Document


 

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

FORM 10-Q
(Mark one)
 
[X]
QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
For the quarterly period ended June 30, 2017
OR
[ ]
TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

Commission file number: 000-09165
strykerlogoa28.jpg
STRYKER CORPORATION
(Exact name of registrant as specified in its charter)
Michigan
 
38-1239739
(State of incorporation)
 
(I.R.S. Employer Identification No.)
 
 
 
 
 
 
2825 Airview Boulevard, Kalamazoo, Michigan
 
49002
(Address of principal executive offices)
 
(Zip Code)
 
 
 
(269) 385-2600
(Registrant’s telephone number, including area code)

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.                         YES [X]        NO [   ]
Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).         YES [X]        NO [   ]
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, a smaller reporting company, or an emerging growth company. See the definitions of "large accelerated filer," "accelerated filer," "smaller reporting company, "and "emerging growth company" in Rule 12b-2 of the Exchange Act.
Large accelerated filer
[X]
 
Accelerated filer
[ ]
 
 
 
 
 
Non-accelerated filer
[ ]
(Do not check if a smaller reporting company)
 
 
 
 
 
 
 
 
 
Small reporting company
[ ]
 
 
 
 
 
 
 
 
Emerging growth company
[ ]
If an emerging growth company, indicate by check mark if the registrant has elected not to use the extended transition period for complying with any new or revised financial accounting standards provided pursuant to Section 13(a) of the Exchange Act. [ ]
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act). YES [   ]         NO [X]
Number of shares outstanding of each of the issuer’s classes of common stock, as of the latest practicable date: 374,063,294 shares of Common Stock, $0.10 par value, on June 30, 2017.
 


STRYKER CORPORATION
 
2017 SECOND QUARTER FORM 10-Q

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

CONSOLIDATED STATEMENTS OF EARNINGS (Unaudited)
 
Three Months
 
Six Months

2017
 
2016
 
2017
 
2016
Net sales
$
3,012

 
$
2,840

 
$
5,967

 
$
5,335

Cost of sales
1,022

 
998

 
2,015

 
1,799

Gross profit
$
1,990

 
$
1,842

 
$
3,952

 
$
3,536

Research, development and engineering expenses
192

 
183

 
384

 
342

Selling, general and administrative expenses
1,130

 
1,043

 
2,232

 
1,987

Recall charges
72

 
28

 
98

 
47

Amortization of intangible assets
95

 
88

 
183

 
141

Total operating expenses
$
1,489

 
$
1,342

 
$
2,897

 
$
2,517

Operating income
$
501

 
$
500

 
$
1,055

 
$
1,019

Other income (expense), net
(57
)
 
(67
)
 
(112
)
 
(105
)
Earnings before income taxes
$
444

 
$
433

 
$
943

 
$
914

Income taxes
53

 
53

 
108

 
132

Net earnings
$
391

 
$
380

 
$
835

 
$
782

 
 
 
 
 
 
 
 
Net earnings per share of common stock:
 
 
 
 
 
 
 
Basic net earnings per share of common stock
$
1.04

 
$
1.02

 
$
2.23

 
$
2.09

Diluted net earnings per share of common stock
$
1.03

 
$
1.00

 
$
2.20

 
$
2.07

 
 
 
 
 
 
 
 
Weighted-average shares outstanding:
 
 
 
 
 
 
 
Basic
373.9

 
374.2

 
373.7

 
373.7

Effect of dilutive employee stock options
5.9

 
4.3

 
5.9

 
4.3

Diluted
379.8

 
378.5

 
379.6

 
378.0

Anti-dilutive shares excluded from the calculation of dilutive employee stock options were de minimis in all periods.
CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME (Unaudited)
 
Three Months
 
Six Months
 
2017
 
2016
 
2017
 
2016
Net earnings
$
391

 
$
380

 
$
835

 
$
782

Other comprehensive income, net of tax:
 
 
 
 
 
 
 
Marketable securities

 

 

 

Pension plans
(6
)
 
(2
)
 
(10
)
 
(3
)
Unrealized gains (losses) on designated hedges
5

 
(15
)
 
(1
)
 
(35
)
Financial statement translation
86

 
44

 
182

 
82

Total other comprehensive income, net of tax
$
85

 
$
27

 
$
171

 
$
44

Comprehensive income
$
476

 
$
407

 
$
1,006

 
$
826


See accompanying notes to Consolidated Financial Statements.

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

STRYKER CORPORATION
 
2017 SECOND QUARTER FORM 10-Q

Stryker Corporation and Subsidiaries

CONSOLIDATED BALANCE SHEETS
 
June 30
 
December 31
2017
 
2016
 
(Unaudited)
 
 
Assets
 
 
 
Current assets
 
 
 
Cash and cash equivalents
$
3,649

 
$
3,316

Marketable securities
98

 
68

Accounts receivable, less allowance of $60 ($56 in 2016)
1,905

 
1,967

Inventories:
 
 
 
Materials and supplies
495

 
425

Work in process
151

 
130

Finished goods
1,633

 
1,475

Total inventories
$
2,279

 
$
2,030

Prepaid expenses and other current assets
547

 
480

Total current assets
$
8,478

 
$
7,861

Property, plant and equipment:
 
 
 
Land, buildings and improvements
892

 
820

Machinery and equipment
2,626

 
2,341

Total property, plant and equipment
$
3,518

 
$
3,161

Less allowance for depreciation
1,760

 
1,592

Property, plant and equipment, net
$
1,758

 
$
1,569

Goodwill
6,471

 
6,356

Other intangibles, net
3,382

 
3,508

Other noncurrent assets
1,203

 
1,141

Total assets
$
21,292

 
$
20,435

 
 
 
 
Liabilities and shareholders' equity

 
 
Current liabilities
 
 
 
Accounts payable
$
427

 
$
437

Accrued compensation
548

 
767

Income taxes
80

 
40

Dividend payable
159

 
159

Accrued recall expenses
538

 
594

Accrued expenses and other liabilities
1,026

 
923

Current maturities of debt
774

 
228

Total current liabilities
$
3,552

 
$
3,148

Long-term debt, excluding current maturities
6,592

 
6,686

Other noncurrent liabilities
1,113

 
1,051

Total liabilities
$
11,257

 
$
10,885

Shareholders' equity
 
 
 
Common stock, $0.10 par value:
 
 
 
Authorized: 1 billion shares, outstanding: 374 million shares (375 million shares in 2016)
37

 
37

Additional paid-in capital
1,452

 
1,432

Retained earnings
9,136

 
8,842

Accumulated other comprehensive loss
(590
)
 
(761
)
Total shareholders' equity
$
10,035

 
$
9,550

Total liabilities & shareholders' equity
$
21,292

 
$
20,435


See accompanying notes to Consolidated Financial Statements.

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

STRYKER CORPORATION
 
2017 SECOND QUARTER FORM 10-Q

Stryker Corporation and Subsidiaries

CONSOLIDATED STATEMENT OF SHAREHOLDERS’ EQUITY (Unaudited)
 
Common
Stock
 
Additional
Paid-In
Capital
 
Retained
Earnings
 
Accumulated
Other
Comprehensive
(Loss) Income
 
Total
December 31, 2016
$
37

 
$
1,432

 
$
8,842

 
$
(761
)
 
$
9,550

Net earnings


 


 
835

 


 
835

Other comprehensive income


 


 


 
171

 
171

Issuance of 1.4 million shares of common stock under stock option and benefit plans


 
(31
)
 


 


 
(31
)
Repurchases of 1.9 million shares of common stock


 
(7
)
 
(223
)
 


 
(230
)
Share-based compensation


 
58

 


 


 
58

Cash dividends declared of $0.850 per share of common stock


 


 
(318
)
 


 
(318
)
June 30, 2017
$
37

 
$
1,452

 
$
9,136

 
$
(590
)
 
$
10,035

CONSOLIDATED STATEMENTS OF CASH FLOWS (Unaudited)
 
Six Months
 
2017
 
2016
Operating activities
 
 
 
Net earnings
$
835

 
$
782

Adjustments to reconcile net earnings to net cash provided by operating activities:
 
 
 
Depreciation
127

 
106

Amortization of intangible assets
183

 
141

Share-based compensation
58

 
49

Recall charges
69

 
47

Sale of inventory stepped-up to fair value at acquisition

 
35

Changes in operating assets and liabilities:
 
 
 
Accounts receivable
97

 
57

Inventories
(192
)
 
(225
)
Accounts payable
(12
)
 
(5
)
Accrued expenses and other liabilities
(122
)
 
(133
)
Recall-related payments, net of insurance recovery
(124
)
 
(104
)
Income taxes
24

 
25

Other
(142
)
 
(20
)
Net cash provided by operating activities
$
801

 
$
755

Investing activities
 
 
 
Acquisitions, net of cash acquired
(38
)
 
(4,219
)
Purchases of marketable securities
(66
)
 
(116
)
Proceeds from sales of marketable securities
36

 
652

Purchases of property, plant and equipment
(270
)
 
(229
)
Net cash used in investing activities
$
(338
)
 
$
(3,912
)
Financing activities
 
 
 
Proceeds from borrowings
1,227

 
3,868

Payments on borrowings
(784
)
 
(257
)
Dividends paid
(318
)
 
(284
)
Repurchases of common stock
(230
)
 
(13
)
Cash paid for taxes from withheld shares
(73
)
 
(57
)
Other financing
1

 
1

Net cash (used in) provided by financing activities
$
(177
)
 
$
3,258

Effect of exchange rate changes on cash and cash equivalents
47

 
10

Change in cash and cash equivalents
$
333

 
$
111

Cash and cash equivalents at beginning of period
3,316

 
3,379

Cash and cash equivalents at end of period
$
3,649

 
$
3,490


See accompanying notes to Consolidated Financial Statements.

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

STRYKER CORPORATION
 
2017 SECOND QUARTER FORM 10-Q

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Unaudited)

NOTE 1 - BASIS OF PRESENTATION
General Information
These statements should be read in conjunction with our Annual Report on Form 10-K for 2016. Management believes that the accompanying unaudited Consolidated Financial Statements contain all adjustments, including normal recurring items, considered necessary for a fair presentation of the interim periods. However, the results of operations included in these Consolidated Financial Statements may not necessarily be indicative of our annual results. Certain prior year amounts have been reclassified to conform to current year presentation in our Consolidated Statement of Cash Flows and our segment information in Note 10.
New Accounting Pronouncements Not Yet Adopted
In May 2017 the Financial Accounting Standards Board (FASB) issued Accounting Standards Update (ASU) 2017-09, Compensation - Stock Compensation, which revises the guidance related to changes in terms or conditions of a share-based payment award. We plan to adopt this update on January 1, 2018 and do not expect the adoption to have a material impact on our Consolidated Financial Statements.
In March 2017 the FASB issued ASU 2017-07, Compensation - Retirement Benefits, which revises the presentation of net periodic pension cost and net periodic post-retirement benefit cost. We plan to adopt this update on January 1, 2018 and do not expect the adoption to have a material impact on our Consolidated Financial Statements.
In January 2017 the FASB issued ASU 2017-01, Business Combinations: Clarifying the Definition of a Business, which provides a more robust framework to use in determining when a set of acquired assets and activities constitutes a business.  
In February 2016 the FASB issued ASU 2016-02, Leases. This update requires an entity to recognize assets and liabilities on the balance sheet for leases with terms greater than 12 months. We plan to adopt this update on January 1, 2019, and we are still evaluating the impact on our Consolidated Financial Statements.
In October 2016 the FASB issued ASU 2016-16, Income Taxes, Intra-Entity Transfers of Assets Other Than Inventory, which requires companies to account for the income tax effect of intercompany sales and transfers of assets other than inventory when the transfer occurs. Current guidance requires companies to defer the income tax effects of intercompany transfers of assets until the asset has been sold to an outside party or otherwise recognized. We plan to adopt this update on January 1, 2018 and are still evaluating the impact that this update will have on our Consolidated Financial Statements.
In May 2014 the FASB issued ASU 2014-09, Revenue from Contracts with Customers. This update outlines a single, comprehensive model for accounting for revenue from contracts with customers. The guidance permits two methods of adoption: retrospectively to each prior reporting period presented (full retrospective method) or retrospectively with the cumulative effect of initially applying the guidance recognized at the date of initial application (modified retrospective method). We plan to adopt this update on January 1, 2018 using the modified retrospective method. While we are still in the process of evaluating the full impact, we have identified certain immaterial historical revenue transactions on which the timing of recognition would have been different under this update. The actual amount of the cumulative adjustment will depend on the timing of revenue recognition of similar transactions at the end of 2017. While we cannot determine the amount based
 
on information currently available, we do not expect it to have a material impact on our Consolidated Financial Statements. We are in the process of updating our revenue accounting policy and implementing changes to our business processes and controls in response to the new update.
Accounting Pronouncements Recently Adopted
On January 1, 2017 we adopted ASU 2016-09, Compensation-Stock Compensation: Improvements to Employee Share-Based Payment Accounting (ASU 2016-09). The impact on our Consolidated Statements of Earnings in 2017 was a tax benefit of $40. In our 2016 Consolidated Statements of Cash Flow we reclassified $27 from other financing to income taxes within operating activities to conform to current year presentation.
On January 1, 2017 we adopted ASU 2016-15, Statement of Cash Flows: Classification of Certain Cash Receipts and Cash Payments. The adoption of this update did not have a material impact on our Consolidated Financial Statements.
No other new accounting pronouncements were issued or became effective in the period that had, or are expected to have, a material impact on our Consolidated Financial Statements.
NOTE 2 - ACCUMULATED OTHER COMPREHENSIVE (LOSS) INCOME (AOCI)
Three Months 2017
Marketable Securities
Pension Plans
Hedges
Financial Statement Translation
Total
Beginning
$

$
(136
)
$
18

$
(557
)
$
(675
)
OCI

(9
)
4

68

63

Income taxes

2

(1
)
18

19

Reclassifications to:
 
 
 
 
 
Cost of sales

1

3


4

Other income





Income taxes


(1
)

(1
)
Net OCI
$

$
(6
)
$
5

$
86

$
85

Ending
$

$
(142
)
$
23

$
(471
)
$
(590
)
Three Months 2016
Marketable Securities
Pension Plans
Hedges
Financial Statement Translation
Total
Beginning
$

$
(120
)
$
(16
)
$
(486
)
$
(622
)
OCI

(3
)
(18
)
49

28

Income taxes

1

5

(5
)
1

Reclassifications to:
 
 
 
 
 
Cost of sales

1

(2
)

(1
)
Other expense
(1
)



(1
)
Income taxes
1

(1
)



Net OCI
$

$
(2
)
$
(15
)
$
44

$
27

Ending
$

$
(122
)
$
(31
)
$
(442
)
$
(595
)
Six Months 2017
Marketable Securities
Pension Plans
Hedges
Financial Statement Translation
Total
Beginning
$

$
(132
)
$
24

$
(653
)
$
(761
)
OCI

(15
)
(10
)
153

128

Income taxes

3

3

29

35

Reclassifications to:
 
 
 
 
 
Cost of sales

3

8


11

Other income





Income taxes

(1
)
(2
)

(3
)
Net OCI
$

$
(10
)
$
(1
)
$
182

$
171

Ending
$

$
(142
)
$
23

$
(471
)
$
(590
)

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

STRYKER CORPORATION
 
2017 SECOND QUARTER FORM 10-Q

Six Months 2016
Marketable Securities
Pension Plans
Hedges
Financial Statement Translation
Total
Beginning
$

$
(119
)
$
4

$
(524
)
$
(639
)
OCI
2

(6
)
(40
)
77

33

Income taxes
(1
)
1

11

5

16

Reclassifications to:
 
 
 
 
 
Cost of sales

3

(8
)

(5
)
Other income
(2
)



(2
)
Income taxes
1

(1
)
2


2

Net OCI
$

$
(3
)
$
(35
)
$
82

$
44

Ending
$

$
(122
)
$
(31
)
$
(442
)
$
(595
)
NOTE 3 - DERIVATIVE INSTRUMENTS
Foreign Currency Hedges
We use operational and economic hedges, foreign currency exchange forward contracts, net investment hedges (both long-term intercompany loans payable and forward exchange contracts) and interest rate derivative instruments to manage the impact of currency exchange and interest rate fluctuations on earnings and cash flow. We do not enter into derivative instruments for speculative purposes. We did not change our hedging strategies, accounting practices or objectives from those disclosed in our Annual Report on Form 10-K for 2016.
June 2017
Designated
Non-Designated
Total
Gross notional amount
$
1,123

$
3,175

$
4,298

Maximum term in days
 
 
548

Fair value:
 
 
 
Other current assets
$
15

$
4

$
19

Other noncurrent assets
1


1

Other current liabilities
(17
)
(20
)
(37
)
Other noncurrent liabilities



Total
$
(1
)
$
(16
)
$
(17
)
December 2016
Designated
Non-Designated
Total
Gross notional amount
$
1,058

$
2,841

$
3,899

Maximum term in days
 
 
548

Fair value:
 
 
 
Other current assets
$
24

$
17

$
41

Other noncurrent assets
4


4

Other current liabilities
(9
)
(7
)
(16
)
Other noncurrent liabilities
(2
)

(2
)
Total
$
17

$
10

$
27

On June 30, 2017 the total after-tax amount in AOCI related to our designated net investment hedges was $1. We evaluate the effectiveness of our net investment hedges quarterly. We have not recognized any ineffectiveness in 2017.
We are exposed to credit loss in the event of nonperformance by our counterparties on our outstanding derivative instruments but do not anticipate nonperformance by any of our counterparties. Should a counterparty default, our maximum exposure to loss is the asset balance of the instrument.
Net Currency Exchange Rate (Losses) Gains
 
Three Months
 
Six Months
Recorded in:
2017
2016
 
2017
2016
Cost of sales
$
(3
)
$
2

 
$
(8
)
$
8

Other income (expense), net
(4
)
(6
)
 
(4
)
(10
)
Total
$
(7
)
$
(4
)
 
$
(12
)
$
(2
)
 
On June 30, 2017 and December 31, 2016 pretax (losses) gains on derivatives designated as hedges recorded in AOCI that are expected to be reclassified to earnings during the next 12 months were ($8) and less than $1. This reclassification is primarily due to the sale of inventory that includes previously hedged purchases. There were no ineffective portions of derivatives that resulted in gains or losses in any of the periods presented.
Interest Rate Risk on Future Debt Issuance
On June 30, 2017 we had interest rate swaps with notional amounts of $600 designated as forward starting interest rate swaps in anticipation of future debt issuances. The market value of outstanding interest rate swap agreements on June 30, 2017 was $41, which was recorded in other current assets with an offsetting amount recorded in AOCI. Upon the probable issuance of the debt, these amounts will be released to interest expense over the term of the debt. The cash flow effect of this hedge is recorded in cash flow from operations.
On June 30, 2017 we had interest rate swaps with gross notional amounts of $500 designated as fair value hedges of underlying fixed rate obligations representing a portion of our $600 senior unsecured notes due in 2024. There was no hedge ineffectiveness recorded as a result of these fair value hedges in 2017.
Fair Value Interest Rate Hedge Instruments
 
June 2017
December 2016
Gross notional amount
$
500

$
500

Fair value:
 
 
Other noncurrent assets
$
11

$
9

Long-term debt
(11
)
(9
)
Total
$

$

NOTE 4 - FAIR VALUE MEASUREMENTS
Financial assets and liabilities carried at fair value are classified and disclosed in one of the following three categories:
Level 1
Quoted market prices in active markets for identical assets or liabilities
Level 2
Observable market-based inputs or unobservable inputs that are corroborated by market data
Level 3
Unobservable inputs reflecting our assumptions or external inputs from active markets
When applying the fair value principles in the valuation of assets and liabilities, we are required to maximize the use of quoted market prices and minimize the use of unobservable inputs. We calculate the fair value of our Level 1 and Level 2 instruments based on the exchange traded price of identical or similar instruments, where available, or based on other observable inputs taking into account our credit and that of our counterparties. Foreign currency exchange contracts and interest rate hedges are included in Level 2 as we use inputs other than quoted prices that are observable for the asset or liability. The Level 2 derivative instruments are primarily valued using standard calculations and models that are based on readily observable market data. Our Level 3 liabilities represent milestone payments for acquisitions recorded at fair value calculated using either the Black-Scholes option pricing model or a discounted cash flow technique. Significant unobservable inputs were used in our probability assessments and were appropriately discounted considering the uncertainties associated with the obligation. We estimate that substantially all triggering events will occur. We remeasure the fair value of our assets and liabilities each reporting period. We record the changes in fair value within selling, general and administrative expense and the changes in the time value of money within other income (expense), net.

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

STRYKER CORPORATION
 
2017 SECOND QUARTER FORM 10-Q

Assets and Liabilities Measured at Fair Value
 
June
December
 
2017
2016
Cash and cash equivalents
$
3,649

$
3,316

Trading marketable securities
109

94

Level 1 - Assets
$
3,758

$
3,410

Available-for-sale marketable securities:
 
 
Corporate and asset-backed debt securities
$
31

$
25

United States agency debt securities
16

9

United States Treasury debt securities
28

16

Certificates of deposit
23

18

Total available-for-sale marketable securities
$
98

$
68

Foreign currency exchange forward contracts
20

45

Interest rate swap asset
52

57

Level 2 - Assets
$
170

$
170

Total assets measured at fair value
$
3,928

$
3,580

 
 
 
Deferred compensation arrangements
$
109

$
94

Level 1 - Liabilities
$
109

$
94

Foreign currency exchange forward contracts
$
37

$
18

Level 2 - Liabilities
$
37

$
18

Contingent consideration:
 
 
Beginning
$
86

$
56

Additions
5

49

Change in estimate
(2
)
(7
)
Settlements
(21
)
(12
)
Ending
$
68

$
86

Level 3 - Liabilities
$
68

$
86

Total liabilities measured at fair value
$
214

$
198

There were no significant transfers into or out of any level in 2017.
Fair Value of Available for Sale Securities by Maturity
 
June 2017
December 2016
Due in one year or less
$
55

$
36

Due after one year through three years
$
43

$
32

On June 30, 2017 the aggregate difference between the cost and fair value of available-for-sale marketable securities was nominal. Interest and marketable securities income was $12 and $7 in the three months and $23 and $12 in the six months 2017 and 2016, which was recorded in other income (expense), net.
Less than 1% of our investments in available-for-sale marketable securities had a credit quality rating of less than A2 (Moody's), A (Standard & Poor's) and A (Fitch). We do not plan to sell the investments, and it is not more likely than not that we will be required to sell the investments before recovery of their amortized cost basis, which may be maturity. We do not consider these investments to be other-than-temporarily impaired on June 30, 2017. Substantially all our investments with unrealized losses that were not deemed to be other-than-temporarily impaired were in a continuous unrealized loss position for less than twelve months, and the losses were nominal.
Securities in a Continuous Unrealized Loss Position
 
Number of Investments
Fair Value
Corporate and asset-backed
29
$
11

United States agency
13
13

United States Treasury
17
28

Certificates of deposit
6
3

Total
65
$
55

NOTE 5 - ACQUISITIONS
In June 2017 we announced an agreement to acquire NOVADAQ Technologies Inc. (NOVADAQ) for approximately $701. NOVADAQ is a leading developer of fluorescence imaging technology that provides surgeons with visualization of blood flow in vessels. We expect the acquisition will close in the third quarter of 2017 and will enhance product offerings within our MedSurg segment.
 
In April 2016 we completed the acquisition of Sage Products, LLC (Sage) for total consideration of approximately $2,875. Sage develops, manufactures and distributes intensive care disposable products. This acquisition enhanced our product offerings within our MedSurg segment. The finalization of our purchase price allocation resulted in a $30 increase in goodwill from our preliminary allocation in 2016.
In April 2016 we completed the acquisition of Physio-Control International, Inc. (Physio) for total net consideration of approximately $1,299. Physio develops, manufactures and markets monitors/defibrillators, AEDs and CPR-assist devices along with data management and support services. This acquisition enhanced our product offerings within our MedSurg segment. The finalization of our purchase price allocation resulted in a $19 decrease in goodwill from our preliminary allocation in 2016.
The Other acquisitions in 2016 include the acquisition of the Synergetics neuro portfolio (Synergetics). The Synergetics acquisition enhanced our product offerings within our MedSurg segment. The finalization of our purchase price allocation resulted in an $11 increase in goodwill from our preliminary allocation in 2016.
Purchase price allocations for additional Other acquisitions in 2017 and 2016 were based on preliminary valuations. Our estimates and assumptions are subject to change within the measurement period.
Goodwill acquired with the Sage and Synergetics acquisitions is deductible for tax purposes.
Purchase Price Allocation of Acquired Net Assets
 
2017
 
2016
 
Other
 
Sage
Physio
Other
Purchase price paid
$
38

 
$
2,870

$
1,299

$
348

Contingent consideration
5

 
5


27

Loss on settlement of pre-existing contract

 


(19
)
Total consideration
$
43

 
$
2,875

$
1,299

$
356

Tangible assets:
 
 
 
 
 
Cash
$

 
$
91

$
32

$
1

Accounts receivable
1

 
29

107

17

Inventory
2

 
63

61

5

Other assets
1

 
80

103

21

Liabilities
(2
)
 
(83
)
(364
)
(29
)
Intangible assets:
 
 
 
 
 
Customer relationship

 
930

344

12

Trade name

 
70

160

10

Developed technology and patents
33

 
173

226

119

Non-compete

 


2

IPR&D

 

7

7

Goodwill
8

 
1,522

623

191

 
$
43

 
$
2,875

$
1,299

$
356

Weighted-average life of intangible assets
15

 
15

14

12

Estimated Amortization Expense
Remainder of 2017
2018
2019
2020
2021
$
177

$
344

$
336

$
317

$
306

NOTE 6 - CONTINGENCIES AND COMMITMENTS
We are involved in various ongoing proceedings, legal actions and claims arising in the normal course of business, including proceedings related to product, labor, intellectual property and other matters that are more fully described below. The outcomes of these matters will generally not be known for prolonged periods of time. In certain of the legal proceedings, the claimants seek damages as well as other compensatory and equitable relief that could result in the payment of significant claims and settlements and/or the

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

STRYKER CORPORATION
 
2017 SECOND QUARTER FORM 10-Q

imposition of injunctions or other equitable relief. For legal matters for which management had sufficient information to reasonably estimate our future obligations, a liability representing management's best estimate of the probable loss, or the minimum of the range of probable losses when a best estimate within the range is not known, is recorded. The estimates are based on consultation with legal counsel, previous settlement experience and settlement strategies. If actual outcomes are less favorable than those estimated by management, additional expense may be incurred, which could unfavorably affect future operating results. We are self-insured for product liability claims and expenses. The ultimate cost to us with respect to product liability claims could be materially different than the amount of the current estimates and accruals and could have a material adverse effect on our financial position, results of operations and cash flows.
In June 2012 we voluntarily recalled our Rejuvenate and ABG II Modular-Neck hip stems and terminated global distribution of these hip products. Product liability lawsuits relating to this voluntary recall have been filed against us. On November 3, 2014 we announced that we had entered into a settlement agreement to compensate eligible United States patients who had revision surgery to replace their Rejuvenate and/or ABG II Modular-Neck hip stem prior to that date and in December 2016 the settlement program was extended to patients who had revision surgery prior to December 19, 2016. We continue to offer support for recall-related care and reimburse patients who are not eligible to enroll in the settlement program for testing and treatment services, including any necessary revision surgeries. In addition, some lawsuits remain and we will continue to defend against them. Based on the information that has been received, the actuarially determined range of probable loss to resolve this matter globally is currently estimated to be approximately $2,037 to $2,292 ($2,269 to $2,531 before $232 of third-party insurance recoveries). In the three months 2017 we recognized additional charges to earnings of $48, representing the excess of the minimum of the range over the previously recorded reserves. The final outcome of this matter is dependent on many factors that are difficult to predict including the number of enrollees in the settlement program and the total awards to them, the number and costs of patients not eligible for the settlement program who seek testing and treatment services and require revision surgery and the number and actual costs to resolve the remaining lawsuits. Accordingly, the ultimate cost to resolve this entire matter globally may be materially different than the amount of the current estimate and accruals and could have a material adverse effect on our financial position, results of operations and cash flows.
In 2010 we filed a lawsuit in federal court against Zimmer Biomet Holdings, Inc. (Zimmer), alleging that a Zimmer product infringed on three of our patents. In 2013 following a jury trial favorable to us, the trial judge entered a final judgment that, among other things, awarded us damages of $76 and ordered Zimmer to pay us enhanced damages. Zimmer appealed this ruling. In December 2014 the Federal Circuit affirmed the damages awarded to us, reversed the order for enhanced damages and remanded the issue of attorney fees to the trial court. In May 2015 the trial court entered a stipulated judgment that, among other things, required Zimmer to pay us the base amount of damages and interest, while the issues of enhanced damages and attorney fees continue to be pursued. In June 2015 we recorded a $54 gain, net of legal costs, which was recorded within selling, general and administrative expenses. On June 13, 2016 the United States Supreme Court vacated the decision of the Federal Circuit that reversed our judgment for enhanced damages and remanded the case to the Federal Circuit to reconsider the issue. On September 12, 2016 the Federal Circuit issued an opinion that, among other things, remanded the issue of
 
enhanced damages to the trial court. On July 12, 2017 the trial court reaffirmed its award of enhanced damages and then entered a judgment of $164 in our favor. On July 24, 2017, Zimmer filed a notice of appeal of this decision.
In April 2011 Hill-Rom Company, Inc. and affiliated entities (Hill-Rom) brought a lawsuit against us alleging infringement under United States patent laws with respect to nine patents related to electrical network communications for hospital beds. On July 18, 2017, the parties resolved the litigation pursuant to a confidential settlement agreement under which we agreed to pay $15 to Hill-Rom.
NOTE 7 - DEBT AND CREDIT FACILITIES
In January 2017 we sold $500 of senior unsecured notes with an interest rate of 1.800% due on January 15, 2019. Our commercial paper program allows us to have a maximum of $1,500 in commercial paper outstanding with maturities up to 397 days from the date of issuance. On June 30, 2017 outstanding commercial paper totaled $120, the weighted average original maturity of the commercial paper outstanding was approximately 20 days and the weighted average annualized interest rate of short-term debt was approximately 1.46%.
We have lines of credit issued by various financial institutions that are available to fund our day-to-day operating needs. Certain of our credit facilities require us to comply with financial and other covenants. We were in compliance with all covenants on June 30, 2017.
Summary of Total Debt
Senior unsecured notes:
 
June 2017
December 2016
 
Rate
 
Due
 
 
 
 
1.300%
 
04/01/2018
 
$
599

$
598

 
1.800%
 
01/15/2019
 
497


 
2.000%
 
03/08/2019
 
748

746

 
4.375%
 
01/15/2020
 
498

497

 
2.625%
 
03/15/2021
 
746

745

 
3.375%
 
05/15/2024
 
604

602

 
3.375%
 
11/01/2025
 
745

744

 
3.500%
 
03/15/2026
 
987

987

 
4.100%
 
04/01/2043
 
391

391

 
4.375%
 
05/15/2044
 
394

395

 
4.625%
 
03/15/2046
 
980

979

Commercial paper
 
120

200

Other
 
57

30

Total debt
 
$
7,366

$
6,914

Less current maturities
 
774

228

Total long-term debt
 
$
6,592

$
6,686

 
 
 
Unamortized debt issuance costs
$
43

$
45

Available borrowing capacity
$
1,518

$
1,551

Fair value of debt
 
$
7,449

$
6,762

The fair value of the debt (excluding the interest rate hedge) was estimated using quoted interest rates, maturities and amounts of borrowings based on quoted active market prices and yields that took into account the underlying terms of the debt instruments. Substantially all of our debt is classified within Level 2 of the fair value hierarchy.
NOTE 8 - CAPITAL STOCK
In February 2017 we declared a quarterly dividend of $0.425 per share payable on April 28, 2017 to shareholders of record at the close of business on March 31, 2017. In May 2017 we declared a quarterly dividend of $0.425 per share payable on July 31, 2017 to shareholders of record at the close of business on June 30, 2017.
In March 2015 we announced that our Board of Directors had authorized us to purchase up to $2,000 of our common stock. In

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

STRYKER CORPORATION
 
2017 SECOND QUARTER FORM 10-Q

January 2017 we repurchased 1.9 million shares at a cost of $230 under our authorized repurchase program. The manner, timing and amount of repurchases are determined by management based on an evaluation of market conditions, stock price, and other factors and is subject to regulatory considerations. Purchases are made from time-to-time in the open market, in privately negotiated transactions or otherwise. On June 30, 2017 the total dollar value of shares that could be acquired under our authorized repurchase programs was $1,640.
NOTE 9 - INCOME TAXES
Our effective tax rates were 11.8% and 12.3% in the three months and 11.4% and 14.5% in the six months 2017 and 2016. The decrease in the effective income tax rates in the three and six months 2017 was primarily due to the income tax effect of the adoption of ASU 2016-09. Refer to Note 1 for further information.
NOTE 10 - SEGMENT INFORMATION
 
Three Months
 
Six Months
 
2017
2016
 
2017
2016
Orthopaedics
$
1,141

$
1,082

 
$
2,276

$
2,139

MedSurg
1,336

1,258

 
2,641

2,216

Neurotechnology and Spine
535

500

 
1,050

980

Net sales
$
3,012

$
2,840

 
$
5,967

$
5,335

Orthopaedics
$
394

$
391

 
$
786

$
769

MedSurg
285

255

 
569

445

Neurotechnology and Spine
150

135

 
288

264

Segment operating income
$
829

$
781

 
$
1,643

$
1,478

Items not allocated to segments:
 
 
 
 
 
Corporate and other
(77
)
(77
)
 
(176
)
(170
)
Acquisition and integration-related charges
(9
)
(66
)
 
(18
)
(71
)
Amortization of intangible assets
(95
)
(88
)
 
(183
)
(141
)
Restructuring-related charges
(45
)
(22
)
 
(83
)
(42
)
Rejuvenate and ABG II and other recalls
(72
)
(28
)
 
(98
)
(47
)
Legal matters
(30
)

 
(30
)
12

Consolidated operating income
$
501

$
500

 
$
1,055

$
1,019

There were no significant changes to total assets by segment from information provided in our Annual Report on Form 10-K for 2016.

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

STRYKER CORPORATION
 
2017 SECOND QUARTER FORM 10-Q

ITEM 2.
MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
ABOUT STRYKER
Stryker Corporation is a global leader in medical technology with net sales of $11,325 and net earnings of $1,647 in 2016. We offer a diverse array of innovative medical technologies, including orthopaedic, medical and surgical, and neurotechnology and spine products, to help people lead more active and satisfying lives.
We segregate our operations into three reportable business segments: Orthopaedics, MedSurg, and Neurotechnology and Spine. Orthopaedics products consist primarily of implants used in hip and knee joint replacements and trauma and extremities surgeries. MedSurg products include surgical equipment and surgical navigation systems (Instruments), endoscopic and communications systems (Endoscopy), patient handling and emergency medical equipment, and intensive care disposable products (Medical), reprocessed and remanufactured medical devices (Sustainability) and other medical device products used in a variety of medical specialties. Neurotechnology and Spine products include neurosurgical, neurovascular and spinal implant devices.
 
Overview of the Three and Six Months
In the three months 2017 we achieved sales growth of 6.1%. Excluding the impact of acquisitions, sales grew 6.7% in constant currency, in line with our goal to grow organic sales at the high-end of the medical technology industry. We reported net earnings of $391 in the three months and achieved 3.0% growth in net earnings per diluted share. Excluding the impact of certain items, we achieved adjusted net earnings(1) of $581 and growth of 10.1% in adjusted net earnings per diluted share(1).
In the six months 2017 we achieved sales growth of 11.8%. Excluding the impact of acquisitions, sales grew 7.4% in constant currency, in line with our goal to grow organic sales at the high-end of the medical technology industry. We reported net earnings of $835 in the six months and achieved 6.3% growth in net earnings per diluted share. Excluding the impact of certain items, we achieved adjusted net earnings(1) of $1,141 and growth of 14.4% in adjusted net earnings per diluted share(1).
Recent Developments
In June 2017 we announced an agreement to acquire NOVADAQ Technologies Inc. (NOVADAQ) for approximately $701. NOVADAQ is a leading developer of fluorescence imaging technology that provides surgeons with visualization of blood flow in vessels. We expect the acquisition will close in the third quarter of 2017 and will enhance product offerings within our MedSurg segment.
 
RESULTS OF OPERATIONS
 
Three Months
 
Six Months
 
 
 
Percent Net Sales
Percentage
 
 
 
Percent Net Sales
Percentage
 
2017
2016
2017
2016
Change
 
2017
2016
2017
2016
Change
Net sales
$
3,012

$
2,840

100.0
 %
100.0
 %
6.1
 %
 
$
5,967

$
5,335

100.0
 %
100.0
 %
11.8
 %
Gross profit
1,990

1,842

66.1

64.9

8.0

 
3,952

3,536

66.2

66.3

11.8

Research, development and engineering expenses
192

183

6.4

6.4

4.9

 
384

342

6.4

6.4

12.3

Selling, general and administrative expenses
1,130

1,043

37.5

36.7

8.3

 
2,232

1,987

37.4

37.2

12.3

Recall charges
72

28

2.4

1.0

157.1

 
98

47

1.6

0.9

108.5

Amortization of intangible assets
95

88

3.2

3.1

8.0

 
183

141

3.1

2.6

29.8

Other income (expense), net
(57
)
(67
)
(1.9
)
(2.4
)
(14.9
)
 
(112
)
(105
)
(1.9
)
(2.0
)
6.7

Income taxes
53

53

 
 

 
108

132

 
 
(18.2
)
Net earnings
$
391

$
380

13.0
 %
13.4
 %
2.9
 %
 
$
835

$
782

14.0
 %
14.7
 %
6.8
 %
 
 
 
 
 
 
 
 
 
 
 
 
Net earnings per diluted share
$
1.03

$
1.00

 
 
3.0
 %
 
$
2.20

$
2.07

 
 
6.3
 %
Adjusted net earnings per diluted share(1)
$
1.53

$
1.39

 
 
10.1
 %
 
$
3.01

$
2.63

 
 
14.4
 %
(1) Refer to "Non-GAAP Financial Measures" for a discussion of non-GAAP financial measures used in this report and a reconciliation to the most directly comparable GAAP financial measure.
Geographic and Segment Net Sales
Three Months
 
Six Months
 
 
 
Percentage Change
 
 
 
Percentage Change
 
2017
2016
As Reported
Constant
Currency
 
2017
2016
As Reported
Constant
Currency
Geographic:
 
 
 
 
 
 
 
 
 
United States
$
2,201

$
2,050

7.4
%
7.4
%
 
$
4,364

$
3,871

12.7
%
12.7
%
International
811

790

2.7

5.7

 
1,603

1,464

9.5

11.9

Total
$
3,012

$
2,840

6.1
%
6.9
%
 
$
5,967

$
5,335

11.8
%
12.5
%
Segment:
 
 
 
 
 
 
 
 
 
Orthopaedics
$
1,141

$
1,082

5.5
%
6.5
%
 
$
2,276

$
2,139

6.4
%
7.2
%
MedSurg
1,336

1,258

6.2

6.8

 
2,641

2,216

19.2

19.7

Neurotechnology and Spine
535

500

6.9

7.9

 
1,050

980

7.1

7.8

Total
$
3,012

$
2,840

6.1
%
6.9
%
 
$
5,967

$
5,335

11.8
%
12.5
%

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

STRYKER CORPORATION
 
2017 SECOND QUARTER FORM 10-Q

Supplemental Net Sales Growth Information
 
Three Months
 
Six Months
 
 
Percentage Change
 
 
Percentage Change
 
 
 
 
United States
International
 
 
 
 
United States
International
 
2017
2016
As Reported
Constant Currency
As Reported
As Reported
Constant Currency
 
2017
2016
As Reported
Constant Currency
As Reported
As Reported
Constant Currency
Orthopaedics:
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Knees
$
389

$
370

5.0
 %
5.9
 %
7.0
 %
0.1
 %
3.0
 %
 
$
780

$
731

6.8
%
7.3
%
7.2
%
5.5
 %
7.4
%
Hips
322

323

(0.3
)
1.0

2.1

(4.3
)
(0.8
)
 
642

639

0.4

1.5

2.1

(2.2
)
0.6

Trauma and Extremities
351

328

7.0

8.0

11.4

(0.5
)
2.4

 
703

655

7.3

8.1

10.7

1.5

4.0

Other
79

61

32.0

32.1

34.8

20.1

20.9

 
151

114

33.0

33.0

30.5

45.2

44.6

Total Orthopaedics
$
1,141

$
1,082

5.5
 %
6.5
 %
8.8
 %
(1.0
)%
2.1
 %
 
$
2,276

$
2,139

6.4
%
7.2
%
8.3
%
2.6
 %
4.9
%
MedSurg:
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Instruments
$
392

$
377

4.1
 %
4.7
 %
4.2
 %
3.6
 %
6.2
 %
 
$
786

$
742

5.9
%
6.4
%
6.0
%
5.7
 %
8.0
%
Endoscopy
406

357

13.9

14.3

15.5

8.4

10.2

 
779

685

13.8

14.0

15.0

9.4

10.7

Medical
474

465

1.6

2.4

2.3

(0.7
)
2.8

 
949

672

41.2

42.3

38.9

49.8

55.2

Sustainability
64

59

10.0

10.0

10.0

8.4

13.0

 
127

117

8.8

8.8

8.7

27.0

28.2

Total MedSurg
$
1,336

$
1,258

6.2
 %
6.8
 %
7.0
 %
3.4
 %
6.2
 %
 
$
2,641

$
2,216

19.2
%
19.7
%
18.9
%
20.3
 %
22.9
%
Neurotechnology and Spine:
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Neurotechnology
$
352

$
312

12.8
 %
13.9
 %
10.3
 %
17.3
 %
20.4
 %
 
$
683

$
613

11.3
%
12.0
%
10.0
%
13.7
 %
15.6
%
Spine
183

188

(2.9
)
(2.1
)
(1.3
)
(7.7
)
(4.7
)
 
367

367

0.1

0.6

0.5

(1.3
)
1.1

Total Neurotechnology and Spine
$
535

$
500

6.9
 %
7.9
 %
5.5
 %
10.0
 %
13.1
 %
 
$
1,050

$
980

7.1
%
7.8
%
6.1
%
9.4
 %
11.5
%
Total
$
3,012

$
2,840

6.1
 %
6.9
 %
7.4
 %
2.7
 %
5.7
 %
 
$
5,967

$
5,335

11.8
%
12.5
%
12.7
%
9.5
 %
11.9
%
 
Consolidated Net Sales
Consolidated net sales increased 6.1% in the three months 2017 as reported and 6.9% in constant currency, as foreign currency exchange rates negatively impacted net sales by 0.8%. Excluding the 0.2% impact of acquisitions, net sales in constant currency increased by 8.2% from increased unit volume partially offset by 1.5% due to lower prices. The unit volume increase was primarily due to higher shipments of endoscopy, neurotechnology, joint replacement capital, trauma and extremities and knee products.
Consolidated net sales increased 11.8% in the six months 2017 as reported and 12.5% in constant currency, as foreign currency exchange rates negatively impacted net sales by 0.7%. Excluding the 5.1% impact of acquisitions, net sales in constant currency increased by 8.6% from increased unit volume partially offset by 1.2% due to lower prices. The unit volume increase was primarily due to higher shipments of endoscopy, knee, trauma and extremities, instrument and neurotechnology products.
Orthopaedics Net Sales
Orthopaedics net sales increased 5.5% in the three months 2017 as reported and 6.5% in constant currency, as foreign currency exchange rates negatively impacted net sales by 1.0%. Excluding the 0.3% impact of acquisitions, net sales in constant currency increased by 8.6% from increased unit volume partially offset by 2.4% due to lower prices. The unit volume increase was primarily due to higher shipments of joint replacement capital, knee and trauma and extremities products.
Orthopaedics net sales increased 6.4% in the six months 2017 as reported and 7.2% in constant currency, as foreign currency exchange rates negatively impacted net sales by 0.8%. Excluding the 0.5% impact of acquisitions, net sales in constant currency increased by 9.2% from increased unit volume partially offset by 2.5% due to lower prices. The unit volume increase was primarily due to higher shipments of knee, trauma and extremities and joint replacement capital products.
MedSurg Net Sales
MedSurg net sales increased 6.2% in the three months 2017 as reported and 6.8% in constant currency, as foreign currency
 
exchange rates negatively impacted net sales by 0.6%. Excluding the 0.1% impact of acquisitions, net sales in constant currency increased by 7.1% from increased unit volume partially offset by 0.4% due to lower prices. The unit volume increase was primarily due to higher shipments of endoscopy and instrument products.
MedSurg net sales increased 19.2% in the six months 2017 as reported and 19.7% in constant currency, as foreign currency exchange rates negatively impacted net sales by 0.5%. Excluding the 11.2% impact of acquisitions, net sales in constant currency increased by 8.3% from increased unit volume and 0.2% due to higher prices. The unit volume increase was primarily due to higher shipments of endoscopy, instrument and medical products.
Neurotechnology and Spine Net Sales
Neurotechnology and Spine net sales increased 6.9% in the three months 2017 as reported and 7.9% in constant currency, as foreign currency exchange rates negatively impacted net sales by 1.0%. Net sales in constant currency increased by 10.0% from increased unit volume partially offset by 2.1% due to lower prices. The unit volume increase was primarily due to higher shipments of neurotechnology products.
Neurotechnology and Spine net sales increased 7.1% in the six months 2017 as reported and 7.8% in constant currency, as foreign currency exchange rates negatively impacted net sales by 0.7%. Excluding the 1.2% impact of acquisitions, net sales in constant currency increased by 8.2% from increased unit volume partially offset by 1.6% due to lower prices. The unit volume increase was primarily due to higher shipments of neurotechnology products.
Gross Profit
Gross profit as a percentage of sales in the three months 2017 increased to 66.1% from 64.9% in 2016. Excluding the impact of the charges noted below, gross profit increased to 66.3% of sales in the three months 2017 from 66.2% in 2016 primarily due to product mix. Gross profit as a percentage of sales in the six months 2017 decreased to 66.2% from 66.3% in 2016. Excluding the impact of the charges noted below, gross profit decreased to 66.4% of sales in the six months 2017 from 67.0% in 2016 primarily due to recent acquisitions and product mix.

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

STRYKER CORPORATION
 
2017 SECOND QUARTER FORM 10-Q

 
 
Percent Net Sales
Three Months
2017
2016
2017
2016
Reported
$
1,990

$
1,842

66.1
%
64.9
%
Inventory stepped-up to fair value
1

35


1.2

Restructuring-related charges
6

2

0.2

0.1

Adjusted
$
1,997

$
1,879

66.3
%
66.2
%
 
 
Percent Net Sales
Six Months
2017
2016
2017
2016
Reported
$
3,952

$
3,536

66.2
%
66.3
%
Inventory stepped-up to fair value

35


0.6

Restructuring-related charges
11

5

0.2

0.1

Adjusted
$
3,963

$
3,576

66.4
%
67.0
%
Research, Development and Engineering Expenses
Research, development and engineering expenses increased $9 or 4.9% in the three months 2017 and were 6.4% of sales in 2017 and 2016. These expenses increased $42 or 12.3% in the six months 2017 and were 6.4% of sales in 2017 and 2016. Recent acquisitions and the timing of spending on projects and investments in new technologies contributed to the increased spending levels.
Selling, General and Administrative Expenses
Selling, general and administrative expenses increased $87 or 8.3% in the three months 2017 and increased as a percentage of sales to 37.5% from 36.7% in 2016. Excluding the impact of the charges noted below, expenses increased to 35.0% of sales for the three months 2017 from 34.9% in 2016, primarily due to the continued focus on operating expense improvement initiatives, cost containment efforts and business mix, including leverage from our recent acquisitions, offset by planned investments in our selling organization and our new global ERP system.
Selling, general and administrative expenses increased $245 or 12.3% in the six months 2017 and increased as a percentage of sales to 37.4% from 37.2% in 2016. Excluding the impact of the charges noted below, expenses decreased to 35.4% of sales in the six months 2017 from 36.1% in 2016, primarily due to the continued focus on operating expense improvement initiatives, cost containment efforts and business mix, including leverage from our recent acquisitions, partially offset by planned investments in our selling organization and our new global ERP system.
 
 
Percent Net Sales
Three Months
2017
2016
2017
2016
Reported
$
1,130

$
1,043

37.5
 %
36.7
 %
Other acquisition and integration-related
(8
)
(31
)
(0.2
)
(1.1
)
Restructuring-related charges
(39
)
(20
)
(1.3
)
(0.7
)
Legal matters
(30
)

(1.0
)

Adjusted
$
1,053

$
992

35.0
 %
34.9
 %
 
 
Percent Net Sales
Six Months
2017
2016
2017
2016
Reported
$
2,232

$
1,987

37.4
 %
37.2
 %
Other acquisition and integration-related
(18
)
(36
)
(0.3
)
(0.6
)
Restructuring-related charges
(72
)
(37
)
(1.2
)
(0.7
)
Legal matters
(30
)
12

(0.5
)
0.2

Adjusted
$
2,112

$
1,926

35.4
 %
36.1
 %
Recall Charges
Recall charges were $72 and $28 in the three months and $98 and $47 in the six months 2017 and 2016. The charges were primarily due to the previously disclosed Rejuvenate and ABG II Modular-Neck hip stems voluntary recalls. Refer to Note 6 to our Consolidated Financial Statements for further information.
 
Amortization of Intangible Assets
Amortization of intangible assets was $95 and $88 in the three months and $183 and $141 in the six months 2017 and 2016. The increase in 2017 was primarily due to our recent acquisitions. Refer to Note 5 to our Consolidated Financial Statements for further information.
Other Income (Expense), Net
Other income (expense), net was ($57) and ($67) in the three months and ($112) and ($105) in the six months 2017 and 2016. The decrease in the three months 2017 was primarily due to an increase in interest income. The increase in the six months 2017 was primarily due to higher interest expense from higher debt levels as a result of our March 2016 and January 2017 debt offerings.
Income Taxes
The effective income tax rate on earnings was 11.8% and 12.3% in the three months and 11.4% and 14.5% in the six months 2017 and 2016. The decrease in the effective income tax rate in the three and six months 2017 is primarily due to the income tax effect of the adoption of ASU 2016-09. Refer to Note 1 to our Consolidated Financial Statements for further information.
Net Earnings
Net earnings increased to $391 or $1.03 per diluted share in the three months 2017 from $380 or $1.00 per diluted share in 2016. Adjusted net earnings per diluted share increased 10.1% to $1.53 in the three months 2017 from $1.39 in 2016. The impact of foreign currency exchange rates on net earnings reduced net earnings per diluted share by approximately $0.04 and $0.03 in the three months 2017 and 2016.
Net earnings increased to $835 or $2.20 per diluted share in the six months 2017 from $782 or $2.07 per diluted share in 2016. Adjusted net earnings per diluted share increased 14.4% to $3.01 in the six months 2017 from $2.63 in 2016. The impact of foreign currency exchange rates on net earnings reduced net earnings per diluted share by approximately $0.07 and $0.05 in the six months 2017 and 2016.
 
 
Percent Net Sales
Three Months
2017
2016
2017
2016
Reported
$
391

$
380

13.0
%
13.4
%
Inventory stepped-up to fair value

22


0.8

Other acquisition and integration-related
7

21

0.2

0.7

Amortization of intangible assets
63

59

2.1

2.1

Restructuring-related charges
41

20

1.4

0.7

Rejuvenate and other recall matters
54

23

1.8

0.8

Legal matters
25


0.8


Adjusted
$
581

$
525

19.3
%
18.5
%
 
 
Percent Net Sales
Six Months
2017
2016
2017
2016
Reported
$
835

$
782

14.0
%
14.7
 %
Inventory stepped-up to fair value

22


0.4

Other acquisition and integration-related
14

25

0.2

0.5

Amortization of intangible assets
124

98

2.1

1.8

Restructuring-related charges
68

34

1.1

0.6

Rejuvenate and other recall matters
75

39

1.3

0.7

Legal Matters
25

(7
)
0.4

(0.1
)
Adjusted
$
1,141

$
993

19.1
%
18.6
 %
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

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

STRYKER CORPORATION
 
2017 SECOND QUARTER FORM 10-Q

sales growth; adjusted gross profit; cost of sales excluding specified items; adjusted selling, general and administrative expenses; adjusted amortization of intangible assets; adjusted operating income; adjusted effective income tax rate; adjusted net earnings; and adjusted net earnings per diluted share (Diluted EPS). We believe that these non-GAAP measures provide meaningful information to assist investors and shareholders in understanding our financial results and assessing our prospects for future performance. Management believes percentage sales growth in constant currency and the other adjusted measures described above are important indicators of our operations because they exclude items that may not be indicative of or are unrelated to our core operating results and provide a baseline for analyzing trends in our underlying businesses. Management uses these non-GAAP financial measures for reviewing the operating results of reportable business segments and analyzing potential future business trends in connection with our budget process and bases certain management incentive compensation on these non-GAAP financial measures.
To measure percentage sales growth in constant currency, we remove the impact of changes in foreign currency exchange rates that affect the comparability and trend of sales. Percentage sales growth in constant currency is calculated by translating current and prior year results at the same foreign currency exchange rate. 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 sa