Boston Scientific Corporation — Q2 2014 Form 10-Q
Reporting period: Three and six months ended June 30, 2014. Boston Scientific develops, manufactures, and markets medical devices across cardiovascular, rhythm management, and MedSurg businesses. Amounts below are in U.S. dollars; financial statement figures are in millions unless noted.
Financial results
| Metric | Q2 2014 | Q2 2013 | First half 2014 | First half 2013 |
|---|---|---|---|---|
| Net sales | $1,873 | $1,809 | $3,647 | $3,570 |
| Gross profit | $1,310 | $1,279 | $2,547 | $2,462 |
| Gross margin | 69.9% | 70.7% | 69.8% | 69.0% |
| Operating income (loss) | $(69) | $220 | $128 | $(109) |
| Net income (loss) | $4 | $130 | $137 | $(224) |
| Diluted EPS | $0.00 | $0.10 | $0.10 | $(0.17) |
| Operating cash flow | $286 | $396 | $483 | $584 |
- Q2 sales increased 4% as reported and 4% excluding currency and divested-business effects. First-half sales increased 2% as reported and 4% excluding those effects.
- Management reported adjusted net income of $285 million, or $0.21 per share, in Q2, versus $247 million, or $0.18 per share, a year earlier. First-half adjusted net income was $553 million, or $0.41 per share, versus $471 million, or $0.35 per share. These are non-GAAP measures and exclude specified impairment, acquisition/divestiture, restructuring, litigation, tax, and amortization items.
- Q2 reported results included $267 million of litigation-related charges, $110 million of intangible-asset impairment charges, and a $96 million benefit from changes in contingent-consideration fair value. The large unusual items materially affected GAAP operating results.
- Q2 gross margin declined 0.8 percentage point year over year, mainly reflecting pricing and product mix, partly offset by manufacturing cost reductions. First-half margin rose 0.8 point, helped by cost reductions and lower-margin divested-business sales rolling off.
- Q2 SG&A rose 12% to $743 million, reflecting acquisitions, product launches, commercial programs, and emerging-market investment; R&D fell 8% to $206 million, and royalty expense fell 47% to $25 million following a royalty-agreement renegotiation.
- By business, Q2 sales grew 2% in Cardiovascular, 8% in Rhythm Management, and 5% in MedSurg. Electrophysiology increased 55%, substantially reflecting the Bard EP acquisition. Neuromodulation grew 3%; management cited slower market growth amid changed Medicare reimbursement for physician-office stimulation trials.
Liquidity, debt, and capital resources
- At June 30, 2014, cash and equivalents were $357 million, current assets $3.214 billion, and current liabilities $1.773 billion; reported working capital was $1.441 billion.
- Total debt was $4.255 billion, including $3.8 billion of senior notes and a $400 million term loan. Cash less total debt was approximately $3.898 billion net debt.
- The company had no borrowings under its $2.0 billion revolving credit facility or $300 million receivables-backed facility. It reported compliance with debt covenants: leverage ratio 2.5x versus a 3.5x maximum, and interest coverage 5.7x versus a 3.0x minimum.
- First-half operating cash flow fell 17% to $483 million, attributed primarily to higher inventories and a prior-year litigation-related cash receipt; an $80 million Spanish government-funded receivables settlement partly offset the decline. Investing cash use was $189 million and financing cash use was $154 million.
- The company repurchased 10 million shares for $125 million in the first half and had approximately $535 million of authorization remaining. It held investment-grade ratings with all three major rating agencies.
Changes, outlook, and material risks
- Restructuring: The plan, expected to be substantially completed by the end of 2015, is estimated to cost $175–$225 million pre-tax, with $160–$210 million expected as cash outlays. Management targets $150–$200 million of gross annual pre-tax operating-expense reductions exiting 2015, with a substantial portion expected to be reinvested in growth initiatives.
- Acquisitions and launches: Boston Scientific completed its acquisition of IoGyn in May for net cash consideration of $65 million and expected to launch its FDA-approved Symphion system in the U.S. in the second half of 2014. It agreed to acquire Bayer AG’s Interventional Division for $415 million in cash, with closing expected in the second half of 2014, subject to customary conditions.
- Product and regulatory outlook: Following notice of another FDA advisory panel review, the company moved its WATCHMAN U.S. approval and launch goal to the first half of 2015. It expected a limited launch of its Rhythmia mapping system in the second half of 2014. These are expectations, not guarantees.
- Impairment exposure: Q2 included $110 million of intangible impairments, including $67 million related to Vessix hypertension technology and $35 million related to Atritech projects. Management identified CRM-related amortizable intangibles of $4.236 billion as more exposed to future impairment testing; Neuromodulation and Electrophysiology goodwill also had identified sensitivity to adverse assumptions. No reporting unit failed the 2014 annual goodwill test.
- Legal and regulatory contingencies: Accrued legal reserves were $826 million, up from $607 million at year-end, following $260 million of first-half litigation charges. More than 23,000 transvaginal mesh cases or claims were pending as of August 5, 2014; management said resolution remains uncertain and could materially affect results, liquidity, and financial condition. The company also disclosed a government subpoena concerning Cognis/Teligen devices and a physician education program, and a separate subpoena concerning BridgePoint products and activities; it said it was cooperating.
- Tax uncertainty: The IRS proposed significant transfer-pricing audit adjustments for 2008–2010 using methodologies also contested in Tax Court for 2001–2007. The company disagreed and considered reserves adequate, but stated final resolution could materially affect financial condition, results, or cash flows. Gross unrecognized tax benefits were $1.039 billion at June 30.
- Other risks: Management highlighted competitive pricing and reimbursement pressure, product performance and regulatory approval risks, international receivables collection, foreign-exchange exposure, integration and execution risks, and potential cybersecurity and data-security impacts. Net receivables over 180 days past due in Italy, Spain, Portugal, and Greece totaled $41 million.
Most important facts for investors to verify
- Whether underlying sales growth and profitability persist after separating segment performance from acquisitions, currency, pricing, and divestitures.
- How much of the gap between Q2 GAAP net income of $4 million and adjusted net income of $285 million reflects recurring versus unusual items, particularly litigation charges and contingent-consideration benefits.
- Cash conversion, inventory trends, and the funding needs for the Bayer acquisition, litigation payments, restructuring, and share repurchases.
- Developments in mesh litigation, legal reserves, government investigations, and IRS transfer-pricing disputes, including any resulting cash or covenant impact.
- Progress against restructuring savings and launch expectations, and whether CRM, Neuromodulation, or Electrophysiology performance changes trigger additional asset impairments.