19.4
 
(2.5)
13.4
 
524

488

 
7.2
13.1
 
14.9
 
(4.4)
10.4
Spine
 
186

185

 
0.8
4.1
 
8.7
 
(15.9)
(5.6)
 
363

362

 
0.4
3.6
 
5.5
 
(11.6)
(0.9)
NEUROTECHNOLOGY AND SPINE
 
$
458

$
430

 
6.4
11.5
 
14.5
 
(7.5)
6.3
 
$
887

$
850

 
4.3
9.1
 
10.5
 
(7.0)
6.4

Consolidated Net Sales
Consolidated net sales in the three months increased 2.9% as reported and 7.6% in constant currency as net sales were negatively impacted by 4.7% due to the impact of foreign currency exchange rates. Excluding the 0.7% impact of acquisitions, net sales increased 6.9% in constant currency, including 8.7% from increased unit volume partially offset by 1.8% lower prices. The increase was led primarily by higher shipments of neurotechnology, trauma and extremities, instruments and medical products.
Consolidated net sales in the six months increased 3.1% as reported and 7.5% in constant currency as net sales were negatively impacted by 4.5% due to the impact of foreign currency
 
exchange rates. Excluding the 1.3% impact of acquisitions, net sales increased 6.3% in constant currency, including 7.9% from increased unit volume partially offset by 1.7% lower prices. The increase was led primarily by higher shipments of trauma and extremities, medical, neurotechnology and instruments products.
Orthopaedics Net Sales
Orthopaedics net sales in the three months increased 0.6% as reported and 6.2% in constant currency as net sales were negatively impacted by 5.6% due to the impact of foreign currency exchange rates. Excluding the 0.9% impact of acquisitions, net sales increased 5.3% in constant currency, including 7.7% from increased unit volume partially offset by 2.4% lower prices. The increase was


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

STRYKER CORPORATION
 
2015 Second Quarter Form 10-Q

led primarily by higher shipments of trauma and extremities products.
Orthopaedics net sales in the six months increased 1.5% as reported and 6.9% in constant currency as net sales were negatively impacted by 5.4% due to the impact of foreign currency exchange rates. Excluding the 0.9% impact of acquisitions, net sales increased 5.9% in constant currency, including 8.6% from increased unit volume partially offset by 2.7% lower prices. The increase was led primarily by higher shipments of trauma and extremities products.
MedSurg Net Sales
MedSurg net sales in the three months increased 3.9% as reported and 7.4% in constant currency as net sales were negatively impacted by 3.5% due to the impact of foreign currency exchange rates. Excluding the 0.7% impact of acquisitions, net sales increased 6.7% in constant currency, including 7.3% from increased unit volume partially offset by 0.6% lower prices. The increase was led primarily by higher shipments of our instruments and medical products.
MedSurg net sales in the six months increased 4.2% as reported and 7.6% in constant currency as net sales were negatively impacted by 3.3% due to the impact of foreign currency exchange rates. Excluding the 2.1% impact of acquisitions, net sales increased 5.5% in constant currency, including 5.6% from increased unit volume partially offset by 0.1% lower prices. The increase was led primarily by higher shipments of our medical and instruments products.
Neurotechnology and Spine Net Sales
Neurotechnology and Spine net sales in the three months increased 6.4% as reported and 11.5% in constant currency as net sales were negatively impacted by 5.1% due to the impact of foreign currency exchange rates. Net sales in constant currency increased 14.1% from increased unit volume partially offset by 2.7% lower prices. The increase was led primarily by higher shipments of neurotechnology products.
Neurotechnology and Spine net sales in the six months increased 4.3% as reported and 9.1% in constant currency as net sales were negatively impacted by 4.8% due to the impact of foreign currency exchange rates. Excluding the 0.3% impact of acquisitions, net sales in constant currency increased 11.2% from increased unit volume partially offset by 2.4% lower prices. The increase was led primarily by higher shipments of neurotechnology products.
Cost of Sales
Cost of sales as a percentage of net sales in the three months decreased to 34.0% from 34.5% in 2014, primarily due to favorable product mix, impact of foreign currency exchange rates and operational efficiencies. Cost of sales in 2015 and 2014 includes $6 and $9, respectively, related to inventory that was stepped up to fair value following acquisitions, and $1 of restructuring-related costs in 2015. Excluding the impact of the acquisition and restructuring-related costs described above, cost of sales as a percentage of net sales was 33.7% and 34.1% in 2015 and 2014, respectively.
Cost of sales as a percentage of net sales in the six months increased to 34.4% from 34.1% in 2014, primarily due to unfavorable product mix and impact of foreign currency exchange rates that were partially offset by operational efficiencies. Cost of sales in 2015 and 2014 also includes $13 and $14, respectively, related to inventory that we stepped up to fair value following acquisitions and $2 and $1, respectively, of restructuring-related costs. Excluding the impact of the acquisition and restructuring-
 
related costs described above, cost of sales as a percentage of net sales was 34.1% and 33.8% in 2015 and 2014, respectively.
Research, Development and Engineering Expenses
Research, development and engineering expenses for the three months decreased 2.5% to $154 or 6.3% of net sales from 6.7% in 2014 and for the six months decreased 0.6% to $306 or 6.4% of net sales from 6.6% in 2014. The decreased spending levels in 2015 were driven by the timing of spending on projects and investments in new technologies.
Selling, General and Administrative Expenses
Selling, general and administrative expenses as a percentage of net sales for the three months decreased to 35.4% from 36.8% in 2014, primarily due to a $54 gain from a legal settlement, and in 2015 and 2014 includes acquisition and integration-related charges of $6 and $16, respectively, and restructuring-related charges of $29 and $15, respectively. Excluding the impact of the gain and the charges noted above, expenses increased to 36.1% of net sales from 35.5% in 2014, primarily due to increased expenses related to our European regional headquarters and related selling activities. In addition, higher compensation costs, due in part to sales performance-related commissions, were partially offset by other expense controls.
Selling, general and administrative expenses as a percentage of net sales for the six months decreased to 36.4% from 37.0% in 2014, primarily due to a $54 gain from a legal settlement, and in 2015 and 2014 includes acquisition and integration-related charges of $19 and $32, respectively, and restructuring-related charges of $54 and $24, respectively. Excluding the impact of the gain and the charges noted above, expenses increased to 36.0% of net sales from 35.8% in 2014, primarily due to increased expenses related to our European regional headquarters and related selling activities. In addition, higher compensation costs due in part to sales performance-related commissions were partially offset by other expense controls.
Recall Charges
Recall charges were due to the previously disclosed Rejuvenate and ABG II modular-neck hip stems voluntary recall and other recall matters and in 2015 and 2014 were $112 and $276 in the three months, and $166 and $620 in the six months, respectively. In the three and six months we recorded charges representing the excess of the minimum of the range of probable loss over the previously recorded reserves.
Intangibles Amortization
Intangibles amortization in 2015 and 2014 was $49 and $47 in the three months and $98 and $92 in the six months, respectively. The increase was primarily due to acquisitions.
Other Income (Expense), net
Other income (expense), net in 2015 and 2014 was $28 and $30 in the three months, and $57 and $54 in the six months, respectively.
Income Taxes
The effective income tax rate on earnings was 2.2% and 23.5% in the three months and 20.8% and 27.8% in the six months 2015 and 2014, respectively. The decrease in the effective tax rate for the three and six months was primarily due to the tax jurisdiction applicable to the recall-related charges. The operating impact of the European regional headquarters and certain discrete tax matters are also included in the 2015 six month rate.
Net Earnings
Net earnings in the three months increased to $392 or $1.03 per diluted share from $128 or $0.33 per diluted share in 2014. Adjusted diluted net earnings per share increased 11.1% to $1.20 in 2015


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

STRYKER CORPORATION
 
2015 Second Quarter Form 10-Q

from $1.08 in 2014. The impact of foreign currency exchange rates on net earnings reduced adjusted diluted net earnings per share by approximately $0.07 and $0.03 in 2015 and 2014, respectively.
Net earnings in the six months increased to $616 or $1.61 per diluted share from $198 or $0.51 per diluted share in 2014. Adjusted diluted net earnings per share increased 7.9% to $2.31 in 2015 from $2.14 in 2014. The impact of foreign currency exchange rates on net earnings reduced adjusted diluted net earnings per share by approximately $0.13 and $0.07 in 2015 and 2014, respectively.
NON-GAAP FINANCIAL MEASURES
We supplement the reporting of our financial information determined under accounting principles generally accepted in the United States (GAAP) with certain non-GAAP financial measures, including percentage sales growth in constant currency; percentage organic sales growth; adjusted gross profit; cost of sales excluding specified items; adjusted selling, general and administrative expenses; adjusted amortization of intangible assets; adjusted operating income; adjusted effective income tax rate; adjusted net earnings; and adjusted diluted net earnings per share (Diluted EPS). We believe that these non-GAAP measures provide meaningful information to assist investors and shareholders in understanding our financial results and assessing our prospects for future performance. Management believes percentage sales growth in constant currency and the other adjusted measures described above are important indicators of our operations because they exclude items that may not be indicative of or are unrelated to our core operating results and provide a baseline for analyzing trends in our underlying businesses. Management uses these non-GAAP financial measures for reviewing the operating results of reportable business segments and analyzing potential future business trends in connection with our budget process and bases certain management incentive compensation on these non-GAAP financial measures.
To measure percentage sales growth in constant currency, we remove the impact of changes in foreign currency exchange rates that affect the comparability and trend of sales. Percentage sales growth in constant currency is calculated by translating current year results at prior year average foreign currency exchange rates. To measure percentage organic sales growth, we remove the impact of changes in foreign currency exchange rates and acquisitions that affect the comparability and trend of sales. Percentage organic sales growth is calculated by translating current year results at prior year average foreign currency exchange rates excluding the impact of acquisitions.
 
To measure earnings performance on a consistent and comparable basis, we exclude certain items that affect the comparability of operating results and the trend of earnings. These adjustments are irregular in timing, may not be indicative of our past and future performance and are therefore excluded to allow investors to better understand underlying operating trends. The following are examples of the types of adjustments that may be included in a period:
1.
Acquisition and integration-related costs. Costs related to integrating recently acquired businesses and specific costs related to the consummation of the acquisition process.
2.
Amortization of intangible assets. Periodic amortization expense related to purchased intangible assets.
3.
Restructuring-related charges. Costs associated with focused workforce reductions and other restructuring activities.
4.
Recall matters. Our best estimate of the minimum of the range of probable loss to resolve certain product recalls.
5.
Regulatory and legal matters. Our best estimate of the minimum of the range of probable loss to resolve certain regulatory matters and other legal settlements.
6.
Tax matters. Certain significant and discrete tax items and adjustments to interest expense related to the settlement of certain tax matters.
Because non-GAAP financial measures are not standardized, it may not be possible to compare these financial measures with other companies' non-GAAP financial measures having the same or similar names. These adjusted financial measures should not be considered in isolation or as a substitute for reported sales growth, gross profit, cost of sales, selling, general and administrative expenses, amortization of intangible assets, operating income, effective income tax rate, net earnings and diluted net earnings per share, the most directly comparable GAAP financial measures. These non-GAAP financial measures are an additional way of viewing aspects of our operations that, when viewed with our GAAP results and the reconciliations to corresponding GAAP financial measures at the end of the discussion of Results of Operations below, provide a more complete understanding of our business. We strongly encourage investors and shareholders to review our financial statements and publicly-filed reports in their entirety and not to rely on any single financial measure.


The following reconciles the non-GAAP financial measures of adjusted gross profit; adjusted selling, general and administrative expense; adjusted amortization of intangible assets; adjusted operating income; adjusted net earnings; adjusted effective tax rate; and adjusted diluted net earnings per share with the most directly comparable GAAP financial measures:
2015 Three Months
Gross Profit
Selling, General & Administrative Expenses
Intangible Amortization
Operating Income
Net Earnings
Effective Tax Rate
Diluted EPS
AS REPORTED
$
1,605

$
861

$
49

$
429

$
392

2.2
%
$
1.03

Acquisition and integration-related charges
 
 
 
 
 
 
 
    Inventory stepped up to fair value
6



6

4

0.2

0.01

    Other acquisition and integration-related

(6
)

6

4

0.2

0.01

  Amortization of intangible assets


(49
)
49

34

1.7

0.09

  Restructuring-related charges
1

(29
)

30

24

0.2

0.06

  Rejuvenate and other recall matters



112

46

11.8

0.12

  Legal matters

53


(53
)
(46
)
0.5

(0.12
)
ADJUSTED
$
1,612

$
879

$

$
579

$
458

16.8
%
$
1.20


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

STRYKER CORPORATION
 
2015 Second Quarter Form 10-Q

2014 Three Months
Gross Profit
Selling, General & Administrative Expenses
Intangible Amortization
Operating Income
Net Earnings
Effective Tax Rate
Diluted EPS
AS REPORTED
$
1,548

$
870

$
47

$
197

$
128

23.5
 %
$
0.33

Acquisition and integration-related charges
 
 
 
 
 
 
 
    Inventory stepped up to fair value
9



9

6

0.6

0.01

    Other acquisition and integration-related

(16
)

16

11

0.8

0.02

  Amortization of intangible assets


(47
)
47

33

2.0

0.09

  Restructuring-related charges

(15
)

20

20

(1.9
)
0.05

  Rejuvenate and other recall matters



276

217

(2.6
)
0.58

ADJUSTED
$
1,557

$
839

$

$
565

$
415

22.4
 %
$
1.08

2015 Six Months
Gross Profit
Selling, General & Administrative Expenses
Intangible Amortization
Operating Income
Net Earnings
Effective Tax Rate
Diluted EPS
AS REPORTED
$
3,158

$
1,753

$
98

$
835

$
616

20.8
 %
$
1.61

  Acquisition and integration-related charges
 
 
 
 
 
 
 
    Inventory stepped up to fair value
13



13

8

0.3

0.02

    Other acquisition and integration-related

(19
)

19

13

0.3

0.04

  Amortization of intangible assets


(98
)
98

69

1.4

0.18

  Restructuring-related charges
2

(54
)

56

43

0.4

0.11

  Rejuvenate and other recall matters



166

95

5.3

0.25

   Legal matters

53


(53
)
(46
)
0.3

(0.12
)
  Tax matters




84

(10.7
)
0.22

ADJUSTED
$
3,173

$
1,733

$

$
1,134

$
882

18.1
 %
$
2.31

2014 Six Months
Gross Profit
Selling, General & Administrative Expenses
Intangible Amortization
Operating Income
Net Earnings
Effective Tax Rate
Diluted EPS
AS REPORTED
$
3,077

$
1,729

$
92

$
328

$
198