BOSTON SCIENTIFIC CORP quarterly report, Q1 FY2011

Boston Scientific Corporation — Q1 2011 Form 10-Q

Reporting period: Three months ended March 31, 2011. Boston Scientific develops and sells medical devices globally. Financial statements are unaudited and prepared under U.S. GAAP.

Financial results and liquidity

Metric	Q1 2011	Q1 2010 / comparison
Net sales	$1.925 billion	$1.960 billion; down 2% reported
Gross profit / margin	$1.294 billion / 67.2%	$1.297 billion / 66.2%
Operating income (loss)	$322 million	$(1.486) billion
Net income (loss)	$46 million; $0.03 diluted EPS	$(1.589) billion; $(1.05) diluted EPS
Adjusted net income (non-GAAP)	$336 million; $0.22 per share	$251 million; $0.16 per share
Cash from operations	$(97) million	$(284) million
Cash and cash equivalents	$595 million at March 31	$213 million at December 31, 2010
Total debt	$4.924 billion at March 31	$5.438 billion at December 31, 2010

Q1 investing activities provided $968 million, mainly from the Neurovascular sale, while financing activities used $491 million, including $500 million of debt repayments. Capital expenditures were $69 million. The company prepaid a further $250 million of term debt in April, reporting gross debt of $4.674 billion as of April 30. At March 31, it had no borrowings under its $2.0 billion revolving credit facility and was compliant with debt covenants; leverage was 1.7x against a 3.85x maximum, and interest coverage was 7.8x against a 3.0x minimum.

Material changes and business drivers

• Excluding currency effects and divested-business sales, revenue declined 1%; currency contributed $33 million to reported Q1 sales. The Neurovascular business contributed $34 million in Q1 2011 versus $89 million in Q1 2010.
• Revenue growth was led by Endoscopy (+10% reported), Neuromodulation (+14%), and CRM (+4%). Interventional Cardiology declined 8% and coronary stent sales fell 8% reported (10% excluding currency).
• Gross margin improved by 1.0 percentage point, principally due to a $50 million retroactive PROMUS supply-price credit from Abbott. The filing says the credit is nonrecurring; stent pricing and sales mix and the Neurovascular transition offset some of the benefit.
• SG&A fell 5% to $596 million, including a $20 million reversal of Greek receivables allowances. R&D declined 16% to $212 million, partly due to the divestiture, project reprioritization, and delayed trials; management expected R&D spending to rise over the rest of 2011.
• Boston Scientific sold Neurovascular to Stryker for a stated $1.5 billion cash purchase price and recorded a $760 million pretax gain ($530 million after tax). It received $1.450 billion at closing; $24 million was in escrow and up to $50 million remained contingent on facility transfers. The company expects lower Neurovascular sales and margins under transition supply arrangements.
• Q1 acquisitions included Sadra Medical, Intelect Medical, ReVascular Therapeutics, and Atritech. Aggregate preliminary purchase price was $715 million, including $287 million fair value of contingent consideration. Acquired in-process R&D was valued at $533 million; estimated completion costs were $150–$200 million, with material inflows expected from 2014–2016.

Outlook, risks, contingencies, and unusual items

• A $697 million nondeductible goodwill impairment was recorded for U.S. CRM after a lower estimated market outlook; the amount was an estimate pending finalization in Q2. Management anticipated mid-single-digit negative U.S. CRM market growth in 2011 and reduced modeled longer-term sales growth assumptions. The remaining U.S. CRM goodwill was $782 million, and management warned of possible further impairment.
• Four reporting units were identified as at higher risk of future goodwill impairment: U.S. CRM, U.S. Cardiovascular, U.S. Neuromodulation, and EMEA. Their allocated goodwill totaled approximately $8 billion; modest adverse changes in assumptions could trigger further testing or charges.
• Management expected launches of next-generation U.S. CRM defibrillators and pacemakers in late 2011 or early 2012, and expected U.S. and Japan launches of PROMUS Element in mid-2012. These plans depend on regulatory timing, product performance, and supply; U.S. and Japan PROMUS supply remained dependent on Abbott through June 2012.
• Restructuring and related costs were $50 million in Q1. The 2010 restructuring plan was expected to cost $180–$200 million, generate about $250 million in gross annual expense reductions when complete in 2012, and eliminate approximately 1,000–1,300 positions. Plant optimization costs were estimated at $130–$145 million; expected annual manufacturing savings exiting 2012 were reduced to $50–$55 million following the divestiture.
• Legal accruals were $285 million at March 31, down from $588 million at year-end, primarily after a $296 million DOJ payment. The company is substantially self-insured for product liability and IP infringement and warns that legal outcomes could materially affect results, cash flows, liquidity, or covenant compliance.
• The IRS asserted $525 million plus interest for Guidant 2001–2003 transfer-pricing adjustments; the company contested the notices in Tax Court. Further proposed adjustments for later tax years were expected. Management considered reserves adequate but acknowledged resolution could materially affect results or financial condition.
• The reported tax rate was 83.2%, affected by the divestiture gain, nondeductible impairment, other charges and credits, and discrete tax items. The quarter also included a $38 million gain on remeasurement of prior acquisition investments and $14 million of losses on other investments.
• Japan’s earthquake, tsunami, and related infrastructure and power disruptions had not significantly affected Q1 results, but could affect future operations. Other material risks include competitive pricing, product actions, regulatory or reimbursement changes, clinical trial results, supplier reliability, and intellectual-property litigation.

Important facts for investors to verify

• Whether CRM market conditions and product launches develop in line with management’s assumptions, and whether further goodwill impairment is required.
• The sustainability of Q1 margin and adjusted earnings, particularly the one-time $50 million Abbott pricing credit and the non-GAAP exclusions.
• Cash generation after Q1, planned debt repayments, and compliance with the tighter leverage covenant and other financing terms.
• Final proceeds and transition costs from the Neurovascular divestiture, including escrow release and the contingent $50 million payment.
• Developments in IRS transfer-pricing disputes, significant litigation, and other contingencies that could affect cash flow or reserves.