Business context and reporting period
Boston Scientific Corporation develops, manufactures and markets medical devices across cardiovascular, rhythm management and MedSurg businesses. This unaudited Form 10-Q covers the quarter and nine months ended September 30, 2013. The company reorganized into global business units effective January 1, 2013 and recast prior-period segment data.
Financial performance and liquidity
- Revenue: Third-quarter net sales were $1.735 billion, flat year over year; excluding currency effects and divested businesses, sales increased 4%. Nine-month sales were $5.305 billion, down 2% reported, but approximately flat excluding currency effects and divested businesses.
- Segment trends: Third-quarter MedSurg sales increased 12% on a constant-currency basis, led by Neuromodulation (+32%), Endoscopy (+8%) and Urology/Women’s Health (+8%). Cardiovascular increased 1%; Rhythm Management increased 1%. Interventional Cardiology declined 2%, including lower coronary-stent sales.
- Profit and margins: Third-quarter gross profit was $1.225 billion and gross margin was 70.6%, up from 67.8%. GAAP operating income was $103 million versus a $594 million loss; GAAP net loss was $5 million versus $664 million. Management-reported adjusted net income, a non-GAAP measure, was $230 million ($0.17 per share), versus $221 million ($0.16). For the first nine months, GAAP net loss was $229 million, while adjusted net income was $701 million ($0.51 per share). Nine-month gross margin was 69.5%, up from 67.5%.
- Cash flow: Operating cash flow was $809 million for the first nine months, down from $891 million. Investing activities used $112 million and financing activities used $333 million; cash increased $364 million to $571 million.
- Balance sheet and liquidity: At September 30, cash was $571 million, current assets $3.525 billion, current liabilities $1.902 billion and working capital $1.623 billion. Total debt was $4.249 billion. The company reported no borrowings on its $2.0 billion revolving credit facility and remained in compliance with its debt covenants.
- Margins and expenses: Cost reductions and lower-margin divested-business sales supported gross-margin improvement; pricing pressure, particularly in drug-eluting stents and CRM products, was a partial offset. Third-quarter SG&A rose 12% to $658 million, including investment in acquisitions and emerging markets and $18 million of medical-device excise tax expense.
Material changes versus the prior comparable period
- Reported third-quarter earnings improved substantially from 2012, when a $748 million goodwill impairment drove the loss; nine-month 2012 results also included $4.350 billion of goodwill impairment charges. The 2013 nine-month GAAP loss primarily reflects a $423 million goodwill impairment recorded in the first quarter following the reporting-unit reorganization.
- Third-quarter gross margin rose 2.8 percentage points year over year, with manufacturing cost reductions the largest stated driver. Sales pricing reduced margin by 0.9 percentage points.
- Third-quarter interest expense increased to $137 million from $65 million, primarily due to a one-time $70 million debt-extinguishment charge. The company issued $1.050 billion of new senior notes and borrowed $400 million under a term loan, then prepaid $1.450 billion of notes due in 2014 and 2015.
- Nine-month operating cash flow declined $82 million year over year, primarily because of increased working capital, partly offset by specified receipts. Share repurchases were $275 million in the first nine months, versus $500 million in 2012.
Outlook, management commentary, risks and unusual items
- Outlook and initiatives: The filing provides no specific full-year 2013 revenue or earnings guidance. A restructuring plan approved October 22, 2013 is expected to be substantially completed by the end of 2015, incur $175 million–$225 million of pre-tax charges, and reduce annual pre-tax operating expenses by approximately $150 million–$200 million exiting 2015; management expects to reinvest a substantial portion of savings in growth initiatives.
- Products and growth: Management cited growth opportunities in emerging markets and product launches. The S-ICD remained supply-constrained, although a controlled launch resumed late in the third quarter. The company expected U.S. launches or approvals for products including Promus PREMIER and WATCHMAN in 2013–2014, subject to regulatory timing. On November 1, 2013, after quarter-end, it completed the $275 million cash acquisition of C.R. Bard’s electrophysiology business.
- Impairment sensitivity: Management identified Neuromodulation goodwill of $1.356 billion as more exposed to a future impairment test; its estimated fair-value cushion was about 16%. CRM-related amortizable intangibles of $4.442 billion were also described as sensitive to future business performance and cash-flow assumptions.
- Legal and tax exposure: Accrued legal reserves were $683 million, up from $491 million at year-end, following $206 million in nine-month litigation-related charges. The company reported more than 17,000 U.S. product-liability cases or claims, principally involving transvaginal surgical mesh. The IRS asserted $1.162 billion plus interest in disputed tax liabilities; the company contested the assessment and stated that resolution could nevertheless materially affect financial condition, results or cash flows. Gross unrecognized tax benefits were $1.080 billion.
- Other contingencies: Maximum undiscounted future contingent acquisition consideration was approximately $2.179 billion. Net receivables more than 180 days past due in Italy, Spain, Portugal and Greece were $78 million. Management also cited competitive pricing, procedure volumes, reimbursement, regulatory approvals, product supply, foreign exchange, litigation and restructuring execution as risks.
Most important facts for investors to verify
- Whether underlying sales and margins continue to improve after separating currency effects, divestitures and non-GAAP adjustments.
- Progress in resolving S-ICD supply constraints and the timing, approval and commercial uptake of key product launches.
- Realization and cash cost of restructuring savings, including the new plan’s charges and reinvestment assumptions.
- Developments in mesh litigation, other legal matters and the IRS tax dispute, and any resulting changes in reserves or cash requirements.
- CRM and Neuromodulation performance and the assumptions supporting goodwill and intangible-asset recoverability.
- Debt covenant headroom, refinancing costs, working-capital trends and collection of overdue European receivables.
Adjusted earnings and constant-currency growth are non-GAAP measures; compare them with the reported GAAP results and the filing’s reconciliations.