Edwards Lifesciences Corp. — Q3 2017 Form 10-Q
Reporting period: Quarter and nine months ended September 30, 2017. Edwards develops and sells medical technologies for structural heart disease and critical care. Its product groups are Transcatheter Heart Valve Therapy (THVT), Surgical Heart Valve Therapy (SHVT), and Critical Care.
Financial performance
| Metric | Q3 2017 | Q3 2016 | First nine months 2017 | First nine months 2016 |
|---|---|---|---|---|
| Net sales | $821.5 million | $739.4 million | $2,546.8 million | $2,196.0 million |
| Gross profit | $608.2 million | $538.0 million | $1,906.8 million | $1,611.8 million |
| Gross margin | 74.0% | 72.8% | 74.9% | 73.4% |
| Net income | $170.1 million | $141.4 million | $586.4 million | $411.0 million |
| Diluted EPS | $0.79 | $0.65 | $2.71 | $1.89 |
| Operating cash flow | Not provided for quarter | Not provided for quarter | $636.8 million | $503.3 million |
- Q3 sales grew 11.1% year over year; nine-month sales grew 16.0%. Q3 U.S. sales increased 12.8% and international sales 8.9%.
- THVT was the largest growth driver: Q3 sales rose 17.3% to $481.2 million; nine-month sales rose 26.0% to $1,507.9 million. SHVT and Critical Care Q3 sales grew 2.4% and 4.5%, respectively.
- Management attributed improved gross margin primarily to product mix favoring THVT. Higher sales drove income growth, partly offset by a second-quarter investment impairment.
- Nine-month cash flow from operations increased $133.5 million, reflecting stronger operating performance, partly offset by greater working-capital needs and tax-payment timing. Cash and cash equivalents declined $299.8 million to $630.3 million over the period.
Balance sheet and liquidity
- At September 30, cash and cash equivalents were $630.3 million; short-term investments were $772.5 million and long-term investments $567.5 million.
- Long-term debt was $1,034.0 million, versus $822.3 million at year-end 2016. This included $435.3 million outstanding under the credit agreement and $600 million of 2.875% senior notes due October 2018.
- Management said available cash, investments, credit facilities, and operating cash flow were sufficient for working capital, capital expenditures, and other commitments over the next 12 months. It noted that most cash and short-term investments were held outside the U.S.; permanent repatriation may face restrictions and taxes.
- Nine-month investing cash use was $696.5 million, primarily net investment purchases, Valtech acquisition costs, and $116.2 million in capital expenditures. Financing cash use was $244.2 million, mainly share repurchases, partly offset by net debt proceeds and employee stock-plan proceeds.
Material changes and unusual items
- Edwards acquired Valtech Cardio in January 2017. Consideration included approximately 2.8 million shares and $86.2 million cash; the acquisition-date fair value of contingent milestone payments was $162.9 million. Edwards also holds an option to acquire a related technology program for approximately $200 million, with a possible additional $50 million payment subject to regulatory approval.
- A $31.2 million second-quarter charge reflected impairment of an investment and related option asset after clinical results and the investee’s prospects did not support continued development.
- Q3 included a $10.2 million charge, primarily severance and related costs, for the planned closure of a Swiss manufacturing plant; 232 employees were affected. Remaining severance obligations were $9.6 million, expected to be substantially paid by September 30, 2018.
- Q3 included a $16.7 million gain from changes in fair value of contingent consideration liabilities; the nine-month gain was $12.5 million. A prior-acquisition liability was reduced by $19.9 million in Q3 following product-development delays.
- The company repurchased 5.3 million shares for $501.0 million during the first nine months and had $530.1 million of repurchase authorization remaining at quarter-end. It retired 33.6 million treasury shares in August, an equity-accounting action.
- Adoption of stock-compensation accounting guidance reduced the effective tax rate by 3.5 percentage points in Q3 and 6.6 points for the nine-month period. Effective tax rates were 19.7% and 17.5%, respectively.
Outlook, risks, and contingencies
- No numeric revenue or earnings guidance is provided in the filing. Management highlighted continued investment in product development; R&D was 15.9% of nine-month sales.
- Product developments included June FDA approval of SAPIEN 3 for certain aortic and mitral valve-in-valve procedures, July FDA approval of the INSPIRIS RESILIA aortic valve, and April FDA clearance of the HemoSphere monitoring platform.
- Patent disputes with Boston Scientific involve SAPIEN 3 and Lotus products. Courts issued adverse infringement rulings in Germany and the U.K.; appeals are pending. Potential injunctions and damages could materially affect financial position, results, or liquidity. The filing does not estimate the possible loss.
- Transfer-pricing matters remain significant and uncertain. An IRS agreement on certain transactions, including a roll-forward through 2020, remained subject to a bilateral agreement; related tax payments were anticipated within 12 months. A separate tax dispute was proceeding to regular appeals after Fast-Track Appeals did not resolve it.
- Other risks include foreign-exchange and investment exposure, contingent payments dependent on milestones, and development, clinical, and regulatory uncertainties for acquired technologies. Hurricane Maria flooding in Puerto Rico and the Swiss plant closure affected Q3 costs.
Investor verification priorities
- Verify the sources and sustainability of THVT-led growth, including the extent to which German inventory purchases pulled sales forward and subsequent inventory consumption.
- Assess the contribution of the stock-compensation tax benefit and contingent-consideration gain to reported earnings, and distinguish these from recurring operating performance.
- Review the SAPIEN 3 and Lotus patent litigation status, potential injunction exposure, and the company’s inability to estimate losses for unreserved legal matters.
- Track the 2018 senior-note maturity, credit-agreement borrowings, and the geographic availability and potential tax cost of overseas cash.
- Monitor Valtech development milestones, contingent consideration, the option to acquire the related program, and progress or impairment risk for acquired in-process R&D.