UNITED STATES SECURITIES AND EXCHANGE COMMISSION Washington, D.C. 20549 FORM 10-Q Quarterly Report Under Section 13 Or 15(d) of the Securities Exchange Act of 1934 For the quarterly period ended June 30, 1998 Commission file number 0-9165 STRYKER CORPORATION (Exact name of registrant as specified in its charter) Michigan 38-1239739 (State or other jurisdiction of (I.R.S. Employer incorporation or organization) Identification No.) P.O. Box 4085, Kalamazoo, Michigan 49003-4085 (Address of principal executive offices) (Zip Code) (616) 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 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 [X] NO [ ] Indicate the number of shares outstanding of each of the issuer's classes of common stock, as of the latest practicable date: 96,329,771 shares of Common Stock, $.10 par value, as of July 31, 1998. PART I. - FINANCIAL INFORMATION ITEM I. FINANCIAL STATEMENTS STRYKER CORPORATION AND SUBSIDIARIES CONDENSED CONSOLIDATED BALANCE SHEETS (Unaudited) (Amounts in thousands, except per share amounts) June 30 December 31 1998 1997 ----------- ----------- ASSETS Current Assets Cash and cash equivalents $ 55,364 $ 154,027 Marketable debt securities 271,473 197,041 Accounts receivable, less allowance of $9,700 (1997 - $11,700) 193,455 176,214 Inventories 157,944 136,246 Deferred income taxes 77,824 78,896 Prepaid expenses and other current assets 16,755 14,184 --------- --------- Total Current Assets 772,815 756,608 Property, Plant and Equipment, less allowance for depreciation of $148,708 (1997 - $136,582) 170,769 163,867 Other Assets 71,957 64,600 --------- --------- TOTAL ASSETS $1,015,541 $ 985,075 ========= ========= LIABILITIES AND STOCKHOLDERS' EQUITY Current Liabilities Accounts payable $ 56,344 $ 55,034 Accrued compensation 35,389 43,927 Income taxes 38,517 36,971 Accrued expenses and other liabilities 69,866 93,452 Current maturities of long-term debt 70,020 73,627 --------- --------- Total Current Liabilities 270,136 303,011 Long Term Debt, excluding current maturities 4,369 4,449 Other Liabilities 28,674 29,168 Minority Interest 34,099 35,672 Stockholders' Equity Common stock, $.10 par value: Authorized - 150,000 shares Outstanding - 96,305 shares (1997 - 96,059) 9,631 9,606 Additional paid-in capital 6,712 18 Retained earnings 684,199 612,939 Accumulated other comprehensive income (22,279) (9,788) --------- --------- Total Stockholders' Equity 678,263 612,775 --------- --------- TOTAL LIABILITIES AND STOCKHOLDERS' EQUITY $1,015,541 $ 985,075 ========= ========= See accompanying notes to condensed consolidated financial statements. STRYKER CORPORATION AND SUBSIDIARIES CONDENSED CONSOLIDATED STATEMENTS OF EARNINGS (Unaudited) (Amounts in thousands, except per share amounts) Three Months Ended Six Months Ended June 30 June 30 1998 1997 1998 1997 -------- -------- -------- -------- Net sales $267,273 $248,036 $520,861 $487,572 Cost of sales 111,457 100,532 212,870 198,217 -------- -------- -------- -------- Gross profit 155,816 147,504 307,991 289,355 Operating expenses: Research, development and engineering 15,420 14,361 28,450 28,059 Selling, general and administrative 89,428 88,088 176,322 172,101 -------- -------- -------- -------- 104,848 102,449 204,772 200,160 -------- -------- -------- -------- Operating income 50,968 45,055 103,219 89,195 Other income 3,262 1,643 6,411 5,343 -------- -------- -------- -------- Earnings before income taxes 54,230 46,698 109,630 94,538 Income taxes 18,980 17,318 38,370 35,138 -------- -------- -------- -------- Net earnings $ 35,250 $ 29,380 $ 71,260 $ 59,400 ======== ======== ======== ======== Net earnings per share of common stock: Basic $.37 $.31 $.74 $.62 ==== ==== ==== ==== Diluted $.36 $.30 $.73 $.61 ==== ==== ==== ==== Average outstanding shares for the period: Basic 96,279 96,004 96,197 96,431 Diluted 98,176 97,806 98,117 98,140 See accompanying notes to condensed consolidated financial statements. STRYKER CORPORATION AND SUBSIDIARIES CONDENSED CONSOLIDATED STATEMENT OF STOCKHOLDERS' EQUITY (Unaudited) (Amounts in thousands, except per share amounts) Accumulated Additional Other Common Paid-In Retained Comprehensive Stock Capital Earnings Income Total ------- ---------- -------- ---------- ------- Balance at January 1, 1998 $9,606 $18 $612,939 ($9,788) $612,775 ------- Comprehensive income: Net earnings 71,260 71,260 Net unrealized (losses) on securities (559) (559) Foreign currency translation adjustments (11,932) (11,932) ------- Comprehensive income 58,769 ------- Sales of 246 shares of common stock under stock option and benefit plans, including $3,043 income tax benefit 25 6,694 6,719 ------- ---------- -------- ---------- ------- Balance at June 30, 1998 $9,631 $6,712 $684,199 ($22,279) $678,263 ======= ========== ======== ========== ======= See accompanying notes to condensed consolidated financial statements. In 1997 the Company declared a cash dividend of eleven cents per share to shareholders of record on December 31, 1997, payable on January 30, 1998. No cash dividends have been declared during 1998. STRYKER CORPORATION AND SUBSIDIARIES CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS (UNAUDITED) (Amounts in thousands) Six Months Ended June 30 1998 1997 -------- -------- OPERATING ACTIVITIES Net earnings $ 71,260 $ 59,400 Adjustments to reconcile net earnings to net cash provided by operating activities: Depreciation 13,238 12,865 Amortization 2,643 4,579 Minority interest (841) 430 Changes in operating assets and liabilities, net of effects of business acquisitions: Increase in accounts receivable (17,912) (19,686) Increase in inventories (21,536) (9,730) Decrease in accounts payable (117) (10,340) Decrease in accrued expenses (12,976) (2,941) Increase (decrease) in income taxes 657 (25,487) Other (6,897) (5,186) -------- -------- Net cash provided by operating activities 27,519 3,904 INVESTING AND FINANCING ACTIVITIES Purchases of property, plant and equipment (19,432) (15,599) Sales (purchases) of marketable securities (74,432) 68,845 Business acquisitions (25,393) (24,984) Payments on borrowings (465) (1,278) Dividends paid (10,580) (9,679) Proceeds from exercise of stock options 5,211 3,597 Repurchases of common stock 0 (25,576) Other (419) 5,525 -------- -------- Net cash used in investing and financing activities (125,510) 851 Effect of exchange rate changes on cash and cash equivalents (672) (738) -------- -------- Increase (decrease) in cash and cash equivalents ($98,663) $ 4,017 ========= ======== See accompanying notes to condensed consolidated financial statements. STRYKER CORPORATION AND SUBSIDIARIES NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS June 30, 1998 (Unaudited) Note 1. BASIS OF PRESENTATION The accompanying unaudited condensed consolidated financial statements include all adjustments, consisting of normal recurring accruals, which the Company considers necessary for a fair presentation of the results of operations for the periods shown. The financial statements have been prepared in accordance with the instructions to Form 10-Q and, therefore, do not include all information and footnotes necessary for a fair presentation of consolidated financial position, results of operations and cash flows in conformity with generally accepted accounting principles. The results of operations for any interim period are not necessarily indicative of the results to be expected for the full year. For further information, refer to the consolidated financial statements and footnotes thereto included in the Company's annual report on Form 10-K for the year ended December 31, 1997. As of January 1, 1998 the Company adopted Financial Accounting Standards Board (FASB) Statement No. 130, "Reporting Comprehensive Income". Statement No. 130 establishes rules for the reporting of comprehensive income and its components; however, the adoption of this statement had no impact on the Company's net earnings or shareholders' equity. Statement No. 130 requires unrealized gains or losses on the Company's available-for-sale securities and foreign currency translation adjustments, which, prior to adoption, were reported separately in shareholders' equity, to be aggregated and disclosed as accumulated other comprehensive income, a component of shareholders' equity. Management has elected to disclose total comprehensive income as a subtotal in the Condensed Consolidated Statement of Stockholders' Equity. Prior year financial statements have been reclassed to conform to the requirements of Statement No. 130. Other comprehensive income for the six months ended June 30, 1997 was $52,244. Other comprehensive income for the three months ended June 30, 1998 and 1997 was $27,849 and $27,889, respectively. Note 2. INVENTORIES Inventories are as follows (in thousands): June 30 December 31 1998 1997 --------- --------- Finished goods $ 124,687 $ 103,744 Work-in-process 12,696 10,661 Raw material 28,280 29,560 --------- --------- FIFO Cost 165,663 143,965 Less LIFO reserve 7,719 7,719 --------- --------- $ 157,944 $ 136,246 ========= ========= FIFO cost approximates replacement cost. Note 3. BUSINESS ACQUISITIONS During the first six months of 1998, the Company's subsidiary, Physiotherapy Associates, Inc., purchased certain physical therapy clinic operations at an aggregate cost of $1.8 million. In addition, the Company purchased two domestic distributors of its orthopaedic implants at a cost of $15.0 million and a Canadian manufacturer of hospital beds, at a cost of $8.1 million. All of the above acquisitions were accounted for by the purchase method. Any intangible assets acquired in the above acquisitions are being amortized over periods ranging from five to fifteen years. Pro forma consolidated operating results including the acquisitions would not differ significantly from reported results. Note 4. SUBSEQUENT EVENT On August 14, 1998, the Company announced it had entered into a definitive agreement to acquire Howmedica, the orthopaedic division of Pfizer, Inc., for $1.9 billion in cash. The transaction is expected to be financed with a combination of cash and debt, and is expected to be completed in the fourth quarter of 1998 subject to regulatory approvals. ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS Results Of Operations _____________________ The table below sets forth domestic/international and product line sales information: Three Months Ended Six Months Ended June 30 % June 30 % 1998 1997 Chg 1998 1997 Chg -------- -------- --- -------- -------- --- Domestic/International Sales Domestic $179,624 $157,075 14 $350,776 $306,667 14 International 87,649 90,961 (4) 170,085 180,905 (6) -------- -------- -------- -------- Total net sales $267,273 $248,036 8 $520,861 $487,572 7 ======== ======== ======== ======== Product Line Sales Stryker Surgical $201,215 $188,342 7 $394,767 $366,961 8 Stryker Medical 58,405 52,189 12 109,755 103,526 6 Distributed Products 7,653 7,505 2 16,339 17,085 (4) -------- -------- -------- -------- Total net sales $267,273 $248,036 8 $520,861 $487,572 7 ======== ======== ======== ======== For the six months ended June 30, 1998, Stryker Corporation's net sales increased 7% compared to the same period in 1997. Increased unit volume generated a 7% sales increase. Net sales also increased 2% from business acquisitions and 1% from the acquisition of certain portions of the Osteonics' domestic distribution network and the resulting direct sales. These increases were partially offset by a 2% decrease in sales from unfavorable foreign currency comparisons and a combined 1% decrease from a decline in selling prices and divested businesses. For the second quarter, net sales increased 8% when compared to the second quarter of 1997. Increased unit volume generated a 9% sales increase. Net sales also increased 2% from business acquisitions and 1% from the acquisition of certain portions of the Osteonics' domestic distribution network and the resulting direct sales. These increases were partially offset by a 3% decrease in sales from unfavorable foreign currency comparisons and a combined 1% decrease from a decline in selling prices and divested businesses. The Company's domestic sales increased 14% in the second quarter and the first half of 1998 compared to 1997. The domestic sales increase results from strong shipments of endoscopic equipment, powered surgical instruments and orthopaedic implants and increased revenue from physical therapy services. International sales decreased 4% in the second quarter and 6% in the first half of 1998 when compared to 1997 as unfavorable foreign currency comparisons and lower shipments in Asia more than offset higher shipments in Europe and other international markets. Unfavorable foreign currency comparisons lowered the dollar value of international sales by $7.4 million, or 8%, for the second quarter and $12.2 million, or 7%, for the first half. Worldwide sales of Stryker Surgical products (principally orthopaedic products) increased 7% in the second quarter and 8% in the first half. The sales gains resulted from higher shipments of endoscopic equipment, powered surgical instruments and orthopaedic implants, partially offset by the lower dollar translation of foreign currency sales. Worldwide sales of Stryker Medical products (principally stretchers/beds and physical therapy services) increased 12% in the second quarter and 6% in the first half resulting from increased physical therapy revenues and higher shipments of hospital beds and stretchers. Sales of distributed products, which are sourced from other companies principally for sale in Japan, increased 2% in the second quarter and declined 4% in the first half. Cost of sales for the first six months of 1998 represented 40.9% of sales compared to 40.7% in the same period of 1997. In the second quarter, the cost of sales percentage increased to 41.7% from 40.5% in the second quarter of 1997. Increasing cost of sales is the strength of the U.S. dollar versus foreign currencies, which has increased the cost of U.S. dollar based purchases for international operations. Research, development and engineering (R,D&E) expense increased 1.4% for the first six months of 1998, and represented 5.5% of sales in 1998 compared to 5.8% in the same period of 1997. In the second quarter, these expenses increased 7.4%, and were 5.8% of sales in 1998 and 1997. The Company's R,D&E spending represents the continued development of the OP-1 bone growth device at Stryker Biotech and the Company-wide focus on new product development. The Company's commitment to product development has resulted in several new product introductions in the first half of 1998 including the Quantum 5000 lightsource, the TPS Reciprocating Saw, the InterPulse System, the First Care Ultra bed and the international introduction of the Scorpio Knee system. Selling, general and administrative (S,G&A) expenses increased 2.5% in the first six months and 1.5% in the second quarter of 1998 compared to the same periods of 1997. These costs decreased to 33.9% of sales in the first six months of 1998 compared to 35.3% of sales in the same period of 1997. In the second quarter, S,G&A costs represented 33.5% of sales compared to 35.5% in the same period of 1997. The increase in S,G,&A costs is principally a result of increased selling expenses from larger sales forces and an increase in sales. Other income increased $1.1 million, or 20.0%, for the first six months and $1.6 million, or 98.5%, in the second quarter of 1998 compared to the same periods of 1997. The increase in other income in the first half and second quarter is due to increased interest income attributable to higher levels of invested cash and lower interest expense on the Company's yen denominated debt partially off-set by foreign currency transaction losses. The effective tax rate decreased to 35.0% for the first six months of 1998 compared to 37.2% in the same period of 1997 as a result of a more favorable mix of operating results among tax jurisdictions, principally Japan, and tax- free interest on short-term investments. For the first six months of 1998, earnings before income taxes increased 16.0% and net earnings increased 20.0% compared to the first six months of 1997. Earnings before income taxes increased 16.1% and net earnings increased 20.0% in the second quarter of 1998 when compared to 1997. Liquidity and Capital Resources _______________________________ Stryker's financial position at June 30, 1998 remained strong with cash and marketable securities of $326.8 million and working capital of $502.7 million. Accounts receivable at June 30, 1998 increased 10% from December 31, 1997 as a result of increased sales and a 2-day increase in days sales outstanding from 62 days at December 31, 1997 to 64 days at June 30, 1998. Inventories at June 30, 1998 increased 16% from December 31, 1997 and days in inventory increased 7 days to 134 days from 127 days at December 31, 1997. The Company provided $27.5 million of cash from operations in the first six months of 1998 compared to cash provided of $3.9 million in the same period of 1997. The lower level of cash provided by operations in 1997 is primarily due to first quarter payments in 1997 of attorney fees and taxes totaling $37.9 million relating to the patent judgement received in the fourth quarter of 1996. Excluding those payments, cash provided from operations from the adjusted 1997 amount in the first half of 1997 would be $41.8 million. The decrease in cash from operations is due principally to higher inventory levels and decreases in accrued expenses. In the first half, $25.4 million of cash was used for acquisitions, $15.0 million of which related to the purchase of two previous domestic implant distributors. Cash and marketable securities of $326.8 million and anticipated future cash flows from operations are expected to be sufficient to fund future operating and capital requirements. The Company also has unsecured lines of credit with banks totaling $53.3 million, none of which was utilized at June 30, 1998. On August 14, 1998, the Company announced it had entered into a definitive agreement to acquire Howmedica, the orthopaedic division of Pfizer, Inc., for $1.9 billion in cash. The transaction is expected to be financed with a combination of cash and debt, and is expected to be completed in the fourth quarter of 1998. The information contained in this report includes forward-looking statements within the meaning of the federal securities laws that are subject to risks and uncertainties. Factors that could cause the Company's actual results and financial condition to differ from the Company's expectations include, but are not limited to: a change in economic conditions that adversely affects the level of demand for the Company's products; expected cost savings from the Howmedica acquisition may not be fully realized or realized within the expected time frame; the actual charges incurred in connection with the acquisition could be higher or lower than anticipated; changes in foreign exchange markets; and difficulties related to regulatory requirements attendant to consummation of the Howmedica acquisition could arise. All forward-looking statements contained in this report are qualified in their entirety by this cautionary statement. PART II - OTHER INFORMATION ITEM 5. OTHER INFORMATION Set forth below is a text of the press release issued by the Company on Friday, August 14, 1998. KALAMAZOO, Mich., August 14, 1998--Stryker Corporation (NYSE: SYK), a leading manufacturer of orthopaedic, surgical and medical products, announced today that it has entered into a definitive agreement to acquire Howmedica, the orthopaedic division of Pfizer Inc (NYSE: PFE), for $1.9 billion in cash. The transaction will create one of the world's leading manufacturers of innovative orthopaedic products including implants for reconstructing hips, knees and shoulders damaged by disease or accidents, trauma products and specialty surgical instruments. "The acquisition of Howmedica is a unique opportunity to enhance Stryker's long term competitive position, almost doubling our size and ensuring that Stryker will continue as a vital force in the growing $10 billion global orthopaedics market well into the next century," said John W. Brown, Chairman, President and CEO of Stryker. Noting the consolidation trend among hospitals and medical buying groups, Brown continued: "Howmedica brings an outstanding slate of complementary products, talented employees and one of the premier brands in the marketplace, all of which will enhance our ability to meet the needs of our customers. It also adds important scale to our operations, offers substantial cost and distribution synergies, and greatly enhances our international presence-especially in Europe and Japan." Brown added: "Stryker has continually set high goals for itself since its founding and, in doing so, has created a proven track record of delivering innovative products to its customers and consistent, superior earnings growth for shareholders. As the world's population ages and the incidence of joint disease, fractures and trauma grows in parallel, we believe that--with this strategic move--we are acquiring an outstanding asset at an attractive price that will allow Stryker to excel in today's highly competitive global marketplace." Through its Osteonics Division, Stryker is currently the world's fifth largest manufacturer of orthopaedic implants. Stryker had total 1997 net sales of over $980 million, of which $740 million was orthopaedic surgical products. Howmedica-- currently the world's third largest manufacturer of reconstructive devices including hip, knee and shoulder implants- -also manufactures bone cement, trauma products for internal and external fracture fixation, implantable devices used in oral, facial and skull surgery, and specialty instruments. It had 1997 sales of approximately $820 million. Following the acquisition, Stryker will hold approximately 15 percent of the worldwide orthopaedic market. The transaction is expected to be financed with a combination of cash and debt, and has been approved by the Boards of Stryker and Pfizer. It is expected to be completed in the fourth quarter of 1998, subject to clearance under the Hart-Scott-Rodino Anti- Trust Improvements Act and foreign regulations and other customary conditions. "This is an extraordinarily good strategic fit for Stryker and the transaction should be accretive to net earnings beginning in 2000," said David J. Simpson, Vice President, Chief Financial Officer and Secretary of Stryker. "We expect to take a pre-tax charge in the range of $400 million in the fourth quarter 1998 to write-off in-process R&D and acquisition related expenses. Goodwill is anticipated to be in the range of $1 billion and is expected to be amortized over 30 years." Concluded Brown: "This is a bold move for us, and one that we believe will position us to continue to deliver value for our shareholders long term. Post acquisition, our cash flow will be significant and we do not currently anticipate the need for any divestitures or equity issuance in connection with this transaction." Goldman, Sachs & Co. served as exclusive financial advisor to Stryker and provided a fairness opinion to Stryker's Board. Goldman Sachs Credit Partners L.P. and Bank of America have provided a commitment for a $1.9 billion credit facility to finance the acquisition. Stryker Corporation develops, manufactures and markets specialty surgical and medical products, including orthopaedic implants, powered surgical instruments, endoscopic systems, patient care and handling equipment for the global market and provides outpatient physical therapy services in the United States. ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K (a) Exhibits The exhibits listed below are submitted as a separate section of this report following the signature page: Exhibit 11 - Statement Re: Computation of Earnings per Share of Common Stock Exhibit 27 - Financial Data Schedule (included in EDGAR filing only) (b) Reports on Form 8-K No reports on Form 8-K were filed during the quarter for which this report is filed. SIGNATURES Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized. STRYKER CORPORATION (Registrant) August 14, 1998 JOHN W. BROWN _______________ _________________________________________ Date John W. Brown, Chairman, President and Chief Executive Officer (Principal Executive Officer) August 14, 1998 DAVID J. SIMPSON _______________ _________________________________________ Date David J. Simpson, Vice President, Chief Financial Officer and Secretary (Principal Financial Officer) Exhibit 11 STRYKER CORPORATION AND SUBSIDIARIES COMPUTATION OF EARNINGS PER SHARE OF COMMON STOCK June 30, 1998 Three Months Ended Six Months Ended June 30 June 30 1998 1997 1998 1997 ---------- ---------- ---------- ---------- Basic: Average number of shares outstanding 96,279,000 96,004,000 96,197,000 96,431,000 ---------- ---------- ---------- ---------- Net earnings $35,250,000 $29,380,000 $71,260,000 $59,400,000 ========== ========== ========== ========== Basic net earnings per share of common stock $.37 $.31 $.74 $.62 ==== ==== ==== ==== Diluted: Average number of shares outstanding 96,279,000 96,004,000 96,197,000 96,431,000 Net effect of dilutive stock options, based on the treasury stock method 1,897,000 1,802,000 1,920,000 1,709,000 using average market price ---------- ---------- ---------- ---------- Total diluted shares 98,176,000 97,806,000 98,117,000 98,140,000 ========== ========== ========== ========== Diluted net earnings per share of common stock $.36 $.30 $.73 $.61 ==== ==== ==== ====