Stryker Corporation - 10-Q quarterly report FY

Washington, D.C. 20549

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For the quarterly period ended June 30, 2001

Commission file number: 0-9165

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(Exact name of registrant as specified in its charter)

Registrant's telephone number, including area code: (616) 385-2600

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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:

196,291,806 shares of Common Stock, $.10 par value, as of July 31, 2001.

STRYKER CORPORATION AND SUBSIDIARIES
CONDENSED CONSOLIDATED BALANCE SHEETS
(Amounts in millions, except per share amounts)
(Unaudited)

STRYKER CORPORATION AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF EARNINGS
(Amounts in millions, except per share amounts)
(Unaudited)

STRYKER CORPORATION AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENT OF STOCKHOLDERS' EQUITY
(Amounts in millions)
(Unaudited)

In 2000, the Company declared a cash dividend of eight cents per share to shareholders of record on December 29, 2000, payable on January 31, 2001. No cash dividends have been declared during 2001.

STRYKER CORPORATION AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
June 30, 2001
(Amounts in millions, except per share amounts)
(Unaudited)

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 accounting principles generally accepted in the United States. 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 notes thereto included in the Company's Annual Report on Form 10-K for the year ended December 31, 2000.

The Company follows Financial Accounting Standards Board (FASB) Statement No. 130, "Reporting Comprehensive Income" in accounting for comprehensive income and its components. Other comprehensive gain for the six months ended June 30, 2001 and 2000 was $78.1 million and $60.7 million, respectively. Other comprehensive gain for the three months ended June 30, 2001 and 2000 was $53.7 million and $37.3 million, respectively.

In June 2001, the FASB voted unanimously in favor of Statement No. 141, "Business Combinations" and Statement No. 142, "Goodwill and Other Intangible Assets," which will be issued early in the third quarter of 2001. Statement No. 141 eliminates the pooling of interests method of accounting for business acquisitions and Statement No. 142 eliminates the amortization of goodwill and requires the Company to evaluate goodwill for impairment on an annual basis. Any impairment of goodwill must be recognized currently as a charge to earnings in the financial statements. The Company will be required to apply the provisions of the final Statements to all business combinations initiated after June 30, 2001. For goodwill and intangible assets arising from business combinations completed before July 1, 2001, the Company will be required to apply the provisions of Statement No. 142 beginning on January 1, 2002. Application of the nonamortization provisions of the Statement in the year ending 2002 is expected to reduce intangibles amortization by approximately $15 million and increase net earnings by approximately $10 million ($0.05 per diluted share). During 2002, the Company will perform the initial impairment tests of goodwill and indefinite lived intangible assets as of January 1, 2002. The Company has not yet determined what effect these tests will have on its consolidated results of operations or financial position.

Inventories are as follows:

On December 4, 1998, the Company acquired Howmedica, the orthopaedic division of Pfizer Inc., for $1,650.0 million in cash. The acquisition was funded with cash and cash equivalents and approximately $1,500.0 million borrowed under $1,650.0 million of credit facilities established in December 1998. The acquisition of Howmedica was accounted for using the purchase method of accounting. For further discussion of the allocation of the purchase price, the related establishment of additional purchase liabilities and certain other information regarding the acquisition see Note 4 in the Company's Annual Report on Form 10-K for the year ended December 31, 2000. The working capital adjustment to the Howmedica purchase price, which had been in dispute, was determined in July 2001, and the Company made a final cash payment of $27.2 million (plus interest) in the third quarter of 2001.

Substantially all of the activities for which additional purchase liabilities are recorded were completed during 1999 and 2000. These activities include the conversion of Howmedica's distribution network to direct sales and planned workforce reductions. Payments of distributor conversion obligations and severance and related costs are expected to be completed by the third quarter of 2001. The two Howmedica facilities in Europe and Howmedica's U.S. craniomaxillofacial facility were closed during 1999. The remaining leased facilities in the United States were closed during 2000, with the exception of one facility that is expected to be closed during 2001. Facility closure and contractual obligations include lease obligation payments that extend to 2008.

The following table provides a rollforward from December 31, 2000 to June 30, 2001 of the additional purchase liabilities recorded in connection with the acquisition of Howmedica (in millions):

Note 5 in the Company's Annual Report on Form 10-K for the year ended December 31, 2000 describes acquisition-related and restructuring pretax charges (credits) recorded by the Company in 2000, 1999 and 1998.

Planned workforce reductions covering 38 of the 95 employees for which severance costs were charged to operations in 2000 and covering 80 of the approximately 110 employees in the Company's Japanese distribution operation for which severance costs were charged to operations in 1999 have been completed. The remaining headcount reductions are expected to be completed in 2001.

The following table provides a rollforward from December 31, 2000 to June 30, 2001 of remaining liabilities associated with acquisition-related and restructuring pre-tax charges recorded by the Company (in millions):

The Company segregates its operations into two reportable segments: Orthopaedic Implants and MedSurg Equipment. The Orthopaedic Implants segment includes orthopaedic reconstructive products such as hip, knee, shoulder and spinal implants and trauma-related products. The MedSurg Equipment segment includes powered surgical instruments, endoscopic systems, medical video imaging equipment, patient care and handling equipment, craniomaxillofacial implants and image-guided surgical systems. Other consists of Physical Therapy Services and corporate administration, interest expense and interest income.

The Company's reportable segments are business units that offer different products and services and are managed separately because each business requires different manufacturing, technology and marketing strategies.

Sales and net earnings (loss) by business segment follows:

RESULTS OF OPERATIONS

The table below outlines the components of the condensed consolidated statements of earnings as a percentage of net sales and the period-to-period percentage change in dollar amounts:

The table below sets forth domestic/international and product line sales information (in millions):

Stryker Corporation's net sales increased 13% in the first half of 2001 to $1,273.2 million from $1,128.6 million in 2000. Net sales grew by 12% as a result of increased unit volume; 2% as a result of higher selling prices; 1% due to acquired businesses, and 1% related to the inclusion of freight revenue in net sales in 2001. Freight revenue was recorded as an offset to cost of sales during 2000. The factors increasing sales were partially offset by a 3% decline due to changes in foreign currency exchange rates. For the second quarter of 2001, net sales were $639.0 million representing a 13% increase over net sales of $566.5 million in the second quarter of 2000. Net sales grew by 12% as a result of increased unit volume; 3% as a result of higher selling prices, 1% due to acquired businesses; and 1% due to the inclusion of freight revenue in net sales. These factors were partially offset by a 4% decline due to changes in foreign currency exchange rates.

The Company's domestic sales were $820.9 million for the first half and $417.6 million for the second quarter of 2001 representing increases of 21% and 22%, respectively, as a result of strong shipments of Orthopaedic Implants and MedSurg Equipment and increased revenue from Physical Therapy Services.

International sales were $452.3 million for the first half and $221.4 million for the second quarter of 2001, representing an increase of 1% for the first half and a decline of 2% for the second quarter as higher shipments of Orthopaedic Implants and MedSurg Equipment were offset by lower foreign currency rates. The impact of foreign currency comparisons to the dollar value of international sales was unfavorable by $39.1 million for the first half and $20.3 million in the second quarter. Excluding the impact of foreign currency, international sales increased 9% for the first half and 7% in the second quarter.

Worldwide sales of Orthopaedic Implants were $713.1 million for the first half and $353.5 million for the second quarter of 2001 representing increases of 7% in both periods based on higher shipments of reconstructive (hip, knee and shoulder), trauma and spinal implants. Excluding the impact of foreign currency, sales of Orthopaedic Implants increased 12% in the first half and second quarter. Worldwide sales of MedSurg Equipment were $470.9 million for the first half and $239.9 million for the second quarter of 2001 representing increases of 19% and 20%, respectively, based on higher shipments of powered surgical instruments, endoscopic systems, hospital beds and stretchers and Leibinger craniomaxillofacial implants and image-guided surgical systems. Excluding the impact of foreign currency, sales of MedSurg Equipment increased 22% in the first half and second quarter. Physical Therapy Services revenues were $89.2 million for the first half and $45.6 million for the second quarter of 2001 represen ting increases of 29% and 28%, respectively, as a result of new physical therapy centers and higher revenues from existing centers.

Cost of sales in the first half of 2001 represented 36.9% of sales compared to 35.8% in the same period of 2000. In the second quarter the cost of sales percentage increased to 37.1% from 35.8% in the second quarter of 2000. The higher cost of sales percentage in 2001 primarily resulted from the change in recording of freight revenue described above and the classification of certain shipping costs as cost of sales in 2001 that were reported in selling, general and administrative expenses in the prior year. The cost of sales percentage increased approximately 1.0% from the first half and second quarter of 2000, respectively, as a result of the classification of freight revenue and shipping costs. In addition, overall Orthopaedic Implant margins improved slightly while MedSurg margins were down slightly because of higher sales of lower-margin products.

Research, development and engineering expenses represented 5.6% of sales in the first half of 2001 compared to 5.3% in 2000 and increased 19% to $70.8 million. In the second quarter, these expenses increased 15%, and represented 5.5% of sales in 2001 compared to 5.4% in 2000. New product introductions in the first six months of 2001 include the Accolade Cemented Hip Stem, T2 Intramedulary Nail System, Reflex Anterior Cervical plate, Percutaneous Cement Delivery System, Elite Attachments for TPS, SDC Pro II surgical documentation system and an enhanced Secure II bed. In the second quarter of 2001, the Company received marketing approval for its OP-1 Implant product in Australia and the European Union. The approved indication in Australia is for the treatment of nonunion of long bone fractures secondary to trauma for the purposes of initiating repair by new bone formation. The approved indication in Europe is for tibial nonunions of nine-month duration, secondary to trauma, in skeletally mature pat ients, in cases where previous treatment with autograft has failed or use of autograft is unfeasible. The first commercial sales of OP-1 in Australia began in mid-May and the commercial launch of OP-1 in the European Union is expected to begin in the third quarter. The Company does not anticipate a significant impact on sales from the commercial launch of OP-1 in Australia and the European Union in 2001 and can not predict the impact on sales in future years.

Selling, general and administrative expenses increased 11% in the first half of 2001 and represented 38.1% of sales compared to 38.9% in the same period of 2000. In the second quarter, these expenses increased 10%, and represented 37.9% of sales in 2001 compared to 38.8% in 2000. The classification of certain shipping costs as cost of sales in 2001 as discussed above reduced selling, general and administrative expenses as a percent of sales by approximately 0.4% in both the first half and second quarter of 2001. Included in selling, general and administrative expenses is $3.6 million in the first half and $1.6 million in the second quarter in 2001 compared to $3.3 million in the first half and $1.7 million in the second quarter of 2000 of discount expense related to the accounts receivable securitization program established in November 1999.

Interest expense declined to $36.3 million in the first half of 2001 from $52.2 million in 2000 and declined to $16.8 million in the second quarter of 2001 from $26.0 million in 2000 primarily as a result of lower outstanding debt balances. The increase in intangibles amortization in the first half of 2001 to $19.2 million from $17.7 million in the same period of 2000 is primarily the result of business acquisitions completed in the last nine months of 2000. Intangibles amortization in the second quarter of 2001 declined slightly to $9.3 million from $9.5 million in the same period of 2000. Other income was $1.9 million in the first half of 2001 compared to $2.2 million in 2000 due to foreign currency transaction gains in the current year versus losses in the prior year, partially offset by lower interest income. Other expense (income) decreased to other expense of $0.1 million in the second quarter of 2001 from $2.6 million of other income in 2000 primarily as a result of lower interest income an d foreign currency transaction losses in the current year versus gains in the prior year.

The effective tax rate was 33.0% for the first six months and second quarter of 2001 compared to a rate of 34.0% for the first six months and second quarter of 2000, primarily as the result of tax benefits from manufacturing in Ireland and Puerto Rico. Net earnings for the first half of 2001 were $129.8 million, an increase of 24% when compared to net earnings of $104.5 million in the first half of 2000. Basic net earnings per share increased 22% in the first half to $0.66 in 2001 from $0.54 in 2000, and diluted net earnings per share increased 23% in the first half to $0.64 in 2001 from $0.52 in 2000. Net earnings for the second quarter of 2001 were $65.7 million representing a 25% increase over net earnings of $52.7 million in the second quarter of 2000. Basic net earnings per share increased 22% in the second quarter to $0.33 in 2001 from $0.27 in 2000, and diluted net earnings per share increased 23% in the second quarter to $0.32 in 2001 from $0.26 in 2000.

LIQUIDITY AND CAPITAL RESOURCES

The Company's working capital at June 30, 2001 increased $29.7 million to $409.3 million from $379.6 million at December 31, 2000. The increase in working capital resulted from growth in the Company's overall business and the use of strong cash earnings to pay current liabilities due in the first half of 2001, primarily for accrued compensation. However, improved asset management kept the growth in key assets below the sales growth rate. Accounts receivable days sales outstanding, excluding the effect of the accounts receivable securitization program, decreased three days to 66 days at June 30, 2001 from 69 days at December 31, 2000. Days sales in inventory decreased four days to 162 days at June 30, 2001 from 166 days at December 31, 2000.

The Company generated cash of $152.0 million from operations in the first six months of 2001, compared to $109.5 million in 2000. The cash provided by operating activities in the first half of 2001 is the result of strong cash earnings and increases in accounts payable, income tax liabilities and other accrued expenses. These increases were partially offset by increases in accounts receivable, inventories and deferred charges.

In the first half of 2001, the Company used cash of $39.2 million for capital expenditures, $4.0 million for business acquisitions and $15.7 million for the payment of dividends. The Company also borrowed an additional $151.0 million under its existing credit facilities to fund cash flow needs during the first half and made repayments of $263.6 million against the credit facilities. Total debt declined by $128.9 million during the first half of 2001.

The Company had $42.6 million in cash and cash equivalents at June 30, 2001. The Company had outstanding long-term debt totaling $883.6 million at the end of the first half of 2001. Current maturities of long-term debt at June 30, 2001 were $138.4 million and will increase to $175.5 million and $213.9 million for the twelve months ending June 30, 2003 and 2004, respectively. The Company believes its cash on-hand as well as anticipated cash flows from operations will be sufficient to fund future operating and investing activities and required debt repayments. Should additional funds be required, the Company had $248.3 million of additional borrowing capacity available under existing credit facilities at June 30, 2001.

OTHER MATTERS

The Company has certain investments in net assets in international locations that are not hedged that are subject to translation gains and losses due to changes in foreign currencies. In the first half of 2001, the weakening of foreign currencies reduced the value of these investments in net assets by $40.0 million. The loss is deferred and is recorded as a separate component of stockholders' equity.

In June 2001, the FASB voted unanimously in favor of Statement No. 141, "Business Combinations" and Statement No. 142, "Goodwill and Other Intangible Assets," which will be issued early in the third quarter of 2001. Statement No. 141 eliminates the pooling of interests method of accounting for business acquisitions and Statement No. 142 eliminates the amortization of goodwill and requires the Company to evaluate goodwill for impairment on an annual basis. Any impairment of goodwill must be recognized currently as a charge to earnings in the financial statements. The Company will be required to apply the provisions of the final Statements to all business combinations initiated after June 30, 2001. For goodwill and intangible assets arising from business combinations completed before July 1, 2001, the Company will be required to apply the provisions of Statement No. 142 beginning on January 1, 2002. Application of the nonamortization provisions of the Statement in the year ending 2002 is expected to reduce intangibles amortization by approximately $15 million and increase net earnings by approximately $10 million ($0.05 per diluted share). During 2002, the Company will perform the initial impairment tests of goodwill and indefinite lived intangible assets as of January 1, 2002. The Company has not yet determined what effect these tests will have on its consolidated results of operations or financial position.

Forward-Looking Statements

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: changes in economic conditions that adversely affect the level of demand for the Company's products, changes in foreign exchange markets, changes in financial markets and changes in the competitive environment. All forward-looking statements contained in this report are qualified in their entirety by this cautionary statement.

There have been no material changes from the information provided in the Company's Annual Report on Form 10-K for the year ended December 31, 2000.

PART II. - OTHER INFORMATION

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.