Boston Scientific Corporation — Form 10-Q, Third Quarter 2010
Reporting period: Quarter and nine months ended September 30, 2010. Amounts are in U.S. dollars; financial statement amounts are in millions except per-share data. Boston Scientific develops, manufactures and markets medical devices across multiple interventional specialties.
Financial performance and liquidity
| Metric | Q3 2010 | Q3 2009 | Nine months 2010 | Nine months 2009 |
|---|---|---|---|---|
| Net sales | $1,916 | $2,025 | $5,804 | $6,109 |
| Gross profit | $1,293 | $1,396 | $3,865 | $4,242 |
| Gross margin | 67.5% | 68.9% | 66.6% | 69.4% |
| Operating income (loss) | $251 | $51 | $(1,004) | $337 |
| Net income (loss) | $190 | $(94) | $(1,301) | $51 |
| Diluted EPS | $0.12 | $(0.06) | $(0.86) | $0.03 |
Q3 2010 GAAP results included $5 million of intangible-asset impairment charges, $18 million of restructuring and related costs, $129 million of amortization, and discrete tax items. Management reported non-GAAP net income of $296 million, or $0.19 per share, versus $291 million, or $0.19 per share, in Q3 2009. For the first nine months, non-GAAP net income was $737 million, or $0.48 per share, compared with $878 million, or $0.58 per share. These are management-defined non-GAAP measures and do not replace GAAP results.
- Sales and margins: Q3 sales fell 5% year over year; nine-month sales also fell 5% as reported (6% on a constant-currency basis). Lower CRM and coronary-stent sales were principal drivers. Gross-margin pressure reflected drug-eluting stent pricing and sales mix, including greater contribution from Abbott-supplied PROMUS stents, as well as the CRM product actions.
- Cash flow: Operating activities used $124 million in the first nine months of 2010, versus providing $1,164 million in 2009. The principal driver was the $1.725 billion Johnson & Johnson settlement payment, partly offset by a $250 million Abbott milestone receipt and improved working-capital management. Investing activities used $217 million; financing activities provided $101 million. Cash declined $240 million to $624 million.
- Debt and liquidity: Total debt was $6.037 billion and net debt was $5.413 billion at September 30, versus $5.918 billion and $5.054 billion, respectively, at year-end 2009. Cash was $624 million; the company also had access to a $2.0 billion revolving facility and a $350 million receivables-backed facility, with no borrowings outstanding on either at quarter-end. Current debt obligations were $904 million. The company reported covenant compliance: leverage ratio 2.6x against a 3.85x maximum; interest coverage 5.7x against a 3.0x minimum.
Material changes and business developments
- The March 2010 U.S. ICD and CRT-D ship hold and product removal reduced sales and market share. Distribution resumed in April for key products and in May for earlier-generation products. Management estimated a $162 million adverse sales impact for the first nine months and said recovery had been better than expected to date, while warning that sales and profitability would remain pressured. Q3 worldwide CRM sales declined 10%.
- A $1.817 billion goodwill impairment was recorded for the U.S. CRM reporting unit in 2010, driving the nine-month GAAP loss. The non-cash charge did not affect cash flow or debt-covenant compliance. The filing says the U.S. CRM unit’s carrying value continued to exceed its fair value after the charge and identifies other reporting units as having elevated future impairment risk.
- Worldwide coronary-stent sales fell 12% in Q3. Boston Scientific estimated its worldwide drug-eluting stent market share at 37%, down from 41% a year earlier; U.S. share was estimated at 45%, versus 49%. Competition and pricing pressure were significant factors.
- Growth in Q3 Endoscopy, Urology/Women’s Health, and Neuromodulation partly offset declines elsewhere. The company completed its approximately $900 million Abbott loan repayment and paid the remaining $725 million Johnson & Johnson settlement obligation in August.
Outlook, commentary, risks and unusual items
- The filing does not provide a clear consolidated revenue or earnings forecast. Management expected next-generation defibrillators to launch in the first half of 2011 and its U.S. next-generation pacemaker launch in late 2011 or early 2012, subject to FDA requirements. Management also expected future R&D spending to increase as portfolio priorities were reset.
- The 2010 restructuring plan was expected to cost $180–$200 million and eliminate about 1,000–1,300 positions by the end of 2011. Management estimated $200–$250 million of gross annualized pre-tax operating-expense reductions once completed, with some savings to be reinvested. The separate plant-network program was expected to produce about $65 million of annualized manufacturing-cost reductions exiting 2012.
- Management expected 2010 capital expenditures of about $300 million. A potential DOJ-related litigation payment of approximately $300 million could occur in Q4 2010. The company said it intended to use approximately half of anticipated net proceeds from the Neurovascular sale for future acquisitions and the remainder for debt prepayment.
- After quarter-end, the company agreed to sell Neurovascular to Stryker for $1.5 billion: $1.4 billion at closing and up to $100 million contingent on milestones. Closing was expected in Q4 2010 or Q1 2011, subject to conditions. It also completed the Asthmatx acquisition for about $194 million, with up to $250 million of contingent consideration.
- Key risks include continued CRM market-share and customer-confidence recovery, product reliability and regulatory actions, competitive pricing and clinical outcomes, dependence on Abbott for certain stent supply, patent and product-liability litigation, government investigations, tax disputes, foreign exchange exposure, and the ability to generate cash, manage debt and remain within covenants. The 2.3% U.S. medical-device excise tax was scheduled to begin in 2013.
- Legal accruals were $562 million at September 30, down from $2.316 billion at year-end 2009, principally following the Johnson & Johnson payment. Management cautioned that future litigation losses and cash payments could still materially affect results, cash flow and covenant compliance.
Most important facts for investors to verify
- Whether U.S. CRM sales, defibrillator market share and physician and patient confidence recover as management expects, and the continuing financial effect of the ship hold.
- Whether gross margins stabilize amid stent pricing pressure and the mix shift toward lower-margin Abbott-supplied PROMUS products.
- Whether operating cash flow returns to positive levels after settlement payments, and how the company funds near-term maturities and any further legal obligations.
- Progress on the Neurovascular sale, including closing proceeds and contingent consideration, and the use of proceeds for acquisitions versus debt reduction.
- Developments in litigation, regulatory investigations, the estimated DOJ payment, tax examinations and potential additional goodwill impairment.