Business context and reporting period
Boston Scientific Corporation develops, manufactures and sells medical devices globally. This unaudited Form 10-Q covers the quarter and six months ended June 30, 2010; financial amounts below are in U.S. dollars, millions except per-share data. The filing identifies U.S. CRM defibrillator ship-hold and product-removal actions, announced March 15, 2010, as a major business event.
Financial performance and position
| Metric | Q2 2010 | Q2 2009 | Six months 2010 | Six months 2009 |
|---|---|---|---|---|
| Net sales | $1,928 | $2,074 | $3,888 | $4,084 |
| Gross profit | $1,274 | $1,444 | $2,572 | $2,847 |
| Gross margin | 66.1% | 69.6% | 66.2% | 69.7% |
| Operating income (loss) | $231 | $275 | $(1,255) | $287 |
| Net income (loss) | $98 | $158 | $(1,491) | $145 |
| Diluted earnings (loss) per share | $0.06 | $0.10 | $(0.98) | $0.10 |
| Cash from operating activities | Not separately provided for quarter | $2 | $680 |
- Q2 sales fell 7% year over year; first-half sales fell 5%. U.S. sales declined 10% in Q2 and 9% in the first half. First-half international sales rose 2% as reported, but declined 2% excluding foreign exchange.
- Q2 gross margin fell 3.5 percentage points. Management cited lower sales and pricing of higher-margin TAXUS stents, mix shift toward Abbott-supplied PROMUS stents, the CRM ship hold and foreign-exchange effects.
- The first-half GAAP loss included a $1.817 billion goodwill impairment charge and a $60 million intangible-asset impairment charge. Management’s non-GAAP net income was $190 million in Q2 2010 versus $297 million in Q2 2009, and $441 million for the first half versus $586 million. These are management-defined non-GAAP measures, not substitutes for GAAP results.
- At June 30, cash and equivalents were $811; current assets were $3,987 and current liabilities $3,723. Total debt was $6,033 and net debt $5,222, compared with $5,918 and $5,054, respectively, at year-end 2009. Current debt obligations rose to $850 from $3.
- First-half investing cash use was $138, including $131 of capital expenditures. Cash declined $53 to $811. The company attributed the sharp decline in operating cash flow mainly to the $1.0 billion Johnson & Johnson settlement payment, partly offset by Abbott’s $250 million milestone payment and improved working-capital management.
Material changes versus prior comparable period
- U.S. CRM sales were down $83 million, or 20%, in Q2; worldwide CRM sales were down $82 million, or 13%. The company estimated the ship hold reduced Q2 sales by $62 million and first-half sales by $134 million.
- Worldwide coronary stent sales fell to $422 million from $484 million in Q2. Drug-eluting stent market share was estimated at 38%, versus 42% a year earlier; U.S. share was approximately 46%, versus 50%. Competitive pressure and lower selling prices contributed.
- Endoscopy sales increased 8% in Q2 to $265 million; Urology/Women’s Health rose 4% to $120 million. Other businesses were mixed, including declines in Interventional Cardiology excluding stents and Neurovascular.
- SG&A and R&D expenses declined in dollars year over year, while royalty expense increased with the shift in stent mix. Q2 interest expense rose to $103 million from $92 million, mainly because of a $10 million write-off of the remaining discount on the repaid Abbott loan.
Outlook, management commentary, risks and unusual items
- Management estimated U.S. defibrillator market share exiting 2010 would be about 400 basis points below the 2009 exit level, and that CRM product actions would reduce 2010 U.S. CRM revenue by approximately $300 million. Recovery timing and extent were described as uncertain; management said sales and profitability would likely remain adversely affected.
- Management estimated the worldwide CRM market at about $11.3 billion for 2010, a slight increase from $11.1 billion in 2009, and the worldwide coronary stent market at about $5.0 billion, broadly flat. These are market estimates, not company revenue guidance.
- The company expected 2010 capital expenditures of approximately $350 million. Its 2010 restructuring plan was expected to cost $180–$200 million pre-tax, eliminate about 1,000–1,300 positions and be substantially complete by end-2011; management estimated gross annualized operating expense reductions of $200–$250 million once completed, with some savings reinvested. The plant optimization program was also expected to complete substantially by end-2011.
- In Q2 the company completed a $1.0 billion, three-year term loan and replaced its revolving facility with a $2.0 billion facility maturing in 2013, with extension options. It reported covenant compliance at June 30: leverage ratio 2.6x against a 3.85x maximum and interest coverage 5.7x against a 3.0x minimum. The leverage ceiling declines to 3.5x after March 31, 2011.
- Subsequent to quarter-end, in August 2010, the company paid the remaining $725 million Johnson & Johnson settlement obligation plus interest, cancelled the related letter of credit and reported restored access to its $2.0 billion revolver. This is a subsequent event, not a June 30 cash payment.
- Legal matters remain significant: probable and estimable legal accruals were $1.292 billion at June 30, down from $2.316 billion at year-end, primarily following settlement payments. The filing describes ongoing patent, product-liability, securities and governmental matters, including continuing J&J stent litigation and investigations relating to CRM products and business practices. Management cautioned that further losses may be accrued and could affect cash flow, results and covenant capacity.
- Other notable items include a $250 million Abbott milestone gain following Japanese approval of XIENCE V; a 2.3% U.S. medical-device excise tax scheduled to begin in 2013; and approximately $1.029 billion of gross unrecognized tax benefits. Management said up to about $363 million of gross unrecognized tax benefits could be resolved within 12 months, although timing and outcome are uncertain.
- Product and regulatory execution, physician confidence, competitive pricing, Abbott stent supply and lower margins on Abbott-supplied PROMUS, litigation outcomes, possible further impairment, tax matters, and restructuring execution are key risks. The filing states disclosure controls were effective and there were no material changes in internal control during the quarter.
Important facts for investors to verify
- Whether CRM physician confidence and U.S. market share recover, and whether the estimated $300 million 2010 U.S. CRM revenue impact changes.
- Cash generation after the August Johnson & Johnson payment, ongoing legal payments and planned capital expenditures; also confirm remaining debt maturities and covenant headroom.
- Stent sales mix, pricing, market share and Abbott supply performance, including the effect of lower-margin supplied PROMUS sales.
- Whether litigation, governmental investigations, tax disputes or product actions result in additional cash costs, reserves, restrictions or covenant pressure.
- Progress and realized savings from restructuring, and whether weaker CRM assumptions or other conditions lead to additional goodwill or intangible-asset impairment.