Boston Scientific Corporation — Q3 2018 Form 10-Q
Business context and period. Boston Scientific develops and sells medical devices across cardiovascular, digestive, respiratory, urological, pelvic-health and neurological markets. This unaudited report covers the quarter and nine months ended September 30, 2018; dollar amounts are in millions unless stated otherwise. Segment presentation was revised in 2018, moving Neuromodulation from MedSurg to Rhythm and Neuro, with prior-period segment figures recast.
Financial performance and liquidity
| Metric | Q3 2018 | Q3 2017 | Nine months 2018 | Nine months 2017 |
|---|---|---|---|---|
| Net sales | $2,393 | $2,222 | $7,262 | $6,640 |
| Gross profit | $1,720 | $1,585 | $5,179 | $4,721 |
| Operating income | $388 | $377 | $1,187 | $967 |
| Net income | $432 | $283 | $1,285 | $719 |
| Diluted EPS | $0.31 | $0.20 | $0.92 | $0.52 |
- Q3 sales increased 7.7% reported and 9.1% operationally, excluding currency effects. Nine-month sales increased 9.4% reported and 8.0% operationally.
- Gross margin was 71.9% in Q3, versus 71.3% a year earlier; nine-month gross margin was 71.3%, versus 71.1%. Q3 operating margin was approximately 16.2%, versus 17.0%; nine-month operating margin was approximately 16.3%, versus 14.6%.
- Management’s non-GAAP adjusted net income was $485 million, or $0.35 per diluted share, in Q3, compared with $432 million, or $0.31, in Q3 2017. For nine months, adjusted net income was $1.508 billion, or $1.08 per diluted share, versus $1.272 billion, or $0.91.
- Cash provided by operating activities was $291 million for the first nine months, down from $742 million in 2017; management attributed the decline primarily to the IRS tax settlement payment. Investing cash outflow was $1.326 billion, including $968 million for acquisitions, while financing provided $1.007 billion. The cash-flow statement provides nine-month, not standalone Q3, cash-flow figures.
- At September 30, cash and cash equivalents were $168 million; total debt was $6.626 billion, up from $5.616 billion at year-end 2017. Current assets were $3.971 billion and current liabilities $5.082 billion, with a reported working-capital deficit of $1.111 billion. Restricted cash and equivalents totaled $812 million and should not be treated as unrestricted operating cash.
- The $2.25 billion revolving facility had no borrowings; commercial paper outstanding was $816 million. The company reported covenant compliance and a 2.4x leverage ratio against a 3.5x maximum. Management said existing cash, operating cash generation, capital-market access and credit facilities should fund needs for the next 12 months.
Changes, business drivers and unusual items
- All reported business units grew operationally in Q3. Neuromodulation grew 23.5% operationally, MedSurg 11.7%, Rhythm and Neuro 8.3%, and Cardiovascular 7.7%. Management cited product launches and adoption; CRM growth was partly offset by modest pacemaker share loss, while Interventional Cardiology growth was partly offset by declining drug-eluting stent sales.
- Gross-margin improvement reflected manufacturing cost reductions and favorable other period expenses, partly offset by foreign exchange. R&D increased 14% in Q3 and 13% year to date, reflecting investment in the product pipeline. Nine-month SG&A was 36.0% of sales, down from 36.3%, although Q3 SG&A was 36.4%, up from 36.0%.
- Q3 included $142 million of gains, and the first nine months $182 million, from revaluing previously held interests in acquired companies. These gains contributed to “Other, net” and are excluded from management’s adjusted results. Q3 adjusted earnings also exclude amortization, acquisition-related items, restructuring, litigation and investment impairment items.
- The nine-month effective tax rate was negative 14.1%, including a $250 million net tax benefit tied to resolution of IRS disputes for 2001–2010. The settlement required a $303 million net tax payment plus $307 million estimated interest. The company expected to resolve its 2011–2013 IRS examination within six months and did not expect additional charges based on its recorded reserves.
- Acquisitions completed in 2018 included NxThera, Cryterion, Claret, nVision and VENITI. The Augmenix acquisition closed October 16, after quarter-end, for $500 million upfront and up to $100 million in revenue-based milestone payments. Preliminary 2018 acquisition accounting recorded $619 million of goodwill and $920 million of intangible assets. Maximum undiscounted future contingent consideration was approximately $780 million at quarter-end.
- The 2016 restructuring plan is estimated to cost $275–$325 million and generate $165–$175 million of annual gross expense reductions by the end of 2020, with a substantial portion of savings to be reinvested. Cumulative charges through September 30 were $199 million.
Outlook, risks and contingencies
- The filing provides no specific full-year 2018 revenue or earnings guidance. Management’s stated 12-month liquidity assessment is not a financial forecast.
- Legal accruals were $1.162 billion at September 30, down from $1.612 billion at year-end, primarily after authorized mesh-related settlement payments. Approximately 51,000 transvaginal surgical mesh cases or claims had been asserted; settlement agreements in principle or near completion covered approximately 49,500, of which about 30,000 were final. Management cautioned that additional losses may be accrued and that final outcomes remain uncertain.
- Other material legal matters include ongoing patent disputes involving Edwards and Nevro, and a Channel Medsystems claim alleging breach of a $275 million purchase agreement; Boston Scientific denies the claim and counterclaimed. Outcomes and loss ranges for certain matters are not estimable from the filing.
- Risks highlighted include product performance and regulatory approvals, reimbursement and pricing pressure, competition, foreign exchange, acquisition integration and milestone obligations, litigation and investigations, tax uncertainty, supply disruption, cybersecurity, and debt covenant or refinancing risks. The company reported no material subsequent events requiring financial-statement adjustment.
Important facts for investors to verify
- Underlying growth by product and geography, including the contribution of acquisitions and the distinction between reported and operational growth.
- Cash conversion and liquidity: why nine-month operating cash flow fell, the availability and restrictions on cash, and the ability to manage the working-capital deficit and near-term debt maturities.
- Durability of earnings excluding acquisition-related remeasurement gains, tax benefits, amortization and other adjustments; compare GAAP results with management’s non-GAAP measures.
- Future mesh litigation settlement costs, participation thresholds and payments, plus exposure from patent and contract disputes.
- Integration progress, contingent acquisition payments, and whether restructuring savings materialize while planned growth investment continues.