BSX

Business Context and Reporting Period

This Form 10-Q covers the quarterly period ended September 30, 1998, for Boston Scientific Corporation, a Delaware corporation. The reporting period is significantly impacted by the consummation of the acquisition of Schneider Worldwide on September 10, 1998, for approximately $2.1 billion in cash. The financial statements include Schneider's operating results from the date of acquisition through September 30, 1998.

Key Financial Metrics

Note: The significant net loss is driven by non-cash charges related to the acquisition and specific operational adjustments.

Material Changes vs. Prior Period

• Revenue Growth: Net sales increased 21% in the quarter and 12% for the nine-month period compared to 1997. Excluding foreign exchange impacts, sales growth was approximately 25% (quarter) and 16% (nine months).
• Acquisition Impact: The $2.1 billion cash acquisition of Schneider resulted in a $671 million charge for purchased research and development (R&D) and significant increases in intangible assets and debt.
• Japan Irregularities: The Company recorded a $79 million special charge related to business irregularities in its Japanese subsidiary, involving improperly recorded sales to dealers.
• Product Recall: A provision of approximately $31 million was recorded for the voluntary recall of the NIR ON Ranger with Sox coronary stent system in the U.S.
• Debt Structure: To finance the Schneider acquisition, the Company issued approximately $2.1 billion in commercial paper, causing total current borrowings to rise from $447 million to $2.08 billion.
• Margin Compression: Gross margin decreased from 71.4% to 65.2% in the quarter due to the recall provision, higher manufacturing costs, and inventory write-downs.

Guidance, Outlook, and Risks

• Outlook: Management expects gross margins to remain negatively impacted by high manufacturing costs in the coming quarters. Amortization expense related to the Schneider acquisition is projected to be $60-$65 million in 1999.
• Liquidity Strategy: The Company intends to refinance a portion of its $2.1 billion commercial paper through the issuance of convertible and equity securities (up to $1.2 billion registered). It maintains $2.2 billion in total revolving credit facilities.
• Integration: Integration plans for Schneider are expected to be finalized by the third quarter of 1999. Estimated remaining cash outlays for integration are approximately $197 million.
• Key Risks:
  • Legal Proceedings: Extensive patent litigation involving competitors (Advanced Cardiovascular Systems, C.R. Bard, Cordis, Johnson & Johnson) and a putative stockholder class action regarding the Japan irregularities.
  • Japan Investigation: Ongoing investigation into the scope of the Japanese subsidiary irregularities; management currently believes the impact is not material to previously issued statements.
  • Market Conditions: Pressure on healthcare costs, managed care trends, and foreign exchange fluctuations (specifically the strengthening U.S. dollar vs. Japanese yen).
  • Year 2000 Compliance: Over $100 million has been spent on Y2K compliance; risks remain regarding third-party service providers.

Investor Verification Checklist

• Japan Irregularities: Verify the final outcome of the investigation into the Japanese subsidiary's sales recording and the potential for additional charges.
• Debt Refinancing: Monitor the Company's ability to refinance the $2.1 billion commercial paper into permanent capital (equity/convertibles) to reduce interest expense and meet debt covenants.
• Stent Recall Costs: Track the actual costs associated with the NIR stent recall and the impact on future sales of that product line.
• Patent Litigation: Review the status of major patent disputes (particularly with ACS, Cordis, and J&J) which could result in injunctions or significant damages.
• Integration Synergies: Assess whether the Schneider acquisition delivers projected revenue growth and cost synergies to offset the $671 million R&D charge and integration costs.