SYK

Stryker Corporation 2005 Annual Report (10-K) Summary

Business Context and Reporting Period

This report covers the fiscal year ended December 31, 2005. Stryker Corporation is a leading global medical technology company with two primary reportable segments: Orthopaedic Implants (joint replacement, trauma, spinal, micro implants, and biologics) and MedSurg Equipment (surgical, endoscopic, navigation, and patient handling equipment). The company also operates Physical Therapy Services. In 2005, Stryker completed the repatriation of $722 million in foreign earnings under the American Jobs Creation Act and acquired PlasmaSol Corp. and eTrauma.com Corp.

Key Financial Metrics

Margins: Gross margin was 64.8% in 2005 (up from 64.6% in 2004). Operating margin improved to 20.5% from 16.9%.

Material Changes vs. Prior Period

• Revenue Growth: Net sales increased 14% year-over-year, driven by a 12% increase in unit volume/mix, 1% price increase, and 1% from acquisitions. Orthopaedic Implants sales grew 11%, while MedSurg Equipment sales grew 21%.
• Profitability: Net earnings surged 45% to $675.2 million. This growth was significantly aided by a reduction in "Purchased in-process research and development" (IPR&D) charges, which dropped from $120.8 million in 2004 (SpineCore acquisition) to $15.9 million in 2005 (PlasmaSol acquisition).
• Debt Structure: Long-term debt increased substantially to $231.6 million from $10.0 million. This was primarily due to a €190 million senior term loan drawn in late 2005 to fund the repatriation of foreign earnings.
• Liquidity: Working capital increased to $1,621.3 million. Cash and marketable securities more than tripled to $1.056 billion, bolstered by strong operating cash flow and the repatriation of funds.

Guidance, Outlook, and Risks

2006 Outlook: Management projects diluted earnings per share of $2.02 for 2006, representing a 21% increase over adjusted 2005 earnings. Net sales are forecast to grow 11% to 14%, with organic growth expected between 12% and 15% excluding foreign currency impacts. The company anticipates a 1% to 2% unfavorable impact on full-year sales due to foreign exchange rates.

Key Risks and Contingencies:

• Regulatory & Legal: The company is cooperating with Department of Justice investigations regarding billing practices at Physiotherapy Associates and consulting contracts with orthopedic surgeons. Outcomes are uncertain.
• Product Liability: Exposure to product liability claims and potential unfavorable court decisions.
• Reimbursement: Pricing pressures and cost-containment measures from third-party payors in the U.S., Japan, and other markets.
• Development Risks: Delays in FDA approval for new products, specifically the FlexiCore and CerviCore spinal implants and OP-1 indications.
• Accounting Changes: The company will adopt FASB Statement No. 123(R) effective January 1, 2006, requiring the recognition of stock option compensation expense, which will reduce reported net earnings.

Investor Verification Checklist

• Adjusted vs. Reported Earnings: Verify the impact of the $15.9 million IPR&D charge and the $27.4 million tax charge on repatriated earnings on the reported bottom line versus the adjusted non-GAAP figures.
• Debt Servicing: Confirm the interest rate and repayment schedule for the new €190 million term loan used for repatriation.
• Regulatory Status: Monitor the status of the Department of Justice investigations and the FDA approval timeline for FlexiCore (PMA expected 2007) and CerviCore (PMA expected 2009).
• Stock Compensation Impact: Review the pro forma impact of the new FASB 123(R) adoption on 2006 earnings, estimated at a $31.6 million reduction in net earnings for 2005 if applied retroactively.
• Foreign Currency Exposure: Assess the sensitivity of international sales (35% of total) to fluctuations in the Euro and Japanese Yen.