NON-GAAP FINANCIAL MEASURES We supplement the reporting of our financial information determined under accounting principles generally accepted in
the United States(GAAP) with certain non-GAAP financial measures, including percentage sales growth in constant currency; percentage organic sales growth; adjusted gross profit; adjusted selling, general and administrative expenses; adjusted operating income; adjusted other income (expense); adjusted effective income tax rate; adjusted net earnings; and adjusted diluted net earnings per share. We believe that these non-GAAP measures provide meaningful information to assist shareholders in understanding our financial results and assessing our prospects for future performance. Management believes percentage sales growth in constant currency and the other adjusted measures described above are important indicators of our operations because they exclude items that may not be indicative of or are unrelated to our core operating results and provide a baseline for analyzing trends in our underlying businesses. Management uses these non-GAAP financial measures for reviewing the operating results of reportable business segments and analyzing potential future business trends in connection with our budget process and bases certain management incentive compensation on these non-GAAP financial measures. To measure percentage sales growth in constant currency, we remove the impact of changes in foreign currency exchange rates that affect the comparability and trend of sales. Percentage sales growth in constant currency is calculated by translating current year results at prior year average foreign currency exchange rates. To measure percentage organic sales growth, we remove the impact of changes in foreign currency exchange rates and acquisitions that affect the comparability and trend of sales. Percentage organic sales growth is calculated by translating current year results at prior year average foreign currency exchange rates excluding the impact of acquisitions. To measure earnings performance on a consistent and comparable basis, we exclude certain items that affect the comparability of operating results and the trend of earnings. Because non-GAAP financial measures are not standardized, it may not be possible to compare these financial measures with other companies' non-GAAP financial measures having the same or similar names. These adjusted financial measures should not be considered in isolation or as a substitute for reported sales growth, gross profit, selling, general and administrative expenses, operating income, other income/(expense), effective income tax rate, net earnings and diluted net earnings per share, the most directly comparable GAAP financial measures. These non-GAAP financial measures are an additional way of viewing aspects of our operations that, when viewed with our GAAP results and the reconciliations to corresponding GAAP financial measures at the end of the discussion of Results of Operations below, provide a more complete understanding of our business. We strongly encourage investors and shareholders to review our financial statements and publicly-filed reports in their entirety and not to rely on any single financial measure. ABOUT STRYKER Stryker is one of the world's leading medical technology companies, with 2013 revenues of $9,021and net earnings of $1,006. We are dedicated to helping healthcare professionals perform their jobs more efficiently while enhancing patient care. We offer a diverse array of innovative medical technologies, including reconstructive, medical and surgical, and neurotechnology and spine products, to help people lead more active and more satisfying lives. In the United States, most of our products are marketed directly to doctors, hospitals and other healthcare facilities. In general, we maintain separate dedicated sales forces for each of our principal product lines to provide focus and a high level of expertise to each medical specialty served. Internationally our products are sold in over 100 countries through company-owned sales subsidiaries and branches as well as third-party dealers and distributors. Our business is generally not seasonal in nature; however, the number of reconstructive implant surgeries is generally lower during the summer months and sales of capital equipment are generally higher in the fourth quarter. Recent Business Developments In December 2013we announced our intent to acquire Patient Safety Technologies, Inc. (PST), for an aggregate purchase price of $120. PST conducts its business through its wholly owned subsidiary, SurgiCount Medical, Inc.Its proprietary Safety-Sponge® System and SurgiCount 360™ compliance software help prevent Retained Foreign Objects in the operating room. The System includes bar-coded surgical sponges and towels, an integrated bar-code scanner, and compliance tracking software. The transaction is subject to customary closing conditions and is expected to close in the first quarter of 2014. In December 2013we acquired MAKO Surgical Corp.(MAKO) for an aggregate purchase price of approximately $1,679. The acquisition of MAKO, combined with our strong history in joint reconstruction, capital equipment (operating room integration and surgical navigation) and surgical instruments, will help further advance the growth of robotic arm assisted surgery. Our combined expertise offers the potential to simplify joint reconstruction procedures, reduce variability and enhance the surgeon and patient experience. In April 2013William R. Jellison was named our Vice President and Chief Financial Officer. Mr. Jellisonreplaced Dean Bergywho was our Interim Chief Financial Officer. In March 2013we sold $600of senior unsecured notes due 2018 (the 2018 Notes) and $400of senior unsecured notes due 2043 (the 2043 Notes). The 2018 Notes bear interest at 1.3% per year and, unless previously redeemed, will mature in April 1, 2018. The 2043 Notes bear interest at 4.1% per year and, unless previously redeemed, will mature on April 1, 2043. We intend to use the net proceeds from the offering for working capital and other general Dollar amounts in millions except per share 10 amounts or as otherwise specified
corporate purposes, including acquisitions, stock repurchases and other business opportunities. In
March 2013we acquired Trauson Holdings Company Limitedfor a total consideration of $751. With this acquisition we expanded our presence in a key emerging market with a product portfolio and pipeline that is targeted at the large and fast growing value segment of the Chinese orthopaedic market. In 2013 we recorded charges for the Rejuvenate, ABG II and Neptune recalls of $460, net of tax, and other matters that are discussed more fully in Results of Operations below. RESULTS OF OPERATIONS Consolidated results of operations: Percentage Change 2013 2012 2011 2013/2012 2012/2011 Net Sales $9,021 $8,657 $8,3074.2 4.2 Gross Profit 6,044 5,876 5,496 2.9 6.9 Research, development & engineering expenses 536 471 462 13.8 1.9 Selling, general & administrative expenses 4,066 3,466 3,150 17.3 10.0 Intangibles amortization 138 123 122 12.2 0.8 Restructuring charges 48 75 76 (36.0 ) (1.3 ) Other income (expense) (44) (36) - 22.2 - Income taxes 206 407 341 (49.4 ) 19.4 Net Earnings $1,006 $1,298 $1,345(22.5 ) (3.5 ) Diluted Net Earnings per share $2.63 $3.39 $3.45
(22.4 ) (1.7 )
Geographic and segment net sales: Percentage Change 2013/2012 2012/2011 Year Ended December 31 Constant Constant 2013 2012 2011 Reported Currency Reported Currency Geographic sales: United States
$ 5,984 $ 5,658 $ 5,2695.8 5.8 7.4 7.4 International 3,037 2,999 3,038 1.3 6.0 (1.3 ) 1.9 Total net sales $ 9,021 $ 8,657 $ 8,3074.2 5.9 4.2 5.4 Segment sales: Reconstructive $ 4,004 $ 3,823 $ 3,7104.8 6.9 3.1 4.4 MedSurg 3,359 3,265 3,160 2.9 3.8 3.3 4.2 Neurotechnology and Spine 1,658 1,569 1,437 5.6 7.7 9.2 10.5 Total net sales $ 9,021 $ 8,657 $ 8,3074.2 5.9 4.2 5.4 Net sales increased 4.2% in 2013 after increasing 4.2% in 2012. In 2013 net sales grew by 6.5% as a result of increased unit volume and changes in product mix and 0.8% due to acquisitions and were negatively impacted by 1.4% due to changes in price and 1.6% due to the unfavorable impact of foreign currency exchange rates on net sales. Excluding the impact of acquisitions, net sales increased 5.1% in constant currency. Net sales in 2012 increased 5.6% as a result of unit volume and changes in product mix and 1.2% due to acquisitions and were negatively impacted by 1.4% due to changes in price and 1.2% due to the unfavorable impact of foreign currency exchange rates on net sales. Excluding the impact of acquisitions, 2012 net sales increased 4.2% in constant currency. Net sales in 2013 increased primarily due to higher shipments of trauma and extremities products, neurotechnology products, hips and endoscopy products. Net sales in 2012 increased primarily due to higher shipments of neurotechnology products, instruments products, trauma and extremities products, spine products and reprocessed and remanufactured medical devices; these gains were partially offset by slowness in the European markets. In the United Statesnet sales increased 5.8% in 2013 after increasing 7.4% in 2012. In constant currency, International sales increased 6.0% in 2013 after increasing 1.9% in 2012.
Supplemental geographical sales growth information
December 31, 2013Year Ended December 31, 2012Percentage Change Percentage Change U.S. International
U.S. International Constant Constant Constant Constant 2013 2012 As Reported Currency As Reported As Reported Currency 2012 2011 As Reported Currency As Reported As Reported Currency Reconstructive Knees 1,371 1,356 1.1 % 2.6 % 3.4 % (3.3 )% 1.1 % 1,356 1,316 3.0 % 4.0 % 6.0 % (2.4 )% 0.4 % Hips 1,272 1,233 3.2 % 6.0 % 7.2 % (1.4 )% 4.5 % 1,233 1,228 0.4 % 1.5 % 5.2 % (4.5 )% (2.3 )% Trauma and Extremities 1,116 989 12.8 % 15.1 % 18.4 % 7.2 % 11.8 % 989 931 6.2 % 8.4 % 18.0 % (3.5 )% 0.4 % TOTAL RECONSTRUCTIVE 4,004 3,823 4.8 % 6.9 % 7.9 % 0.5 % 5.5 % 3,823 3,710 3.1 % 4.4 % 9.2 % (4.3 )% (1.4 )% MedSurg Instruments 1,269 1,261 0.6 % 1.9 % 0.7 % 0.6 % 5.1 % 1,261 1,187 6.2 % 7.3 % 9.1 % (0.4 )% 3.1 % Endoscopy 1,167 1,111 5.0 % 6.0 % 6.6 % 1.3 % 4.6 % 1,111 1,080 2.9 % 3.9 % 2.6 % 3.7 % 7.1 % Medical 710 691 2.8 % 3.1 % 3.4 % 0.3 % 2.0 % 691 722 (4.3 )% (3.7 )% (7.8 )% 11.1 % 14.8 % TOTAL MEDSURG 3,359 3,265 2.9 % 3.8 % 3.6 % 0.8 % 4.3 % 3,265 3,160 3.3 % 4.2 % 3.4 % 3.0 % 6.5 % Neurotechnology and Spine Neurotechnology 915 842 8.7 % 11.4 % 11.2 % 5.1 % 11.8 % 842 750 12.3 % 13.9 % 19.0 % 3.9 % 7.6 % Spine 743 727 2.1 % 3.4 % 1.8 % 2.9 % 7.2 % 727 687 5.8 % 6.9 % 9.2 % (1.7 )% 1.7 % TOTAL NEUROTECHNOLOGY AND SPINE 1,658 1,569 5.6 % 7.7 % 6.4 % 4.3 % 10.0 % 1,569 1,437 9.2 % 10.5 % 13.8 % 1.7 % 5.3 % Dollar amounts in millions except per share 11 amounts or as otherwise specified
Reconstructive Net Sales Reconstructive net sales in 2013 increased 4.8%, primarily due to a 7.9% increase in unit volume and changes in product mix and 1.4% due to acquisitions. Net sales were negatively impacted by 2.4% due to changes in price and 2.1% due to the unfavorable impact of foreign currency exchange rates on net sales. Excluding the impact of acquisitions, net sales increased by 5.5% in constant currency in 2013, primarily due to increases in trauma and extremities products and hips. Net sales in 2012 increased 3.1%, primarily due to a 5.6% increase in unit volume and changes in product mix and 0.9% due to acquisitions. Net sales were negatively impacted by 2.2% due to changes in price and 1.3% due to the unfavorable impact of foreign currency exchange rates on net sales. In constant currency, net sales increased by 4.4% in 2012, primarily due to increases in trauma and extremities products and market share gains partially due to a competitor's product recall, partially offset by slowness in the European markets. MedSurg Net Sales MedSurg net sales in 2013 increased 2.9%, primarily due to a 3.8% increase in unit volume and changes in product mix and were negatively impacted by 0.9% due to the unfavorable impact of foreign currency exchange rates on net sales. The effect of pricing was not significant. In constant currency, net sales in 2013 increased 3.8%, led by higher shipments of endoscopy products. Net sales in 2012 increased 3.3%, primarily due to a 4.1% increase in unit volume and changes in product mix and 0.1% due to acquisitions, and were negatively impacted by 0.1% due to changes in price and 0.9% due to the unfavorable impact of foreign currency exchange rates on net sales. In constant currency, net sales in 2012 increased 4.2%, led by higher shipments of instruments products and reprocessed and remanufactured medical devices; these higher shipments were partially offset by challenging global market conditions for capital equipment. Neurotechnology and Spine Net Sales Neurotechnology and Spine net sales in 2013 increased 5.6%, primarily due to an 8.8% increase in unit volume and changes in product mix and 0.9% due to acquisitions, and were negatively impacted by 2.0% due to changes in price and 2.1% due to the unfavorable impact of foreign currency exchange rates on net sales. Excluding the impact of acquisitions, net sales in 2013 increased 6.8% in constant currency, due to higher shipments of neurotechnology products. Net sales in 2012 increased 9.2%, primarily due to an 8.5% increase in unit volume and changes in product mix and 4.2% due to acquisitions, and were negatively impacted by 2.2% due to changes in price and 1.3% due to the unfavorable impact of foreign currency exchange rates on net sales. In constant currency net sales in 2012 increased 10.5%. Consolidated Cost of Sales Cost of sales increased 7.0% in 2013 to 33.0% of sales compared to 32.1% in 2012. The Medical Device Excise Tax was 0.9% of sales in the current year. Cost of sales as a percentage of sales was adversely impacted by changes in selling prices for our products and by the unfavorable effect of foreign currency exchange rates; these effects were offset by improvements in manufacturing productivity. Cost of sales in 2013 and 2012 includes an additional cost of
$28and $18, respectively, related to inventory that was "stepped up" to fair value following acquisitions; $11and $5, respectively in restructuring and restructuring related costs; and $7in 2013 for disgorgement of profits associated with a legal settlement. Cost of sales decreased 1.1% in 2012 to 32.1% of sales compared to 33.8% in 2011. Cost of sales in 2012 and 2011 includes an additional cost of $18and $143, respectively, related to inventory that was "stepped up" to fair value following acquisitions and $5in 2012 in restructuring and related costs. Research, Development and Engineering Expenses Research, development and engineering expenses represented 5.9% of sales in 2013 compared to 5.4% in 2012 and 5.6% in 2011. The increased spending level in 2013 was driven by the timing of projects and continued investment in new technologies. The spending level in 2012 decreased as a percentage of sales primarily due to the termination of all development of the OP-1 molecule in late 2011. Selling, General and Administrative Expenses Selling, general and administrative expenses increased 17.3% in 2013 and represented 45.1% of sales compared to 40.0% in 2012 and 37.9% in 2011. These expenses included $70and $37in 2013 and 2012, respectively, of acquisition and integration related charges; $622and $174, respectively, related to the Rejuvenate, ABG II and Neptune recalls; $62and $33in 2013 and 2012, respectively, related to regulatory and legal matters; $25in 2013 representing a donation to an educational institution and $4in 2013 in restructuring related charges. Excluding the impact of these charges, selling, general and administrative expenses were 36.4% of sales in 2013 compared to 37.2% in 2012. In 2011 general and administrative expenses included the payment of an intellectual property infringement claim, offset by a favorable resolution of a value added tax issue. Restructuring Charges In 2013, 2012 and 2011 we recorded $50( $2in cost of sales and $48in selling, general and administrative expense), $75and $76, respectively, in restructuring charges related to focused reductions of our global workforce and other restructuring initiatives. The targeted reductions and other restructuring activities were initiated to provide efficiencies and realign resources as well as to allow for continued investment in strategic areas and drive growth. Other Income (Expense) Other expense increased by $8in 2013 after increasing by $36in 2012. Net expense in 2013 increased due to lower income from interest and marketable securities, offset by hedge gains and lower interest expense. The decrease in interest expense was due to favorable tax audit resolutions in multiple jurisdictions that resulted in interest expense credits, partially offset by higher interest expense on borrowings. The increase in 2012 was primarily due to reductions of accrued interest expense in 2011 resulting from settlements reached with the United States Internal Revenue Service(IRS). In 2011 we reached a favorable settlement regarding an IRSproposed adjustment to our previously filed 2003 through 2007 income tax returns related to the income tax positions we had taken for our Irish cost sharing arrangements. We also reached a settlement with the IRSwith respect to the allocation of income Dollar amounts in millions except per share 12 amounts or as otherwise specified
with a wholly owned subsidiary operating in
Puerto Ricofor the years 2006 through 2009. The higher interest expense in 2012 due to the effect of the 2011 tax settlements was partially offset by higher interest income on our investments, due to higher cash and cash equivalents and marketable securities balances compared to 2011. Income Taxes Our effective income tax rate on earnings was 17.0%, 23.9% and 20.2% in 2013, 2012 and 2011, respectively. The effective income tax rate for 2013 includes income tax benefits relating to favorable audit resolutions in multiple jurisdictions. The effective income tax rate for 2012 includes the net impact of effective settlement of all tax matters through 2004 relating to two German subsidiaries, and adjustment of the estimate of foreign tax credits to the amount shown on the tax return as filed. The effective income tax rate for 2011 includes the net impact of the settlements with the IRSas described above. The American Taxpayer Relief Act of 2012 (the Act) was signed on January 2, 2013. The Act provided numerous tax provisions for corporations including an extension of the research tax credit and an extension of certain provisions for companies with significant international operations. The provisions originally expired at December 31, 2011but were retroactively extended through December 31, 2013. In 2013 we recorded tax benefits of $13related to the 2012 research tax credit and other provision of the Act. Net Earnings Net earnings in 2013 decreased 22.5% to $1,006. Basic net earnings per share in 2013 decreased 22.0% to $2.66, and diluted net earnings per share in 2013 decreased 22.4% to $2.63. Net earnings in 2012 decreased 3.5% to $1,298. Basic net earnings per share in 2012 decreased 2.0% to $3.41, and diluted net earnings per share in 2012 decreased 1.7% to $3.39. Reported net earnings in 2013 includes charges for the Rejuvenate, ABG II and Neptune recalls, acquisition and integration related charges related to the Neurovascular, Surpass, Trausonand MAKO acquisitions, additional cost of sales for inventory sold that was "stepped up" to fair value related to the Trausonand MAKO acquisitions, restructuring and related charges, certain charges related to legal and regulatory matters, a donation to an educational institution and benefits associated with the resolution of certain tax matters. Excluding the impact of these items, adjusted net earnings in 2013 increased 3.6% to $1,616after increasing 7.7% in 2012. Adjusted diluted net earnings per share in 2013 increased 3.9% to $4.23after increasing 9.4% in 2012. Non-GAAP Financial Measures The following reconciles the non-GAAP financial measures: adjusted gross profit; adjusted selling, general and administrative expense; adjusted operating income; adjusted other income/(expense); adjusted net earnings; adjusted effective tax rate; and adjusted diluted net earnings per share; with the most directly comparable GAAP financial measures: Selling, General and Operating Other Income Effective Tax
$ 6,044$ 4,066 $
Acquisition and integration related charges Inventory stepped up to fair value 28 - 28 - 21 0.1 0.06 Other acquisition and integration related - (70 ) 70 - 51 0.3 0.13 Restructuring and related charges 11 (4 ) 63 - 46 0.3 0.12 Rejuvenate and recall matters - (622 ) 622 - 460 2.0 1.20 Regulatory and legal matters 7 (62 ) 69 2 63 (0.6 ) 0.17 Donation - (25 ) 25 - 15 0.3 0.04 Tax matters - - - (13 ) (46 ) 2.9 (0.12 ) ADJUSTED
$ 6,090$ 3,283 $ 2,133 $ (55 ) $ 1,61622.3 % $ 4.23Year Ended December 31, 2012AS REPORTED $ 5,876 $ 3,466 $ 1,741 $ (36 )$
1,298 23.9 %
Acquisition and integration related charges Inventory stepped up to fair value 18 - 18 - 13 - 0.03 Other acquisition and integration related - (37 ) 37 - 24 0.3 0.06 Restructuring and related charges 5 - 80 - 59 0.1 0.15 Rejuvenate and recall matters - (174 ) 174 - 133 - 0.35 Regulatory and legal matters - (33 ) 33 - 33 (0.5 ) 0.09 ADJUSTED
$ 5,899 $ 3,222 $ 2,083 $ (36 ) $ 1,56023.8 % $ 4.07Year Ended December 31, 2011AS REPORTED $ 5,496 $ 3,150 $ 1,686$ - $
1,345 20.2 %
Acquisition and integration related charges Inventory stepped up to fair value 143 - 143 - 97 0.6 0.25 Other acquisition and integration related - (66 ) 66 - 45 0.3 0.12 Restructuring and related charges - - 76 -
60 (0.2 ) 0.16
Regulatory and legal matters - (1 ) 1 - - - - Tax matters - - - (27 ) (99 ) 4.7 (0.26 ) ADJUSTED
$ 5,639 $ 3,083 $ 1,972 $ (27 )$
1,448 25.6 %
The weighted-average basic and diluted shares outstanding used in the calculation of these non-GAAP financial measures are the same as the weighted-average shares outstanding used in the calculation of the reported per share amounts.
Dollar amounts in millions except per share 13 amounts or as otherwise specified
FINANCIAL CONDITION AND LIQUIDITY Operating Activities Operating cash flow was
$1,886in 2013, an increase of 13.8% and resulted primarily from net earnings adjusted for non-cash items (depreciation and amortization, share-based compensation, sale of inventory "stepped up" to fair value at acquisition and deferred income taxes), along with a decrease of $278in cash paid for income taxes, associated with the timing of cash payments as well as favorable tax audit resolutions in multiple jurisdictions. These increases were partially offset by higher levels of inventory and accounts receivable. The net of accounts receivable, inventory and accounts payable resulted in the consumption of $165of cash in 2013. Inventory days on hand improved by 1 day due to continued focus on improved inventory management; accounts receivable days sales outstanding remained consistent with 2012. Operating cash flow was $1,657in 2012, an increase of 15.6%, and resulted primarily from net earnings adjusted for non-cash items (depreciation and amortization, share-based compensation, sale of inventory "stepped up" to fair value at acquisition and deferred income taxes). The net of accounts receivable, inventory and accounts payable consumed $50of cash in 2012. Inventory reductions contributed $18of cash as inventory days on hand decreased by 5 days, due to lower inventory levels driven primarily by improved inventory management. Accounts receivable increases from business growth resulted in the consumption of $20of cash, while accounts receivable days sales outstanding decreased by 3 days due to timing of sales. Investing Activities Net investing activities resulted in cash consumption of $2,217, $736and $2,135in 2013, 2012 and 2011, respectively, primarily due to acquisitions and capital spending. Acquisitions. Acquisitions resulted in cash consumption of $2,320in 2013 and $154in 2012. In 2013 the cash consumed was primarily for Trausonand MAKO. In 2012 cash consumed was primarily for Surpass for $99as well as for milestone payments related to previous acquisitions. Cash consumed in 2011 of $2,066was primarily for the acquisitions of Neurovascular for $1,450; Orthovita for $316; Memometal for $150; and Concentric for $135. Capital Spending. We manage capital spending to support our business growth. Capital expenditures, primarily to support integration of acquisitions, information technology infrastructure upgrades, capacity expansion, new product introductions, innovation and cost savings, were $195, $210and $226in 2013, 2012 and 2011, respectively. Proceeds from Asset Sales. Proceeds from asset sales contributed $67of cash in 2011, primarily due to the sale of certain assets related to the OP-1 product family. Financing Activities Dividend Payments. Dividends paid per common share increased 24.7% to $1.06per share in 2013, and increased 18.1% to $0.85per share in 2012. As a result of the annual increase in dividends paid per share, total dividend payments to common shareholders were $401, $324and $279in 2013, 2012 and 2011, respectively. Short-term and Long-Term Debt. We maintain debt levels we consider appropriate after evaluating a number of factors, including cash flow expectations, cash requirements for ongoing operations, investment and financing plans (including acquisitions and share repurchase activities) and overall cost of capital. In March 2013we sold $600 millionof senior unsecured notes due 2018 (the 2018 Notes) and $400 millionof senior unsecured notes due 2043 (the 2043 Notes). The 2018 Notes bear interest at 1.3% per year and mature in April 1, 2018. The 2043 Notes bear interest at 4.1% per year and mature on April 1, 2043. We intend to use the net proceeds from the offering for working capital and other general corporate purposes, including acquisitions, stock repurchases and other business opportunities. Total debt was $2,764and $1,762in 2013 and 2012, respectively. Share Repurchases. The total use of cash for share repurchases was $317, $108and $622in 2013, 2012 and 2011, respectively. Liquidity Our cash, cash equivalents and marketable securities were $3,980and $4,285at December 31, 2013and 2012, respectively, and our current assets exceeded current liabilities by $5,678and $6,272at December 31, 2013and 2012, respectively. We anticipate being able to support our short-term liquidity and operating needs, including settlements related to the Rejuvenate and ABG II recalls, from a variety of sources, including cash from operations, commercial paper and existing credit lines. In the past we have also raised funds in the capital markets and may continue to do so from time to time in the future. We have strong short-term and long-term debt ratings that we believe should enable us to refinance our debt as it becomes due. In August 2012we refinanced our credit facility with a new $1,000Unsecured Revolving Credit Facility due August 2017(2012 Facility). The 2012 Facility replaced the previously outstanding $1,000Unsecured Credit Facility that would have become due in August 2013. The 2012 Facility includes an increase option permitting us to increase the size of the facility up to an additional $500, a $500multicurrency sublimit (with no sublimit for euro borrowings) and a $100letter of credit sublimit. The 2012 Facility has an annual facility fee ranging from 5 to 22.5 basis points and bears interest at LIBOR, as defined in the 2012 Facility agreement, plus an applicable margin ranging from 57.5 to 127.5 basis points, both of which are dependent on our credit ratings. Should additional funds be required we had approximately $1,052of borrowing capacity available under all of our existing credit facilities at December 31, 2013, including the 2012 Facility. At December 31, 2013, approximately 78% of our consolidated cash, cash equivalents and marketable securities were held outside of the United States. These funds are considered indefinitely reinvested to be used to expand operations either organically or through acquisitions outside the United States. We continually evaluate our receivables, particularly in Spain, Portugal, Italyand Greece(the Southern European Region). The total net receivables from the Southern European Regionwere approximately $199and $198at December 31, 2013and 2012, respectively, including approximately $103of sovereign Dollar amounts in millions except per share 14 amounts or as otherwise specified
receivables in both years. We believe that our current reserves related to receivables are adequate and any additional credit risk associated with the
Southern European Regionis not expected to have a material adverse impact on our financial position or liquidity. We currently do not have any investments in the sovereign debt instruments of the Southern European Region. Any non-sovereign exposure in these countries in our investment portfolio is considered immaterial. Guarantees and Other Off-Balance Sheet Arrangements We do not have guarantees or other off-balance sheet financing arrangements, including variable interest entities, of a magnitude that we believe could have a material impact on our financial condition or liquidity. CONTRACTUAL OBLIGATIONS AND FORWARD-LOOKING CASH REQUIREMENTS As further described in Note 7 to the Consolidated Financial Statements, as of December 31, 2013we have recorded charges to earnings totaling $790representing the minimum of the range of probable loss to resolve the Rejuvenate and ABG II recalls. Based on the information that has been received, the actuarially determined range of probable loss to resolve this matter is estimated to be approximately $790to $1,235, before third-party insurance recoveries. The final outcome of this matter is dependent on many variables that are difficult to predict. The ultimate cost to entirely resolve this matter may be materially different than the amount of the current estimate and could have a material adverse effect on our financial position, results of operations and cash flows. We are not able to reasonably estimate the future periods in which payments will be made. As further described in Note 12 to the Consolidated Financial Statements, as of December 31, 2013our defined benefit pension plans were underfunded by $175, of which approximately $174related to plans outside the United States. Due to the rules affecting tax-deductible contributions in the jurisdictions in which the plans are offered and the impact of future plan asset performance, changes in interest rates and the potential for changes in legislation in the United Statesand other foreign jurisdictions, we are not able to reasonably estimate, beyond 2013, the amounts that may be required to fund defined benefit pension plans. As further described in Note 11 to the Consolidated Financial Statements, as of December 31, 2013we have recorded a liability for uncertain income tax positions of $204. Due to uncertainties regarding the ultimate resolution of income tax audits, we are not able to reasonably estimate the future periods in which income tax payments to settle these uncertain income tax positions will be made. Our future contractual obligations for agreements with initial terms greater than one year, including agreements to purchase materials in the normal course of business, are: Payment Period 2014 2015 2016 2017 2018 After 2018 Total Short-term and long-term debt $ 25 $ 500 $ 750$ - $ 600 $ 900 $ 2,775Unconditional purchase obligations 479 136 11 6 33 3 668 Operating leases 51 53 33 26 21 38 222 Contributions to defined benefit plans 20 - - - - - 20 Other 5 5 5 3 2 55 75 $ 580 $ 694 $ 799 $ 35 $ 656 $ 996 $ 3,760
CRITICAL ACCOUNTING POLICIES AND ESTIMATES
In preparing our financial statements in accordance with GAAP, there are certain accounting policies that may require a choice between acceptable accounting methods or may require substantial judgment or estimation in their application. These include allowance for doubtful accounts, inventory reserves, income taxes, acquisitions, goodwill and intangible assets, and legal and other contingencies. We believe these accounting policies and the others set forth in Note 1 to the Consolidated Financial Statements should be reviewed as they are integral to understanding our results of operations and financial condition.
Allowance for Doubtful Accounts
We maintain an allowance for doubtful accounts for estimated losses in the collection of accounts receivable. We make estimates regarding the future ability of our customers to make required payments based on historical credit experience and expected future trends. If actual customer financial conditions are less favorable than projected by management, additional accounts receivable write offs may be necessary, which could unfavorably affect future operating results. Inventory Reserves We maintain reserves for excess and obsolete inventory resulting from the potential inability to sell certain products at prices in excess of current carrying costs. We make estimates regarding the future recoverability of the costs of these products and record provisions based on historical experience, expiration of sterilization dates and expected future trends. If actual product life cycles, product demand or acceptance of new product introductions are less favorable than projected by management, additional inventory write downs may be required, which could unfavorably affect future operating results.
Our annual tax rate is determined based on our income, statutory tax rates and the tax impacts of items treated differently for tax purposes than for financial reporting purposes. Tax law requires certain items be included in the tax return at different times than the items are reflected in the financial statements. Some of these differences are permanent, such as expenses that are not deductible Dollar amounts in millions except per share 15 amounts or as otherwise specified
in our tax return, and some differences are temporary and reverse over time, such as depreciation expense. These temporary differences create deferred tax assets and liabilities. Deferred tax assets generally represent the tax effect of items that can be used as a tax deduction or credit in future years for which we have already recorded the tax benefit in our income statement. Deferred tax liabilities generally represent tax expense recognized in our financial statements for which payment has been deferred, the tax effect of expenditures for which a deduction has already been taken in our tax return but has not yet been recognized in our financial statements or assets recorded at fair value in business combinations for which there was no corresponding tax basis adjustment. Inherent in determining our annual tax rate are judgments regarding business plans, tax planning opportunities and expectations about future outcomes. Realization of certain deferred tax assets is dependent upon generating sufficient taxable income in the appropriate jurisdiction prior to the expiration of the carryforward periods. Although realization is not assured, management believes it is more likely than not that our deferred tax assets, net of valuation allowances, will be realized. We operate in multiple jurisdictions with complex tax policy and regulatory environments. In certain of these jurisdictions, we may take tax positions that management believes are supportable but are potentially subject to successful challenge by the applicable taxing authority. These differences of interpretation with the respective governmental taxing authorities can be impacted by the local economic and fiscal environment. We evaluate our tax positions and establish liabilities in accordance with the applicable accounting guidance on uncertainty in income taxes. We review these tax uncertainties in light of changing facts and circumstances, such as the progress of tax audits, and adjust them accordingly. We have a number of audits in process in various jurisdictions. Although the resolution of these tax positions is uncertain, based on currently available information, we believe that it is more likely than not that the ultimate outcomes will not have a material adverse effect on our financial position, results of operations or cash flows. Because there are a number of estimates and assumptions inherent in calculating the various components of our tax provision, certain changes or future events, such as changes in tax legislation, geographic mix of earnings, completion of tax audits or earnings repatriation plans, could have an impact on those estimates and our effective tax rate.
Acquisitions, Goodwill and Intangibles, and Long-Lived Assets
We account for acquired businesses using the purchase method of accounting. Under the purchase method, our financial statements include the operations of an acquired business starting from the completion of the acquisition. In addition, the assets acquired and liabilities assumed are recorded at the date of acquisition at their respective estimated fair values, with any excess of the purchase price over the estimated fair values of the net assets acquired recorded as goodwill. Significant judgment is required in estimating the fair value of intangible assets and in assigning their respective useful lives. Accordingly, we typically obtain the assistance of third-party valuation specialists for significant items. The fair value estimates are based on available historical information and on future expectations and assumptions deemed reasonable by management but are inherently uncertain. We typically use an income method to estimate the fair value of intangible assets, which is based on forecasts of the expected future cash flows attributable to the respective assets. Significant estimates and assumptions inherent in the valuations reflect a consideration of other marketplace participants and include the amount and timing of future cash flows (including expected growth rates and profitability), the underlying product or technology life cycles, the economic barriers to entry and the discount rate applied to the cash flows. Unanticipated market or macroeconomic events and circumstances may occur that could affect the accuracy or validity of the estimates and assumptions. Determining the useful life of an intangible asset also requires judgment. With the exception of certain trade names, the majority of our acquired intangible assets (e.g., certain trademarks or brands, customer and distributor relationships, patents and technologies) are expected to have determinable useful lives. Our assessment as to the useful lives of these intangible assets is based on a number of factors including competitive environment, market share, trademark and/or brand history, underlying product life cycles, operating plans and the macroeconomic environment of the countries in which the trademarks or brands are sold. Our estimates of the useful lives of determinable-lived intangibles are primarily based on these same factors. Determinable-lived intangible assets are amortized to expense over their estimated useful life. In certain of our acquisitions, we acquire in-process research and development (IPRD) intangible assets. IPRD is considered to be an indefinite-lived intangible asset until such time as the research is completed (at which time it becomes a determinable-lived intangible asset) or determined to have no future use (at which time it is impaired). The value of indefinite-lived intangible assets and goodwill is not amortized but is tested at least annually for impairment. Our impairment testing for goodwill is performed separately from our impairment testing of indefinite-lived intangibles. We perform our annual impairment test for goodwill in the fourth quarter of each year. We have adopted the provisions of Accounting Standards Update (ASU) No. 2011-08, Intangibles - Goodwill and Other: Testing Goodwill for Impairment, which permits us to consider qualitative indicators of the fair value of a reporting unit when it is unlikely that a reporting unit has impaired goodwill. In certain circumstances, we may also utilize a discounted cash flow analysis that requires certain assumptions and estimates be made regarding market conditions and our future profitability. In those circumstances we test goodwill for impairment by reviewing the book value compared to the fair value at the reporting unit level. We test individual indefinite-lived intangibles by reviewing the individual book values compared to the fair value. Dollar amounts in millions except per share 16 amounts or as otherwise specified
We determine the fair value of our reporting units and indefinite-lived intangible assets based on the income approach. Under the income approach, we calculate the fair value of our reporting units and indefinite-lived intangible assets based on the present value of estimated future cash flows. Considerable management judgment is necessary to evaluate the impact of operating and macroeconomic changes and to estimate future cash flows to measure fair value. Assumptions used in our impairment evaluations, such as forecasted growth rates and cost of capital, are consistent with internal projections and operating plans. We believe such assumptions and estimates are also comparable to those that would be used by other marketplace participants. We did not recognize any material impairment charges for goodwill during the years presented, as our annual impairment testing indicated that all reporting unit goodwill fair values exceeded their respective recorded values. Future changes in the judgments, assumptions and estimates that are used in our impairment testing for goodwill and indefinite-lived intangible assets, including discount and tax rates or future cash flow projections, could result in significantly different estimates of the fair values. A significant reduction in the estimated fair values could result in impairment charges that could materially affect our financial statements. We review our other long-lived assets for indicators of impairment whenever events or changes in circumstances indicate that the carrying amount may not be recoverable. The evaluation is performed at the lowest level of identifiable cash flows, which is at the individual asset level or the asset group level. The undiscounted cash flows expected to be generated by the related assets are estimated over their useful life based on updated projections. If the evaluation indicates that the carrying amount of the assets may not be recoverable, any potential impairment is measured based upon the fair value of the related assets or asset group as determined by an appropriate market appraisal or other valuation technique. Assets classified as held for sale, if any, are recorded at the lower of carrying amount or fair value less costs to sell.
Legal and Other Contingencies
We are involved in various ongoing proceedings, legal actions and claims arising in the normal course of business, including proceedings related to product, labor and intellectual property, and other matters that are more fully described in "Other Information" below and in Note 7 to the Consolidated Financial Statements. The outcomes of these matters will generally not be known for prolonged periods of time. In certain of the legal proceedings, the claimants seek damages, as well as other compensatory and equitable relief, that could result in the payment of significant claims and settlements and/or the imposition of injunctions or other equitable relief. For legal matters for which management has sufficient information to reasonably estimate our future obligations, a liability representing management's best estimate of the probable loss, or the minimum of the range of probable losses when a best estimate within the range is not known, for the resolution of these legal matters is recorded. The estimates are based on consultation with legal counsel, previous settlement experience and settlement strategies. If actual outcomes are less favorable than those projected by management, additional expense may be incurred, which could unfavorably affect future operating results. The Company is currently self-insured for product liability-related claims and expenses. The ultimate cost to us with respect to product liability claims could be materially different than the amount of the current estimates and accruals and could have a material adverse effect on our financial position, results of operations and cash flows. NEW ACCOUNTING PRONOUNCEMENTS No accounting pronouncements that were issued or became effective during the year have had or are expected to have a material impact on our Consolidated Financial Statements. OTHER INFORMATION Hedging and Derivative Financial Instruments We sell our products throughout the world. As a result, our financial results could be significantly affected by factors such as weak economic conditions or changes in foreign currency exchange rates. Our operating results are primarily exposed to changes in exchange rates among
the United Statesdollar; European currencies, in particular the euro, Swiss franc and the British pound; the Japanese yen; the Australian dollar; and the Canadian dollar. We develop and manufacture products in the United States, China, France, Germany, Ireland, Puerto Ricoand Switzerlandand incur costs in the applicable local currencies. This worldwide deployment of facilities serves to partially mitigate the impact of currency exchange rate changes on our cost of sales. We enter into designated and non-designated forward currency exchange contracts to mitigate the impact of currency fluctuations on transactions denominated in nonfunctional currencies, thereby limiting risk that would otherwise result from changes in exchange rates. These nonfunctional currency exposures principally relate to intercompany receivables and payables arising from intercompany purchases of manufactured products. The periods of the forward currency exchange contracts correspond to the periods of the exposed transactions, with realized gains and losses included in the measurement and recording of transactions denominated in the nonfunctional currencies. All forward currency exchange contracts are recorded at their fair value each period, with resulting gains (losses) for non-designated forward contracts and any ineffectiveness measured on designated forward currency exchange contracts included in our Consolidated Statements of Earnings. For derivative instruments that are designated and qualify as a cash flow hedge, the effective portion of the gain or loss on the derivative is reported as a component of accumulated other comprehensive income, and reclassified into earnings in the same period during which the hedged transaction affects earnings. The estimated fair value of forward currency exchange contracts represents the measurement of the contracts at month-end spot rates as adjusted by current forward points. A hypothetical 10% change in foreign currencies relative to the United Statesdollar would change the December 31, 2013fair value by approximately $6. We are exposed to credit loss in the event of nonperformance by counterparties on our outstanding forward currency exchange Dollar amounts in millions except per share 17 amounts or as otherwise specified
contracts, but we do not anticipate nonperformance by any of our counterparties. We have certain investments in net assets in international locations that are not hedged. These investments are subject to translation gains and losses due to changes in foreign currency exchange rates. For 2013 the strengthening of foreign currencies relative to
the United Statesdollar increased the value of these investments in net assets and the related foreign currency translation adjustment gain in shareholders' equity by $80to $306, from $226as of December 31, 2012. Legal and Regulatory Matters In 2010 we received a subpoena from the United States Department of Justice(DOJ) related to the sales and marketing of the OtisKnee device. The subpoena concerns allegations of violations of Federal laws related to sales of a device not cleared by the United States Food and Drug Administration(FDA). We continue to discuss the settlement of this matter with the DOJ, but there can be no assurance that we will reach a consensual resolution rather than seeking a resolution through the courts. We have recorded charges totaling $80related to the above matter, including $47in the year ended December 31, 2013. In June 2012we voluntarily recalled our Rejuvenate and ABG II modular-neck hip stems and terminated global distribution of these hip products. We notified healthcare professionals and regulatory bodies of this recall, which was taken due to potential risks associated with fretting and/or corrosion that may lead to adverse local tissue reactions. Product liability lawsuits relating to this voluntary recall have been filed against us. As previously announced, we intend to reimburse implanted patients for reasonable and customary costs of testing and treatment services, including any necessary revision surgeries. We continue to work with the medical community to evaluate the data and further understand this matter and the associated costs. The ultimate total cost with respect to this matter will depend on many factors that are difficult to predict with the information received to date and may vary materially based on the number of and actual costs of patients seeking testing and treatment services, the number of and actual costs of patients requiring revision surgeries, the number of and actual costs to settle lawsuits filed against us, and the amount of third-party insurance recoveries. Based on the information that has been received, the actuarially determined range of probable loss to resolve this matter is estimated to be approximately $790to $1,235, before third-party insurance recoveries. In the year ended December 31, 2013, we recorded charges to earnings of $600representing the excess of the $790minimum of the range over the previously recorded reserves. No contingent gain for third-party insurance recoveries was recorded as of December 31, 2013. As noted above, the final outcome of this matter is dependent on many variables that are difficult to predict. The ultimate cost to entirely resolve this matter may be materially different than the amount of the current estimate and accruals and could have a material adverse effect on our financial position, results of operations and cash flows. In 2010 we filed a lawsuit in federal court against Zimmer Holdings, Inc. (Zimmer), alleging that a Zimmer product infringed three of our patents. In rulings issued in August and September 2013, the trial judge upheld the February 2013jury verdict in our favor, issued a permanent injunction barring Zimmer from making or selling infringing products, and ordered Zimmer to pay us at least $228. Zimmer is appealing this ruling and the ultimate resolution of this matter may differ materially. Accordingly, we have not recorded a contingent gain related to this matter. For each of the following legal matters the final outcome is dependent on many variables and cannot be predicted. Accordingly, it is not possible at this time for us to estimate any material loss or range of losses. However, the ultimate cost to resolve these matters could have a material adverse effect on our financial position, results of operations and cash flows. In April 2011lawsuits brought by Hill-Rom Company, Inc.and affiliated entities (Hill-Rom) against us were filed in the United States District Court for the Western District of Wisconsin and the United States District Courtfor the Southern Districtof Indiana. The Wisconsinlawsuit was subsequently transferred to the United States District Courtin Indiana. The suits allege infringement under United Statespatent laws with respect to certain patient handling equipment we manufactured and sold and seek damages and permanent injunctions. We have entered into an agreement settling the first lawsuit, with terms as previously disclosed. The second lawsuit involves nine patents related to electrical network communications for hospital beds. The case has been stayed with respect to six of the patents, which are currently under reexamination by the United States Patent Office. With respect to the three remaining patents, Hill-Rom is appealing the trial court's grant of summary judgment in our favor and the ultimate resolution of this particular part of the suit may differ. The ultimate resolution of the entire second suit may have no relation to the resolution of the first suit and cannot be predicted; however, the ultimate result could have a material adverse effect on our financial position, results of operations and cash flows. In 2010 we received a subpoena from the DOJ related to sales, marketing and regulatory matters related to the Stryker PainPump. We have received requests for certain documents in connection with this investigation. The investigation is ongoing and we are fully cooperating with the DOJ regarding this matter. ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK We consider our material area of market risk exposure to be exchange rate risk. Quantitative and qualitative disclosures about exchange rate risk are included in the "Other Information" section of Management's Discussion and Analysis of Financial Condition in Item 7, under the caption Other Information - "Hedging and Derivative Financial Instruments". Dollar amounts in millions except per share 18 amounts or as otherwise specified