Boston Scientific Corporation — Q2 2009 Form 10-Q
Reporting period: Three and six months ended June 30, 2009. Boston Scientific develops and sells medical devices globally. The unaudited interim statements are prepared under U.S. GAAP; management cautions that first-half results are not necessarily indicative of full-year results.
Financial performance
| Metric | Q2 2009 | Q2 2008 | Six months 2009 | Six months 2008 |
|---|---|---|---|---|
| Net sales | $2.074B | $2.024B | $4.084B | $4.071B |
| Gross profit | $1.444B | $1.420B | $2.847B | $2.886B |
| Gross margin | 69.6% | 70.2% | 69.7% | 70.9% |
| Operating income | $275M | $303M | $287M | $883M |
| Net income | $158M | $98M | $145M | $420M |
| Diluted EPS | $0.10 | $0.07 | $0.10 | $0.28 |
| Operating cash flow | — | $680M | $524M |
Q2 sales rose 2% as reported and 7% on a constant-currency basis excluding divested businesses. First-half sales were essentially flat as reported, but grew 4% on that constant-currency basis. Currency reduced reported sales by $83M in Q2 and $167M in the first half. Q2 net income improved year over year, while first-half net income fell substantially, reflecting litigation charges and the prior-year divestiture gain, among other items.
- Margins and expenses: Gross margin declined 0.6 percentage point in Q2 and 1.2 points in the first half. Management attributed the principal pressure to sales mix, especially greater PROMUS everolimus-stent sales, which carry materially lower margins than TAXUS; currency provided an offset. SG&A was $671M in Q2 and $1.321B for the half; R&D was $263M and $520M, respectively.
- Cash flow: First-half operating cash flow increased $156M year over year. The filing cites tax refunds versus prior-year tax payments and lower restructuring payments as drivers, partly offset by legal settlement payments and working-capital increases. Cash and equivalents were $1.194B, down from $1.641B at year-end; investing used $640M and financing used $487M.
- Debt and liquidity: Total debt was $6.250B, versus $6.745B at December 31, 2008; net debt was $5.056B versus $5.104B. Average debt interest rate was 5.51%. The company had $1.750B available under its amended revolving facility, subject to its terms, and no borrowings under a separate $350M receivables facility. It was compliant with covenants at June 30: leverage ratio 2.9x against a 4.0x maximum and interest coverage 5.2x against a 3.0x minimum. The leverage limit tightens to 3.5x on September 30.
- Liquidity demands: Management expected approximately $700M of litigation-related payments in the second half, against an accrued liability, partly offset by an expected $250M Abbott milestone payment in Q4 if XIENCE V receives Japanese approval. A $225M term-loan prepayment was made in July; management said the next maturity was $100M due in April 2010.
Material changes and business developments
- U.S. sales increased 10% in Q2; international sales declined 4% reported but increased 5% at constant currency. CRM sales grew 9% constant currency, with U.S. CRM up 11%; Neuromodulation grew 18% constant currency. Interventional Cardiology excluding stents and Neurovascular were weaker.
- Coronary stent sales increased to $484M from $440M in Q2. PROMUS represented 39% of drug-eluting stent sales in Q2 versus 6% a year earlier. Management estimated U.S. drug-eluting stent share at 50% and worldwide share at 42%.
- Restructuring continued. The 2007 plan is expected to cost $425M–$450M pre-tax, with completion expected in 2010. The new Plant Network Optimization plan is expected to cost $135M–$150M, with completion by the end of 2011; management projects annual manufacturing cost reductions of $65M–$80M in 2012 from this plan, in addition to $35M–$40M from the earlier plan.
- The company reported annualized R&D and SG&A reductions of about $500M exiting 2008 and continued to reinvest some savings, particularly in sales capacity. Planned 2009 capital expenditures were approximately $375M.
Outlook, risks, contingencies and unusual items
- No consolidated full-year revenue or earnings guidance is stated in the supplied filing text. Management described planned launches and market expectations, but highlighted execution, regulatory approval, reimbursement, competition, pricing and clinical-data uncertainties. Expected launches include PROMUS Element in EMEA and certain other markets in Q4 2009, and in the U.S. and Japan in mid-2012; timing is subject to approvals.
- Q2 included a $16M pre-tax loss for cancellation of an R&D program and a $10M intangible-asset impairment related to lower Urology product forecasts. First-half results included $287M of litigation-related charges, including a $237M Johnson & Johnson patent ruling accrual and a $50M Saffran settlement charge. First-half tax benefits included $87M of discrete items; the reported tax rate was negative 74.7%, making reported earnings sensitive to unusual tax items.
- Legal accruals were $1.267B at June 30, up from $1.089B at year-end. The company faces substantial patent litigation, particularly with Johnson & Johnson; management said the potential high end of one damages range could not be reasonably estimated. It warned that further accruals or adverse outcomes could affect results, cash flow, liquidity and covenant compliance.
- Product liability and securities claims, governmental investigations, and FDA compliance remain risks. The corporate FDA warning letter remained in place pending remediation of medical-device reporting issues, although the FDA had reported substantial quality-system compliance in October 2008. The company also disclosed a separate warning letter at an acquired sterilization facility.
- Everolimus-stent supply depends on Abbott. The filing warns that supply disruptions or contract price adjustments could affect sales and margins; the European supply agreement was nearing expiry and under review for possible extension. PROMUS supplied by Abbott has substantially lower operating margins than TAXUS.
- Gross unrecognized tax benefits were $1.082B, including $959M that would affect the effective tax rate if recognized. The company was contesting tax audit positions and said up to approximately $82M of unrecognized benefits might be resolved within 12 months. Proposed U.S. tax-law changes were identified as a potential future adverse factor.
- CEO James R. Tobin retired effective July 13, 2009, and J. Raymond Elliott became CEO. The company amended a receivables credit facility in August to extend its term by 364 days and increase certain fees.
Most important facts for investors to verify
- Whether underlying sales growth persists after separating currency impacts, divested-business comparisons and prior-year sales-return adjustments.
- Whether PROMUS mix and Abbott supply and pricing terms continue to pressure gross margins, and whether planned internally manufactured stent launches meet timing and approval targets.
- The final damages and cash-payment outcomes in Johnson & Johnson and other litigation, and their effect on liquidity and debt-covenant headroom.
- Whether the expected $250M Abbott milestone payment is received, and how second-half legal payments and capital spending affect cash and net debt.
- Progress on FDA remediation, restructuring execution and projected manufacturing savings, alongside the resolution of tax audits and unrecognized tax benefits.