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Stryker Corp – ‘10-K405/A’ for 12/31/98

On:  Tuesday, 2/22/00   ·   For:  12/31/98   ·   Accession #:  310764-0-9   ·   File #:  0-09165

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  As Of                Filer                Filing    For·On·As Docs:Size

 2/22/00  Stryker Corp                      10-K405/A  12/31/98    2:292K

Document/Exhibit                   Description                      Pages   Size 

 1: 10-K405/A   Amendment to Annual Report -- [x] Reg. S-K Item     HTML    304K 
                          405                                                    
 2: EX-27       Financial Data Schedule (Pre-XBRL)                     1      6K 

Washington, D.C. 20549

___________________________

Commission file number: 0-9165

(Exact name of registrant as specified in its charter)

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

___________________________

Securities registered pursuant to Section 12(b) of the Act: Common Stock, $.10 par value

Securities registered pursuant to Section 12(g) of the Act: None

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities and Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.

YES [X]         NO [ ]

Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K is not contained herein, and will not be contained, to the best of registrant's knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K. [X]

Based on the closing sales price of March 1, 1999, the aggregate market value of the voting stock held by nonaffiliates of the registrant was approximately $3,169,351,254.

The number of shares outstanding of the registrant's Common Stock, $.10 par value, was 96,775,224 at March 1, 1999.

Portions of the annual stockholders report for the year ended December 31, 1998 (the "1998 Annual Report") are incorporated by reference into Part I.

Portions of the proxy statement filed with the Securities and Exchange Commission relating to the 1999 Annual Meeting of Stockholders (the "1999 proxy statement") are incorporated by reference into Part III.

The information contained in this report includes forward-looking statements within the meaning of the federal securities laws that are subject to risks and uncertainties. Factors that could cause the Company's actual results and financial condition to differ from the Company's expectations include, but are not limited to: changes in economic conditions that adversely affect the level of demand for the Company's products, changes in foreign exchange markets, changes in financial markets, changes in the competitive environment, and the factors regarding Year 2000 issues. All forward-looking statements contained in this report are qualified in their entirety by this cautionary statement.

This Amendment No. 1 on Form 10-K/A is hereby filed with respect to that certain Annual Report on Form 10-K for the year ended December 31, 1998 of Stryker Corporation filed with the Securities and Exchange Commission on March 31, 1999 (the "Form 10-K"). Part II, Item 6 "Selected Financial Data," Part II, Item 7 "Management's Discussion and Analysis of Financial Condition and Results of Operations," Part II, Item 8 "Financial Statements and Supplementary Data," and Part IV, Item 14 "Exhibits, Financial Statement Schedules, and Reports on Form 8-K" of the Form 10-K are hereby amended and restated in their entirety as a result of a restatement of the Company's balance sheet and operating results as of and for the year ended December 31, 1998 to reduce acquisition-related reserves as of December 31, 1998 and acquisition-related charges for the year then ended by $31.0 million ($20.5 million net of tax) and to provide additional disclosures related thereto.

The restatement and the additional disclosures contained herein result from discussions with the Securities and Exchange Commission ("SEC") relating to the accounting for the Company's 1998 acquisition of Howmedica. The Form 10-K as amended hereby continues to speak as of the date of the Form 10-K and the disclosures have not been updated to speak to any later date. Any items in the Form 10-K that are not expressly changed hereby shall be as set forth in the Form 10-K. All information contained in this Amendment No. 1 and the Form 10-K is subject to updating and supplementing as provided in the Company's periodic reports filed with the SEC subsequent to the filing of the Form 10-K.

PART II

The financial information for each of the five years in the period ended December 31, 1998 is set forth below:

1. Other income (expense) has been restated for 1994 through 1997 to reflect the reclassification of minority interest, which was shown separately prior to 1998.
2. Adjusted for the two-for-one stock split effective May 10, 1996.

The table below outlines the components of the consolidated statements of earnings as a percentage of net sales:

1. See the section on "Restatement of 1998 Acquisition-Related Charges" for information concerning the Company's restatement of its 1998 Consolidated Financial Statements. The restatement reduces 1998 acquisition-related charges and is reflected in the table above.

The table below sets forth domestic/international and product line sales information:

Stryker Corporation announced on January 27, 2000 that it is restating its operating results for the year ended December 31, 1998 to reduce acquisition-related charges by $31.0 million ($20.5 million net of tax.) The restatement results from discussions with the Securities and Exchange Commission relating to the accounting for the Company's 1998 acquisition of Howmedica. The Company had provided reserves in the fourth quarter of 1998 for the conversion of a portion of its domestic and foreign distributors to direct sales to accommodate the integration with the Howmedica sales force. The cost of the conversions was based on contractual terms or in accordance with plans to complete such conversions. The $31.0 million restatement relates to reserves provided for certain foreign distributors where contractual terms had not been reached as of December 31, 1998. The effects of this change on previously reported Consolidated Financial Statements for the year ended December 31, 1998 are shown in Note 5 of Notes to Consolidated Financial Statements. The following discussion and analysis have been changed to reflect this restatement.

Stryker Corporation's net sales increased 13% in 1998 to $1,103.2 million from $980.1 million in 1997. Increased unit volume generated a 10% sales increase. Net sales also increased $42.8 million or 4% as a result of the acquisition of Howmedica, which was acquired on December 4, 1998; 3% as a result of other acquired businesses; and 1% related to higher selling prices from the conversion of Osteonics domestic distributors to direct sales. These increases were partially offset by a 2% decrease arising from changes in foreign currency exchange rates, a 2% decrease from sales credits for inventory returns related to the conversion of the remaining Osteonics independent distributors to direct sales and a 1% decline in selling prices.

The Company's domestic sales increased 15% in 1998 compared to 1997. The leading domestic sales gains came from strong shipments of endoscopic equipment, powered surgical instruments, orthopaedic implants, hospital beds and stretchers and increased revenue from physical therapy services. Increased domestic sales from the acquisition of Howmedica were largely offset by fourth quarter sales credits for inventory returns relating to the conversion of the remaining Osteonics independent distributors to direct sales. International sales increased 8% for the year as a result of incremental sales from the acquisition of Howmedica and strong shipment growth in international markets outside of Japan. These gains were offset in part by unfavorable foreign currency comparisons, which reduced the dollar value of international sales by 5%, and by lower sales volume in Japan.

Sales of Orthopaedic Implants increased 9% for the year. The sales gains for the year resulted from incremental sales from the acquisition of Howmedica and higher shipments of hips domestically and spinal, trauma and knee products worldwide. These Orthopaedic Implants sales increases were partially offset by sales credits of $17.1 million for inventory returns in connection with the conversion of the Osteonics domestic distributors, the unfavorable impact of foreign currency translation and lower sales volumes in Japan. Sales of Medical and Surgical Equipment increased 14% for the year. The sales gains for 1998 resulted from higher shipments of endoscopic equipment, powered surgical instruments, especially the TPS advanced micropowered instruments, hospital beds and stretchers and incremental sales from the acquisition of craniomaxillofacial products from Howmedica. These gains were offset in part by a decline in sales of Matsumoto distributed products sold in Japan due to unfavorable foreign currency comparisons and lower sales volume. Revenues from Physical Therapy Services increased 16% during the year as a result of the start-up of rehabilitative clinics, the acquisition of certain clinics and same store revenue growth of 1%, all of which were partially offset by overall price declines of 2%.

Cost of sales represented 42.8% of sales compared to 40.6% in 1997. The higher cost of sales percentage in 1998 resulted from changes in sales mix and the general weakness in foreign currencies, which increased the cost of U.S.-dollar-based inventory purchases for the Company's international operations. The cost of sales percentage also increased due to the inventory returns associated with the sales credits related to the Osteonics distributor conversions and as a result of $7.8 million in additional nonrecurring cost of sales for inventory sold in the period from December 5 to December 31, 1998, that was stepped-up to fair value in connection with the acquisition of Howmedica. Research, development and engineering expenses increased 7% as the Company spent $61.1 million on product development in 1998 compared to $56.9 million in 1997. Research, development and engineering expenses declined as a percentage of sales partially as a result of the acquisition of Howmedica. In addition, the Company spent less on its continuing development of the OP-1 bone growth device at Stryker Biotech. This decrease was offset by greater spending on new product development in the remainder of the Company. Stryker Biotech spending is expected to grow in 1999 as a result of the November 1998 purchase of the manufacturing rights and facilities for OP-1 from Creative BioMolecules, Inc. New products in 1998 included the Secur-Fit Plus hip stem, Scorpioä CR Knee Implant, the InterPulse System, System 4 (the next generation battery powered instrument system), the Quantum 5000 lightsource, the Hermes video control system and the EZ-Pro Ambulance Cot. Selling, general and administrative expenses increased 12% in 1998 as a result of incremental expenses associated with the acquisition of Howmedica and an increase in selling expenses, although such expenses grew at a slower rate than the increase in sales. Selling, general and administrative expenses declined to 34.6% of sales in 1998 from 34.8% in 1997.

There were several significant nonrecurring acquisition-related items included in continuing operations in 1998. The Company charged $83.3 million to operations in the fourth quarter for purchased research and development, $78.4 million related to the valuation of in-process research and development projects acquired in the Howmedica purchase and $4.9 million related to the purchase of tangible research and development assets having no alternative future use in connection with the acquisition of the OP-1 manufacturing rights and facility. The Company also recorded $33.0 million in acquisition-related pre-tax charges in the fourth quarter. These charges included $21.8 million to reorganize Stryker's distribution channels to accommodate the integration with Howmedica and $11.2 million in expensed transaction costs associated with the acquisitions of Howmedica and of the manufacturing rights and facilities for OP-1. The reorganization of Stryker's distribution channels encompassed conversions of all remaining Osteonics U.S. distributors and certain distributors in Europe and the Pacific Rim to direct sales. A portion of the cost to convert Osteonics distributors was incurred in the form of sales credits for inventory returns, which reduced sales and gross profit in the fourth quarter.

The purchased research and development of $78.4 million for the Howmedica acquisition was determined based on an independent valuation of Howmedica's research and development projects using information and assumptions provided by management. Among the in-process projects included in the valuation, two are considered significant. These projects relate to the development of a new spinal technology to be used in the treatment of spinal disorders and the development of an improved polyethylene to be used in hip and knee implants. The estimated future revenues associated with the spinal project were deemed to be approximately 80% attributable to in-process research and development based on technological progression towards completion. For the polyethylene project, future revenues were deemed to be approximately 75% attributable to in-process research and development based on the same criterion. The spinal project is expected to be completed in 2002 and the polyethylene project is expected to be completed in 1999. All of the purchased research and development projects were valued using an income approach utilizing the discounted cash flow method. Revenues were projected from the expected date of product introduction to 2009 with the terminal value included in the discounted cash flow valuation. The spinal project is considered to have greater revenue potential with higher market risk and was valued using a 30% discount rate. The polyethylene project was valued using a 20% discount rate. Margins estimated for the future products were based on the current spinal implant market for the spinal project and on the current margins for hip and knee implants for the polyethylene project. Estimated selling, royalty and other expenses related to the future products were based on Howmedica's historical levels of spending in these areas.

During the fourth quarter of 1998, the Company reduced the effective tax rate for the year to 34% from 35%, thereby reducing income tax expense by $0.6 million. The reduction in the effective tax rate for the year from the 36% rate used in 1997 was the result of increased participation in a U.S. employment-related tax incentive program, a reduction in tax assessed on funds repatriated from Puerto Rico and a more favorable mix of operating results among tax jurisdictions, which was offset in part by certain nondeductible permanent differences. Net earnings were $60.0 million compared to $125.3 million in 1997, a decrease of 52%. Excluding the impact of Howmedica operating results and the nonrecurring acquisition-related costs and charges taken in the fourth quarter, net earnings for the year increased 20% to $150.3 million.

Stryker Corporation's net sales increased 8% in 1997 to $980.1 million from $910.1 million in 1996. Increased unit volume generated an 11% sales increase. Net sales also increased 3% as a result of acquired businesses. These increases were partially offset by a 3% decrease arising from changes in foreign currency exchange rates, a 2% decline in selling prices and a 1% decline from a divested business.

The Company's domestic sales increased 12% in 1997 compared to 1996. The leading domestic sales gains came from strong shipments of powered surgical instruments, endoscopic equipment and orthopaedic implants and increased revenue from physical therapy services. International sales increased less than 1% for the year as unfavorable foreign currency comparisons and flat sales in Japan offset a 20% increase in shipments in the other international markets.

Sales of Orthopaedic Implants increased 8% in 1997 compared to 1996. The sales gains for the year resulted from higher shipments of trauma products related to the acquisition of Osteo Holding AG ("Osteo") in September 1996 and of knees and hips. Sales of Medical and Surgical Equipment increased 4% for the year as higher shipments of powered surgical instruments, especially the TPS advanced micro-powered instruments, and endoscopic equipment were offset in part by the January 1997 sale of the Sterilizer Service Division, by lower shipments of hospital beds and stretchers, by a significant decline in sales of Matsumoto distributed products and by the lower dollar translation of foreign currency sales. Revenues from Physical Therapy Services increased 27% for the year, primarily as a result of business acquisitions and start-ups. Same store revenue growth for Physical Therapy Services was 4% in 1997.

Cost of sales represented 40.6% of sales compared to 43.1% in 1996. The lower cost of sales percentage in 1997 resulted from product mix, the Company's continued efforts in product cost reductions and from inventory adjustments of $13.8 million recorded in 1996 that did not occur in 1997. The 1996 inventory adjustments were for excess inventory and product deletions, principally in Japan, and obsolete inventory resulting from new product introductions. Research, development and engineering expenses were $56.9 million in both 1997 and 1996. The Company's research, development and engineering expenses represent continued development of the OP-1 bone growth device at Stryker Biotech and the Company-wide focus on new product development. New products in 1997 included the Scorpio™ Knee System, the Steri-shield™ Turbo3 Helmet, the SE Sagittal Saw, the Tempest Arthroscopy Pump and the 6080 MX-Pro™ Ambulance Cot. Selling, general and administrative expenses increased 5% in 1997 as a result of an increase in marketing expenses, due to additional marketing campaigns, and an increase in selling expenses resulting from increases in sales volume, larger sales forces and the incremental expenses incurred as a result of the Osteo acquisition. However, selling, general, and administrative expenses declined to 34.8% of sales in 1997 compared to 35.9% in 1996. In 1996, $8.9 million of adjustments were made for additional legal reserves, depreciation charges due to a change in estimate and other matters. The effect of these adjustments and the Company's ongoing effort to control operating expenses reduced selling, general and administrative expenses as a percentage of sales.

There were several significant unusual items reflected in continuing operations in 1996 that did not occur in 1997. Special charges of $34.3 million were recorded in 1996, consisting of $15.0 million for the reorganization of the Company's distribution channels, $14.6 million relating to asset impairments and $4.7 million for patent claims. The Company also recorded a $7.5 million pretax charge for purchased research and development associated with the acquisition of Osteo. In addition, the Company was awarded and received $77.6 million in damages, attorneys' fees and interest for infringement of the Company's U.S. patent on its Omniflex Hip System. The Company recognized a pretax gain, net of related legal fees and other expenses, of $61.1 million.

During the fourth quarter of 1997, the Company reduced the effective tax rate for the year to 36% from 37%, thereby reducing income tax expense by $1.9 million. The reduction in the effective tax rate in the fourth quarter of 1997 and from the 38.4% rate used in 1996 was the result of higher U.S. exports, tax-free interest on short-term investments and a more favorable mix of operating results among tax jurisdictions. Net earnings increased 20% to $125.3 million in 1997 compared to $104.5 million in 1996.

Stryker had a strong operating cash flow year in 1998. Operating activities provided $154.5 million in cash in 1998, compared to $91.9 million provided in 1997. The increase from 1997 is the result of first quarter 1997 payments of attorneys' fees and taxes totaling $37.9 million related to the 1996 gain on patent judgment and to increased 1998 net earnings, excluding the non-cash charge for purchased research and development and the impact of acquisition-related charges that did not yet require cash payment.

On December 4, 1998, the Company acquired Howmedica, the orthopaedic division of Pfizer Inc., for $1,650 million in cash. The acquisition was funded with cash and approximately $1,500 million borrowed under $1,650 million of credit facilities established in December 1998. During 1998, the Company also purchased the manufacturing rights, facilities and product on-hand for its OP-1 bone growth device for $19.3 million in cash and four of Osteonics independent distributors for $19.7 million in cash. In addition, the Company acquired additional shares of the outstanding common stock of Matsumoto Medical Instruments, Inc., thereby increasing its direct ownership interest to 83%, through cash purchases of $3.3 million and the exchange of 75,000 shares of Stryker common stock ($3.8 million value). In January 1999, the Company acquired all of the remaining outstanding common stock of Matsumoto for $1.0 million in cash and 180,605 shares of Stryker common stock ($9.7 million value).

These acquisitions, particularly of Howmedica, significantly changed the Company's liquidity and financial position. Working capital at December 31, 1998, increased by $199.1 million to $632.8 million from $433.7 million in 1997. However, the Company's current ratio declined from 2.4 to 1.9. The working capital increase includes a $213.1 million step-up to fair value of inventories acquired in connection with the acquisition of Howmedica, which will be charged off as additional nonrecurring cost of sales as the inventories are sold. Working capital also includes $175.9 million of acquisition-related reorganization reserves and liabilities in current liabilities. Accounts receivable days sales outstanding at the end of 1998 increased to 70 days from 62 days in 1997, primarily as a result of higher days sales outstanding related to Howmedica direct sales in certain European markets. Days sales in inventory increased from 127 days in 1997 to 142 days at December 31, 1998. The increase in inventory days is primarily the result of higher inventory levels held by the acquired Howmedica business.

The Company had $142.2 million in cash and marketable securities at December 31, 1998. The Company also has outstanding long-term debt totaling $1,503 million at the end of 1998. Current maturities of the long-term debt for 1999 are $15.0 million and will increase to $89.0 million in 2000 and $130.2 million in 2001. The Company believes its cash and marketable securities on-hand as well as anticipated cash flows from operations will be sufficient to fund future operating capital requirements and required debt repayments. Should additional funds be required, the Company has $162.2 million of additional borrowing capacity available under the $1,650 million credit facilities at December 31, 1998.

The Company continues to evaluate its plan to integrate Howmedica and Stryker. As the integration plan evolves, information could become known that will require adjustments to the purchase liabilities recorded in the preliminary purchase price allocation. Such adjustments could result in an increase or decrease to goodwill recorded in connection with the acquisition. In addition, decisions to further reorganize Stryker's operations could be made that would result in additional acquisition-related and special charges against future operating results. As stated in the section on "Restatement of 1998 Acquisition-Related Charges," prior to the restatement the Company had provided reserves for anticipated conversions of certain foreign distributors to direct sales to accommodate the integration with the Howmedica sales force. The restatement relates to those foreign distributors where contractual terms had not been reached as of December 31,1998. The Company expects that certain distributor conversions will be completed through negotiation of contractual terms during 1999, which will result in additional acquisition-related charges totaling $4-$5 million. The Company also anticipated converting one additional foreign distributor to direct sales at a potential cost of $30 million. However, as of January 27, 2000 (the date the 1998 financial statement restatement was announced), the Company no longer expects to negotiate termination of that distributor agreement. This decision was made as a result of changes in the Company's management in late 1999 and consequent changes in the integration plan with respect to that distributor.

The Company manufactures its products in the United States, France, Germany, Ireland, Switzerland, Canada and Puerto Rico and distributes its products throughout the world. As a result, the Company's financial results could be significantly affected by factors such as changes in foreign currency exchange rates or weak economic conditions in foreign markets. The Company's operating results are exposed to changes in exchange rates between the U.S. dollar and the Japanese yen and European currencies, in particular the Euro and the Swiss franc. When the U.S. dollar strengthens against foreign currencies, the dollar value of foreign currency sales declines and the relative cost of U.S.-sourced product increases, thereby decreasing gross margins. When the U.S. dollar weakens, the opposite occurs.

The Company enters into forward foreign exchange contracts and options principally to hedge the currency fluctuations in transactions denominated in foreign currencies, thereby limiting the Company's risk that would otherwise result from changes in exchange rates. During 1998, the principal transactions hedged were intercompany purchases of U.S.-manufactured product and intercompany payables. The periods of the forward foreign exchange contracts and options correspond to the periods of the hedged transactions with realized gains and losses included in the measurement and recording of the hedged transactions.

At December 31, 1998, the Company had outstanding forward foreign exchange contracts and options to purchase $79.7 million and sell $92.3 million of various currencies (principally U.S. dollars) with maturities principally ranging from 30 to 180 days .

The estimated fair value of foreign currency contracts and options represents the measurement of the contracts and options at month-end spot rates. At December 31, 1998, the difference between the fair value of all outstanding contracts and options and the purchased contract and option amounts was not material. A hypothetical 10% change in exchange rates for these currencies would change the fair value by approximately $19.0 million.

The Company's exposure to market risk for changes in interest rates relate to its borrowings and investment portfolio. The Company manages its interest rate risk on its borrowings through the purchase of interest rate swap agreements, which, effective in January 1999, have fixed the base rate on $800.0 million of the approximate $1,500 million of variable borrowings outstanding at December 31, 1998. If market interest rates for similar borrowings average 1% more in 1999 than they did in 1998, the Company's interest expense, after considering the effects of its interest rate swaps, would increase, and income before taxes would decrease by $6.9 million. Comparatively, if market interest rates averaged 1% less in 1999 than they did during 1998, the Company's interest expense, after considering the effects of its interest rate swaps, would decrease, and income before taxes would increase by $6.2 million. These amounts are determined by considering the impact of hypothetical interest rates on the Company's borrowing cost and interest rate swap agreements and does not consider any actions by management to mitigate its exposure to such a change.

The Company manages interest rate risk in its investment portfolio by investing in high-quality issuers and, by policy, seeks to avoid principal loss of its invested funds by limiting default risk, market risk and reinvestment risk. The Company manages default risks by investing in only high-credit-quality securities and by responding appropriately to a significant reduction in a credit rating of any investment issuer or guarantor. The portfolio includes only marketable securities with active secondary or resale markets to ensure portfolio liquidity. In addition, the Company does not plan to hold a significant amount of investments, since it expects to pay off debt with operating cash flow in excess of the Company's needs.

The information provided below constitutes a "Year 2000 Readiness Disclosure" for purposes of the Year 2000 Information and Readiness Disclosure Act.

The Company is in the process of preparing a response for the Year 2000 (Y2K) so that its computer and other systems will function properly with respect to dates in the year 2000 and beyond. The scope of the Company's Y2K response includes replacement or upgrades of information technology, such as software or hardware, as well as non-information-technology systems that may include embedded chips, such as micro-controllers contained in manufacturing equipment and in Company products. The Company has already upgraded the hardware and software at many divisions. Major hardware and software upgrades are in process at Howmedica Osteonics, Physiotherapy Associates and at several manufacturing and distribution locations within Europe. The Company's largest ongoing project is at Howmedica Osteonics, where separate noncompliant manufacturing and distribution systems are being upgraded or replaced with integrated systems that are Y2K compliant. The Company has or will contact key third parties, such as suppliers, customers and financial institutions in an effort to assure no interruption of its business relationships occur due to Y2K compliance issues. However, if the needed conversions or modifications to computer or other systems are not made, or are not completed timely, the Y2K issue could have a material impact on the operations of the Company.

The Company expects that it will be Y2K compliant by September 1999. Substantially all of the Company's products that contain embedded chips are Y2K compliant. The Company will continue testing and documentation efforts throughout 1999 and will formulate and finalize any contingency plans needed during that time. These contingency plans will address worst-case scenarios if needed conversions or modifications are not made or completed with certain key systems as well as worst-case scenarios for key third party relationships affected by Y2K. The total estimated incremental cost for the Y2K project is approximately $5.1 million, of which $2.1 million had been spent through December 31, 1998. All costs will be expensed as incurred and will be funded through operating cash flows.

The costs and timing of the Y2K project are based on management's best estimates, which were derived utilizing assumptions regarding future events, including the continued availability of certain resources and other factors. However, there can be no guarantee that these estimates will be achieved, and actual results could differ materially from those anticipated. Specific factors that might cause such material differences include, but are not limited to, the availability and cost of personnel trained in this area, the ability to locate and correct relevant computer codes and similar uncertainties.

The information contained in this report includes forward-looking statements within the meaning of the federal securities laws that are subject to risks and uncertainties. Factors that could cause the Company's actual results and financial condition to differ from the Company's expectations include, but are not limited to: changes in economic conditions that adversely affect the level of demand for the Company's products, changes in foreign exchange markets, changes in financial markets, changes in the competitive environment, and the factors referred to above regarding Y2K issues. All forward-looking statements contained in this report are qualified in their entirety by this cautionary statement.

The consolidated financial statements of the Company and its subsidiaries and report of independent auditors follow:

BUSINESS: Stryker Corporation develops, manufactures and markets specialty surgical and medical products that are sold primarily to hospitals throughout the world and provides outpatient physical therapy services in the United States.

PRINCIPLES OF CONSOLIDATION: The consolidated financial statements include the accounts of the Company and its wholly owned subsidiaries and its majority owned subsidiary, Matsumoto Medical Instruments, Inc., after elimination of all significant intercompany accounts and transactions. Minority interest represents the minority stockholders' equity in Matsumoto's net earnings (loss) and their equity in Matsumoto's net assets.

REVENUE RECOGNITION: Revenue is recognized on the sale of products and services when the related goods have been shipped or services have been rendered.

USE OF ESTIMATES: The preparation of these consolidated financial statements in conformity with generally accepted accounting principles requires Company management to make estimates and assumptions that affect the amounts reported in the financial statements and accompanying notes. Actual results could differ from those estimates.

CASH EQUIVALENTS AND INVESTMENTS: Cash equivalents are highly liquid investments with a maturity of three months or less when purchased. Investments include marketable debt securities classified as current assets and marketable equity securities classified in other assets.

The Company's investments in marketable equity and debt securities are classified as "available-for-sale" and are carried at fair value, with the unrealized gains and losses, net of income taxes, reported within accumulated other comprehensive gain (loss) in stockholders' equity. Interest, dividends and realized gains and losses on the sale of such securities are included in other income.

INVENTORIES: Inventories are stated at the lower of cost or market. Cost for approximately 94% (78% in 1997) of inventories is determined using the lower of first-in, first-out (FIFO) cost or market. Cost for certain domestic inventories is determined using the last-in, first-out (LIFO) cost method. The FIFO cost for all inventories approximates replacement cost, except for certain inventories acquired in connection with the purchase of Howmedica that have been stepped-up to fair value (see Note 4).

PROPERTY, PLANT AND EQUIPMENT: Property, plant and equipment is stated at cost. Depreciation is computed by the straight-line or declining balance methods over the estimated useful lives of the assets.

GOODWILL AND OTHER INTANGIBLE ASSETS: Goodwill and other intangible assets represent the excess of purchase price over fair value of tangible net assets of acquired businesses. Goodwill is amortized on a straight-line basis over 10 to 40 years (weighted average life of 34 years). Developed technology is amortized on a straight-line basis over 20 years. Other intangible assets, consisting primarily of customer base, which reflects expected continued customer patronage, trademarks, trade names and assembled work force, are amortized on a straight-line basis over 5 to 35 years (weighted average life of 24 years).

The carrying amounts of goodwill and other intangible assets are reviewed if facts and circumstances suggest they may be impaired. If the review indicates that the carrying amount of any intangible asset will not be recoverable, as determined using an undiscounted cash flow analysis, the carrying amount of the goodwill or other intangible asset is reduced by the estimated shortfall of cash flows to fair value.

DEFERRED CHARGES: Deferred charges represent the net book value of loaner instruments for surgical implants provided to customers by the Company. These instruments are amortized on a straight-line basis over periods ranging from one to three years. Amortization expense of instruments is included in selling, general and administrative expense in the Consolidated Statements of Earnings.

DEFERRED LOAN COSTS: Deferred loan costs of $25,493 associated with the Company's Senior Secured Credit Facilities are being amortized over the terms of the related debt, based on the amount of outstanding debt, using the effective interest method and are classified in other assets. Amortization expenses for these deferred loans costs are included in interest expense and were $402 for 1998.

INCOME TAXES: The Company accounts for income taxes using the liability method. Under this method, deferred tax assets and liabilities are determined based on differences between financial reporting and tax bases of assets and liabilities and are measured using the enacted tax rates in effect for the years in which the differences are expected to reverse. Deferred tax expense represents the change in net deferred tax assets and liabilities during the year.

DERIVATIVE FINANCIAL INSTRUMENTS: The Company uses derivative financial instruments to manage the economic impact of fluctuations in interest rates and foreign currency exchange rates. The Company enters into interest rate swaps, foreign currency forward contracts and foreign currency options to manage these economic risks.

Interest rate differentials to be paid or received as a result of interest rate swaps are accrued and recognized as an adjustment of interest expense related to the designated debt. Foreign currency forward contracts and foreign currency options used to hedge intercompany financial activity are carried off-balance sheet with realized gains and losses included in the measurement and recording of the hedged transactions.

STOCK OPTIONS: The Company follows Accounting Principles Board (APB) Opinion No. 25, "Accounting for Stock Issued to Employees" in accounting for its employee stock options. Under APB 25, no compensation expense is recognized because the exercise price of the Company's employee stock options equals the market price of the underlying stock on the date of grant.

COMPREHENSIVE INCOME: As of January 1, 1998, the Company adopted Financial Accounting Standards Board (FASB) Statement No. 130, "Reporting Comprehensive Income". Statement No. 130 establishes rules for the reporting of comprehensive earnings and its components; however, the adoption of this statement had no impact on the Company's net earnings or stockholders' equity. Statement No. 130 requires unrealized gains or losses on the Company's available-for-sale securities and foreign currency translation adjustments, which prior to adoption were reported separately in stockholders' equity, to be aggregated and disclosed as accumulated other comprehensive gain (loss) within stockholders' equity. Prior year financial statements have been reclassified to conform to the requirements of Statement No. 130. The components of accumulated other comprehensive gain (loss) are as follows:

NEW ACCOUNTING STANDARDS NOT YET ADOPTED: In June 1998, the FASB issued Statement No. 133, "Accounting for Derivative Instruments and Hedging Activities". The Statement will require the Company to record all derivatives on the balance sheet at fair value. Changes in the fair value of derivatives that do not meet the criteria to be treated as a hedge under the Statement will be included in earnings. If derivatives meet the hedge criteria, changes in the fair value of the derivatives will offset changes in the fair value of the items being hedged. The Statement is required to be adopted by the Company beginning in the first quarter of 2000. The Company has not determined what effect the Statement will have on the Company's future consolidated results of operations or financial position when adopted.

RECLASSIFICATIONS: Certain prior year amounts have been reclassified to conform with the presentation used in 1998.

The following is a summary of the Company's investments in marketable equity and debt securities:

Gross realized gains on sales of the Company's investments totaled $702, $118 and $516 in 1998, 1997 and 1996, respectively, and gross realized losses totaled $1,145, $750 and $589 in 1998, 1997 and 1996, respectively. At December 31, 1998, approximately 80% of the Company's investments in debt securities mature within one year and substantially all of the remainder mature within two years.

Interest income, which is included in other income, totaled $16,501 in 1998, $14,963 in 1997 and $13,339 in 1996.

Inventories are summarized as follows:

Inventories at December 31, 1998 reflect a step-up of $213,155 to fair value in connection with the acquisition of Howmedica (see Note 4).

On December 4, 1998, the Company acquired Howmedica, the orthopaedic division of Pfizer Inc., for $1,650,000 in cash. Howmedica develops, manufactures and markets a wide range of specialty medical products utilized in the treatment of musculoskeletal disorders. Howmedica products include hip and knee implants for primary and revision surgery, bone cement, trauma systems used in bone repair, craniomaxillofacial fixation devices and specialty surgical equipment used in neurosurgery. The acquisition was funded with cash and cash equivalents and approximately $1,500,000 borrowed under $1,650,000 of credit facilities established in December 1998 (see Note 7).

The acquisition of Howmedica was accounted for using the purchase method of accounting. The results of operations for Howmedica are included in the Company's consolidated financial statements beginning December 5, 1998. The purchase price of $1,650,000 in cash plus an estimate for a contractually required adjustment based on the increase in Howmedica's working capital since December 31, 1997, and liabilities assumed has been preliminarily allocated to the assets acquired based on their estimated fair values at the date of acquisition.

Based on the preliminary purchase price allocation, goodwill of $437,000 was recorded by the Company in connection with the acquisition. Goodwill represents the excess of the purchase price and purchase liabilities over the fair value of net identifiable tangible and intangible assets acquired. Approximately $492,500 of the purchase price was allocated to identifiable intangible assets, including purchased research and development of $78,400, developed technology of $194,000, customer base of $178,900 and trademarks and assembled work force of $41,200. The purchased research and development was charged to operations during the fourth quarter as required by generally accepted accounting principles.

The purchased research and development of $78,400 for the Howmedica acquisition was determined based on an independent valuation of Howmedica's research and development projects using information and assumptions provided by management. Among the in-process projects included in the valuation, two are considered significant. These projects relate to the development of a new spinal technology to be used in the treatment of spinal disorders and the development of an improved polyethylene to be used in hip and knee implants. The estimated future revenues associated with the spinal project were deemed to be approximately 80% attributable to in-process research and development based on technological progression towards completion. For the polyethylene project, future revenues were deemed to be approximately 75% attributable to in-process research and development based on the same criterion. The spinal project is expected to be completed in 2002 and the polyethylene project is expected to be completed in 1999. All of the purchased research and development projects were valued using an income approach utilizing the discounted cash flow method. Revenues were projected from the expected date of product introduction to 2009 with the terminal value included in the discounted cash flow valuation. The spinal project is considered to have greater revenue potential with higher market risk and was valued using a 30% discount rate. The polyethylene project was valued using a 20% discount rate. Margins estimated for the future products were based on the current spinal implant market for the spinal project and on the current margins for hip and knee implants for the polyethylene project. Estimated selling, royalty and other expenses related to the future products were based on Howmedica's historical levels of spending in these areas.

In connection with the preliminary purchase price allocation, Howmedica inventories were stepped-up $221,000 to fair value. This step-up will be charged off as additional nonrecurring cost of sales as the acquired inventory is sold. Fourth quarter cost of sales for 1998 was increased as a result of the step-up, reducing pretax earnings in the quarter by $7,845 ($5,178 net of tax).

Immediately after the acquisition was consummated, management of the Company began to implement an integration plan to combine Stryker and Howmedica. In conjunction with the integration plan, the Company recorded additional purchase liabilities of approximately $111,200 ($67,400 net of related tax benefit), which were included in the acquisition cost allocation. The Company also incurred $32,994 in costs and charges related to the acquisition that were charged to operations during the fourth quarter of 1998 (see Note 5).

The additional purchase liabilities recorded at the date of acquisition reflect estimated liabilities relating to anticipated integration activities and will be adjusted as the restructuring is implemented during 1999. The increases or decreases in these additional purchase liabilities will result in corresponding changes to goodwill associated with the acquisition of Howmedica.

The additional purchase liabilities include approximately $70,400 for severance and related costs for Howmedica employees, approximately $27,800 for the cost to convert Howmedica's distribution network to direct sales and approximately $13,000 for the cost associated with Howmedica facility closures and contractual obligations. The severance and related costs are provided for planned workforce reductions covering approximately 1,300 Howmedica employees in the areas of general management, marketing, research and development, general administration and product manufacturing. The cost of the distributor conversions is based on negotiated contracts. The Howmedica facilities to be closed for which accrual is made include two facilities in Europe--a leased facility used for centralized administrative functions such as finance, accounting and information systems and a leased facility used for centralized warehousing and distribution in Europe and certain other regions. The facilities to be closed also include certain facilities in the United States--a leased facility supporting administration, warehousing and distribution for Howmedica's craniomaxillofacial business in the United States and leased facilities supporting administration, marketing, research and development and a portion of the United States warehousing and distribution for Howmedica's orthopaedic implant business. The contractual obligations represent noncancelable commitments for third party research and development related to projects which were not continued after the acquisition and purchase commitments for inventory related to discontinued Howmedica products. At December 31, 1998, the additional purchase liabilities had been reduced through payments of approximately $68,800 for severance and related costs, $27,800 for distributor conversions and $12,800 for facility closures and contractual obligations. These purchase liabilities remained on the balance sheet at December 31, 1998 along with an estimate for the additional amount to be paid as a result of the working capital adjustment to the purchase price.

The following unaudited pro forma financial information presents the combined results of operations of Stryker and Howmedica as if the acquisition had occurred as of January 1, 1997, after giving effect to certain adjustments, including amortization of goodwill and intangible assets, increased interest expense on debt related to the acquisition, reduced interest income from cash utilized to complete the acquisition and the related tax effects. The pro forma financial information does not necessarily reflect the results of operations that would have occurred had Stryker and Howmedica operated as a combined entity during such periods.

The pro forma financial information presented above does not include nonrecurring charges for purchased research and development, the sale of inventory stepped-up to fair value at the date of acquisition and integration activities. These items are included in the actual results of operations for 1998. The pro forma financial information includes pretax costs of approximately $31,700 for 1998 and $27,000 for 1997, representing an allocation of certain Pfizer corporate and division overhead costs to Howmedica.

In November 1998, the Company purchased the manufacturing rights, facilities and product on-hand for its OP-1 bone growth device from Creative BioMolecules, Inc., for approximately $19,300 in cash. In addition, the purchase agreement provides for increases in royalty payments associated with potential future OP-1 sales. The acquisition was accounted for using the purchase method. In connection with the acquisition, $4,896 of the purchase price paid for tangible research and development assets that have no alternative future use was allocated to purchased research and development and charged to operations during the fourth quarter of 1998.

During 1998, the Company's Osteonics Corp. subsidiary purchased four of its independent distributors at a cost of approximately $19,700. The entire purchase price was allocated to tangible assets acquired.

During 1998 and 1997, the Company acquired additional shares of outstanding common stock of Matsumoto Medical Instruments, Inc., its Japanese distributor, thereby increasing its direct ownership to 83% at December 31, 1998 (75% at December 31, 1997). During 1998, additional shares were acquired for cash of $3,349 and 75 shares of Stryker common stock ($3,792 value). During 1997, additional shares of Matsumoto were purchased for cash of $28,636. Each acquisition of additional shares was accounted for using the purchase method. Subsequent to December 31, 1998, the Company acquired all of the remaining outstanding common stock of Matsumoto, increasing its direct ownership to 100%. The acquisition of these additional shares occurred in January 1999 for cash of $1,009 and 181 shares of Stryker common stock ($9,682 value).

The Company's Physiotherapy Associates, Inc. subsidiary has purchased a number of physical therapy clinic operations. The aggregate purchase price of these clinics in 1998, 1997 and 1996 was approximately $2,600, $5,600 and $8,600, respectively. Intangible assets acquired, principally employment contracts and goodwill, are being amortized over periods ranging from one to 15 years.

In September 1996, the Company purchased 100% of the outstanding stock of Osteo Holding AG and its subsidiaries ("Osteo"), based in Selzach, Switzerland. Osteo designs and manufactures trauma products and reconstructive orthopaedic devices. The purchase price of $45,500 was paid $41,500 in cash with the remaining amount being paid ratably over a five-year period. The acquisition was accounted for using the purchase method. The results of operations for Osteo are included in the Company's consolidated financial statements beginning in September 1996. Of the excess purchase price over fair value of the net tangible assets acquired, $7,500 million was allocated to purchased research and development and was charged to operations upon the completion of the valuation. The remaining excess purchase price of $27,600 was allocated to intangibles to be amortized over 15 years.

For all of the above acquisitions other than that of Howmedica, pro forma consolidated results would not differ significantly from reported results.

In the fourth quarters of 1998 and 1996, the Company recorded acquisition-related and special pretax charges consisting of the following items:

The 1998 acquisition-related charges have been restated to reflect a reduction of those charges by $30,950. The restatement results from discussions with the Securities and Exchange Commission related to the Company's accounting for the acquisition of Howmedica. The acquisition-related charges had previously included $30,950 in reserves for the conversion of certain foreign distributors to direct sales where contractual terms had not been reached as of December 31, 1998. The Company has reversed this reserve and restated its previously reported Consolidated Statements of Earnings and Consolidated Balance Sheets as follows:

The 1998 acquisition-related charges include $21,801 for the reorganization of Stryker's distribution channels to accommodate the integration of the Howmedica sales force. The reorganization of Stryker's distribution channels encompasses the conversion of all remaining Osteonics distributors in the U.S. and certain distributors in Europe to direct sales in the form of branches or agents. These conversions provide the Company greater control over its distribution channels and facilitate the integration with the Howmedica organization. The Company believes this action will improve its ability to manage the sales and marketing of competing Stryker and Howmedica branded products within individual markets. The cost of the conversions is based on contractual terms. The $21,801 charge included $14,002 related to the buyback of inventory from U.S. distributors being converted to direct sales. The inventory was repurchased at its original selling price of $17,127 and was returned to inventory at its manufactured cost of $3,125, resulting in the reversal of gross profit on the original sale totaling $14,002. The 1998 expensed transaction costs represent costs associated with the acquisitions of Howmedica and of the manufacturing rights, facilities and product on-hand for the Company's OP-1 bone growth device (see Note 4.)

In conjunction with the completion of its integration plan, the Company expects that certain additional distributor conversions will be completed through negotiation of contractual terms during 1999, which will result in additional a cquisition-related charges totaling $4,000 to $5,000. The Company also anticipated converting one additional foreign distributor to direct sales at a potential cost of $30,000. However, as of January 27, 2000 (the date the 1998 financial statement restatement was announced), the Company no longer expects to negotiate termination of that distributor agreement. This decision was made as a result of changes in the Company's management in late 1999 and consequent changes in the integration plan with respect to that distributor.

At December 31, 1998, $15,156 of the charges incurred during 1998 were included in acquisition-related reorganization reserves and liabilities, consisting primarily of accruals related to the reorganization of distribution channels that have not yet been completed. All actions are expected to be completed by the end of 2000.

The 1996 special charge for the reorganization of distribution channels related to the implementation of a plan to convert a portion of the Company's distributors to direct sales. The cost of the conversions was based on contractual terms. The charge for asset impairments included $9,678 for property, plant and equipment write-downs and goodwill impairments of $3,900. Both the property and goodwill were written down to fair value. The charge for patent claims was related to patent disputes on certain products. At December 31, 1998, $2,700 related to the 1996 charges was included in other accrued liabilities. The remaining accrual is related to the reorganization of distribution channels that have not yet been completed. The delay in the use of this reserve occurred because the distributor is located in a country where Howmedica has a direct sales operation. The Company has not yet been able to complete the purchase of the Howmedica assets in this country because of the lengthy regulatory approval process there. Regulatory approval is anticipated in late 2000 and the Company anticipates the distributor conversion will take place during 2001.

In September 1996, the United States Court of Appeals for the Federal Circuit affirmed the 1995 decision of the Federal District Court for the Eastern District of New York awarding the Company damages, attorneys' fees and interest for infringement of the Company's U.S. patent on its Omniflex Hip System. A petition for rehearing or rehearing en banc was denied by the Federal Circuit Court in December 1996, and the Company was paid $77,600. The Company recognized a pretax gain, net of related legal fees and other expenses, of $61,094, which was included in operating income in 1996.

Long-term debt is as follows:

In December 1998, the Company entered into $1,650,000 of Senior Secured Credit Facilities in conjunction with the acquisition of Howmedica (see Note 4). The facilities provide for $1,150,000 in term loans, a six-year $250,000 U.S. revolving credit facility and a six-year $250,000 reducing multi-currency facility.

The term loans consist of three tranches. Tranche A provides for a six-year $575,000 term loan, Tranche B a seven-year $290,000 term loan and Tranche C an eight-year $285,000 term loan. The term loans bear interest at a base rate, as defined, plus an applicable margin ranging from 1.75% to 3.75%, depending on the leverage ratio of the Company. The six-year $250,000 U.S. revolving credit facility bears interest at a base rate, as defined, plus an applicable margin ranging from 1.75% to 2.75%, depending on the leverage ratio of the Company. The six-year, $250,000 reducing multi-currency facility provides borrowings in yen, euro, U.S. dollars and other negotiated currencies. Multi-currency borrowings bear interest at a base rate, as defined, plus an applicable margin ranging from 1.375% to 2.25% depending on the leverage ratio of the Company. At December 31, 1998, the Company had borrowed yen 11,900,000 and euro 107,100. The multi-currency borrowing acts as a hedge of the Company's investments in Japan and Europe. As a result, adjustments made to the loan balances to reflect applicable currency exchange rates at December 31 are included within accumulated other comprehensive gain (loss) in stockholders' equity. In addition, the revolving credit facility and the multi-currency facility each requires a commitment fee that ranges from 0.375% to 0.50% on the unused portion of the facility depending on the leverage ratio of the Company. At December 31, 1998, the weighted average interest rate for all borrowings under the Senior Secured Credit Facilities was 8.29%.

Effective in January 1999, the Company has fixed the base rate on an $800,000 notional amount of the U.S.-dollar-denominated borrowings at an average rate of 5.7% using interest rate swaps. The interest rate swaps mature over various terms ranging from September 2000 through December 2004.

Borrowings under the credit facilities are guaranteed by certain of the Company's subsidiaries and are fully secured by a substantial portion of the assets of the Company and such subsidiaries. The credit agreement requires the Company to comply with certain financial and other covenants and places certain limitations on the amount of increases in dividend payments. The Company must comply with the financial covenants beginning in 1999.

The unsecured bank loans represented two separate borrowings made to finance the acquisition of the Company's investment in Matsumoto Medical Instruments, Inc. Both loans were Japanese-yen-denominated, were unsecured and bore interest at rates ranging from 4.10% to 4.76%. Both loans matured in August 1998 and were repaid with a portion of the yen-denominated borrowings under the multi-currency facility.

Maturities of debt for the four years succeeding 1999 are: 2000 - $89,025; 2001 - $130,157; 2002 - $171,138; and 2003 - $212,283.

The carrying amounts of the Company's long-term debt approximate their fair values based on the Company's current borrowing rates for similar types of borrowing agreements and quoted market rates. The fair value of the Company's interest rate swap contracts at December 31, 1998 was ($17,679) and at December 31, 1997, approximated its carrying amount. Interest rate swap agreements are valued based on current termination values.

Interest expense on debt, which is included in other income and approximates interest paid, was $12,181 in 1998, $4,117 in 1997 and $4,349 in 1996.

On May 10, 1996, the Company effected a two-for-one stock split. All share and per share data have been adjusted to reflect the stock split as though it had occurred at the beginning of the earliest period presented.

The Company has key employee and director stock option plans under which options are granted at a price not less than fair market value at the date of grant. The options are granted for periods of up to 10 years and become exercisable in varying installments. A summary of stock option activity follows:

Shares reserved for future grants were 9,173 and 840 at December 31, 1998, and 1997, respectively. Exercise prices for options outstanding as of December 31, 1998, ranged from $7.32 to $44.625. A summary of shares exercisable follows:

The Company follows APB Opinion No. 25 in accounting for its stock option plans. Accordingly, no compensation cost has been recognized in the Consolidated Statements of Earnings for options issued under Company stock option plans. Had compensation cost for the Company's stock-based compensation plans been determined based on the fair value at the grant dates for awards under those plans consistent with the method of FASB Statement No. 123, "Accounting for Stock-Based Compensation", the Company's net earnings and earnings per share would have been as follows:

The weighted average per share fair value of options granted during 1998, 1997 and 1996 estimated on the date of grant using the Black-Scholes option pricing model was $15.74, $11.49 and $9.14, respectively. The fair value of options granted is estimated on the date of grant using the following assumptions:

The Company has 500 authorized shares of $1 par value preferred stock, none of which are outstanding.

The following table sets forth the computation of basic and diluted earnings per share:

                                                                                                              1998               1997                1996

Certain of the Company's subsidiaries have defined benefit plans covering some or all of their employees. Effective in 1998, the Company adopted FASB Statement No. 132, "Employer's Disclosures about Pensions and Other Post-Retirement Benefits", which revises the disclosure requirements related to defined benefit plans. A summary of the information required under the new Statement related to all of the Company's defined benefit plans is as follows:

At December 31, 1998, defined benefit plans with plan assets in excess of benefit obligations had plan assets totaling $23,077 and benefit obligations totaling $19,856, and defined benefit plans with benefit obligations in excess of plan assets had plan assets totaling $12,112 and benefit obligations totaling $14,292.

Retirement plan expense under the Company's profit sharing and defined contribution retirement plans totaled $14,332 in 1998, $11,248 in 1997 and $10,147 in 1996.

Earnings before income taxes consist of the following:

The components of the provision for income taxes follow:

Deferred income taxes reflect the net tax effects of temporary differences between the carrying amounts of assets and liabilities for financial reporting purposes and the amounts used for income tax purposes. The tax effect of significant temporary differences, which comprise the Company's deferred tax assets and liabilities, are as follows:

Deferred tax assets and liabilities are included in the consolidated balance sheets as follows:

No provision has been made for U.S. federal and state income taxes or foreign taxes that may result from future remittances of the undistributed earnings ($196,528 at December 31, 1998) of foreign subsidiaries because it is expected that such earnings will be reinvested overseas indefinitely. Determination of the amount of any unrecognized deferred income tax liability on these unremitted earnings is not practicable.

Total income taxes paid were $56,197 in 1998, $87,462 in 1997 and $62,330 in 1996.

Effective in the fourth quarter of 1998, the Company adopted FASB Statement No. 131, "Disclosures about Segments of an Enterprise and Related Information". Statement No. 131 establishes standards for the way that public business enterprises report information about operating segments in annual financial statements and requires that those enterprises report selected information about operating segments in interim financial reports. The Statement also establishes standards for related disclosures about products and services, geographic areas, and major customers. The adoption of Statement No. 131 does not affect the Company's results of operations or financial position, but does affect the disclosure of segment information.

Prior to 1998, the Company reported under one business segment. Upon the adoption of Statement No. 131, the Company segregated its operations into three reportable business segments: Orthopaedic Implants, Medical and Surgical Equipment and Physical Therapy Services. The Orthopaedic Implants segment sells orthopaedic reconstructive products such as hip, knee, shoulder and spinal implants and trauma related products. The Medical and Surgical Equipment segment sells powered surgical instruments, endoscopic systems, medical video imaging equipment and patient care and handling systems. The Physical Therapy Services segment provides outpatient physical and occupational rehabilitation services.

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

The accounting policies of the segments are the same as those described in the summary of significant accounting policies. The Company evaluates performance based on net earnings of each segment. Identifiable assets are those assets used exclusively in the operations of each business segment or that are allocated when used jointly. Corporate assets are principally cash and cash equivalents, short-term investments and property, plant and equipment.

Sales and other financial information by business segment follows:

The Company's area of operations outside of the United States, Japan and Europe principally includes the Pacific Rim, Canada, Latin America and the Middle East. Geographic information follows: