BSX

Business Context and Reporting Period

Company: Boston Scientific Corporation
Filing Type: Form 10-Q (Quarterly Report)
Period Ended: September 30, 2003
Business Overview: A worldwide developer, manufacturer, and marketer of medical devices for less-invasive procedures, including interventional cardiology, neurovascular intervention, and endosurgery. The company is heavily focused on the transition from bare metal stents to drug-eluting stents, specifically its TAXUS system.

Key Financial Metrics

Note: Debt figures include commercial paper ($654M), bank obligations ($9M), and long-term debt ($977M) as of Sept 30, 2003.

Material Changes vs. Prior Period

• Revenue Growth: Net sales increased 21% year-over-year for both the quarter and the nine-month period. Organic growth (excluding foreign currency) was 18% for the quarter and 16% for the nine months.
• Profitability Decline: Despite revenue growth, Net Income decreased 23% in Q3 ($124M vs $161M) due to special charges. However, for the nine-month period, Net Income increased 25% ($335M vs $268M).
• Margin Expansion: Gross margins improved to 72.3% from 70.8% (Q3) and 69.5% (9M), driven by a shift in product mix toward higher-margin coronary stents and operational cost improvements.
• Expense Increases: R&D expenses rose significantly (30% in Q3, 31% in 9M) due to clinical trials for the TAXUS stent. SG&A expenses increased due to foreign currency fluctuations and sales force expansion.
• Debt Levels: Total borrowings increased substantially to fund acquisitions, strategic alliances, and stock repurchases. Commercial paper outstanding rose from $88M to $654M.

Guidance, Outlook, and Risks

Management Commentary & Outlook

• TAXUS Stent Launch: The company anticipates launching its TAXUS drug-eluting stent in the U.S. in Q1 2004, pending FDA approval (panel review scheduled for Nov 20, 2003). Launch in Japan is expected mid-2005.
• Market Dynamics: U.S. bare metal stent sales are declining as physicians adopt competitor drug-eluting stents. The company expects this trend to continue until its own drug-eluting product is available in the U.S.
• Capital Allocation: The company plans to increase inventory levels in Q4 2003 to prepare for the U.S. launch. Capital expenditures are expected to be approximately $90M in Q4, including a $30M purchase of a manufacturing facility.
• Tax Rate: Management estimates the 2003 effective tax rate will remain at approximately 25%, down from 27% previously, due to geographic manufacturing changes.

Risks and Contingencies

• Litigation: Significant ongoing patent litigation with Johnson & Johnson (Cordis), Medinol Ltd., Guidant, and Medtronic. A $99M litigation credit in 2002 is not recurring. Current litigation accruals range from $18M to $21M.
• Regulatory: Success depends on FDA approval of the TAXUS PMA and favorable outcomes from manufacturing inspections.
• DOJ Investigation: The U.S. Department of Justice is investigating the 1998 recall of the NIR ON Ranger stent. The company and two senior officials are targets of the grand jury investigation.
• Contingent Consideration: The company has potential future acquisition-related payments of up to $520M contingent on performance milestones.

Investor Verification Checklist

• FDA Approval Status: Verify the outcome of the FDA special panel review for the TAXUS stent scheduled for November 20, 2003.
• U.S. Stent Market Share: Monitor the rate of decline in U.S. bare metal stent sales versus the adoption of competitor drug-eluting stents prior to the company's launch.
• Litigation Outcomes: Track developments in the Medinol (Germany/Netherlands) and Johnson & Johnson patent infringement cases, which could impact market access.
• DOJ Investigation: Monitor for any charges or settlements regarding the DOJ investigation into the 1998 stent recall.
• Inventory Build: Confirm the company's ability to manufacture and stockpile sufficient TAXUS inventory to meet demand upon U.S. launch without supply chain disruptions.