BOSTON SCIENTIFIC CORP quarterly report, Q2 FY2016

Business context and reporting period

Boston Scientific Corporation is a global medical-device developer, manufacturer and marketer. This unaudited Form 10-Q covers the three and six months ended June 30, 2016; comparisons are with the corresponding 2015 periods. The 2015 acquisition of the AMS male urology portfolio materially expanded Urology and Pelvic Health sales.

Financial performance

Reported sales grew 15% in Q2 and 13% in the first half; excluding currency effects, growth was 16% and 15%, respectively. The Urology and Pelvic Health increase was substantially supported by the acquired AMS portfolio. Management reported adjusted net income of $373 million, or $0.27 per share, for Q2 and $751 million, or $0.55 per share, for the first half. These are non-GAAP measures that exclude specified items, including litigation charges, restructuring-related costs and amortization.

Gross margin was 70.0% in Q2 versus 70.7% a year earlier, and 70.4% for the first half versus 70.6%. Manufacturing cost reductions helped, but foreign currency and other period expense more than offset those benefits. Q2 interest expense was $59 million, down from $106 million; first-half interest expense was $118 million, down from $167 million.

Liquidity, debt and balance sheet

At June 30, 2016, cash and cash equivalents were $438 million, total debt was $5.427 billion, and working capital was $148 million. Total debt was down from $5.677 billion at December 31, 2015. Current debt was $254 million and long-term debt was $5.173 billion. The company had no borrowings outstanding under its $2.0 billion revolving facility and reported compliance with debt covenants; actual leverage and interest-coverage ratios were 2.6x and 8.8x, respectively, against requirements of no more than 4.5x and at least 3.0x.

First-half investing cash outflow was $150 million, primarily capital expenditure of $138 million, partly offset by $29 million of property-sale proceeds. Financing cash outflow was $268 million, including $250 million of long-term debt repayments. Operating cash flow improved by $674 million year over year, primarily because of litigation payments made in 2015 that did not recur in the first half of 2016. The company paid $366 million in July 2016 to satisfy the Mirowski judgment and interest, funded through cash, operating cash and its revolving facility.

Material changes and operating developments

• Growth was broad-based: Q2 constant-currency sales rose 13% in Cardiovascular, 5% in Rhythm Management and 29% in MedSurg. Urology and Pelvic Health rose 90% on a constant-currency basis, including approximately $102 million from the AMS acquisition.
• CRM sales growth reflected pacemaker strength, partly offset by lower defibrillator replacement volumes. Management cited longer device longevity and competition in high-voltage MRI technologies.
• The company began a new restructuring plan in Q2, expected to run through 2018. It estimates $175–$225 million in total pre-tax charges and $115–$150 million in gross annual expense reductions by the end of 2020, with some savings expected to be reinvested in growth.
• The 2014 restructuring plan was substantially complete, with remaining plant-network actions expected to finish by the end of 2016; the company estimated approximately $200 million of gross annual savings by then.
• The company acquired Cosman Medical on July 27, 2016, expanding its Neuromodulation portfolio. No material acquisitions closed in the first half.

Outlook, risks and unusual items

• No specific full-year revenue or earnings guidance is provided in the filing. Management said available cash, operating cash generation and financing access should be sufficient to fund operations, investment, legal liabilities and debt service for the next 12 months.
• Litigation-related charges were $618 million in Q2 and $628 million in the first half. Accrued legal liabilities totaled $2.375 billion at June 30, up from $1.936 billion at year-end. The company reported more than 39,000 mesh-related product-liability cases or claims as of August 1; settlements and further discussions remained subject to conditions and uncertain outcomes.
• The July 19 IRS settlement stipulation is contingent on further processes. If finalized, the company expects net tax payments of approximately $275 million plus interest, generally within 12–24 months. The IRS had asserted $1.162 billion plus interest in proposed tax liabilities for specified years; the company disputed the proposed methodology and stated its reserves were adequate.
• The Watchman FLX European initial market release was suspended after a higher-than-expected device-embolization rate; management said it would pursue design enhancements before returning a next-generation device to market.
• Other key risks include intellectual-property and product-liability litigation, regulatory and reimbursement changes, product performance and launch execution, foreign exchange exposure, international-market uncertainty and potential impairment of goodwill or intangible assets. The annual goodwill test found fair value above carrying value for all reporting units; future performance or market changes could alter that assessment.

Important facts for investors to verify

• Separate underlying operating growth from the contribution of the AMS acquisition and foreign-currency movements.
• Track cash payments, reserve adequacy and case developments in mesh and other litigation, including the effect of the July Mirowski payment.
• Confirm whether the IRS settlement conditions are met, and the timing and amount of tax payments.
• Assess execution and cash costs of the new restructuring plan against its projected savings and reinvestment commitments.
• Monitor debt reduction, covenant headroom, cash generation and liquidity after legal payments.
• Review product-launch and safety milestones, particularly Watchman FLX and the company’s new and next-generation devices.