Edwards Lifesciences Corporation — Q3 2014 Form 10-Q
Reporting period: Quarter and nine months ended September 30, 2014. Amounts are in U.S. dollars; financial statements are unaudited.
Business context and results
Edwards develops and sells products for structural heart disease and critical care, across Transcatheter Heart Valves, Surgical Heart Valve Therapy, and Critical Care. Management attributed sales growth primarily to transcatheter valve launches, including SAPIEN 3 in Europe and SAPIEN XT in the United States and Japan.
| Metric | Q3 2014 | Q3 2013 | Nine months 2014 | Nine months 2013 |
|---|---|---|---|---|
| Net sales | $607.4 million | $495.6 million | $1,704.9 million | $1,509.5 million |
| Gross margin | 72.3% | 74.1% | 72.7% | 75.3% |
| Net income | $94.6 million | $76.8 million | $701.9 million | $314.0 million |
| Diluted EPS | $0.87 | $0.68 | $6.49 | $2.74 |
| Operating cash flow | Not separately provided | Not separately provided | $929.1 million | $361.4 million |
Financial position and cash flow
- At September 30, cash and cash equivalents were $404.1 million; short-term investments were $1,111.0 million and long-term investments were $92.0 million. Cash plus short-term investments totaled $1,515.1 million.
- Long-term debt carrying value was $596.4 million, comprising 2.875% senior notes due October 2018. The company had no borrowings under its $750 million revolving credit facility and reported compliance with its covenants.
- Nine-month capital expenditures were $48.4 million. Investing cash outflow was $745.0 million, largely reflecting net purchases of investments. Financing cash outflow was $198.9 million, including $300.7 million of treasury-stock purchases.
- Operating cash flow benefited substantially from the Medtronic settlement receipt and a $201.8 million increase in accounts payable and accrued liabilities; it should not be viewed as solely recurring operating performance.
Changes, unusual items, and management commentary
- Q3 sales rose 22.6%; nine-month sales rose 12.9%. Q3 net income increased 23.2%. Nine-month net income more than doubled, primarily because of the Medtronic patent settlement rather than sales growth alone.
- In May, Medtronic paid $750 million upfront to settle outstanding patent litigation. Edwards recognized $750 million as litigation income in Q2; the nine-month statement reports net litigation income of $741.0 million. The agreement also provides quarterly royalties through April 2022; U.S. royalties have a minimum annual payment of $40 million and a maximum of $60 million. Future consideration is to be recognized in net sales over the license term as applicable.
- Gross margin declined 1.8 percentage points in Q3 and 2.6 points for nine months. Management cited foreign-exchange effects, higher manufacturing costs—particularly in Utah—and, for the nine-month period, valve-launch-related sales returns and inventory write-offs.
- SG&A increased to $222.2 million in Q3 and $634.9 million year to date, mainly from sales and marketing support for transcatheter valves and higher incentive compensation. R&D was $87.6 million and $262.5 million, respectively; year-to-date R&D equaled 15.4% of sales.
- Special items included a $50 million contribution to the Edwards Lifesciences Foundation, a $7.5 million intellectual-property agreement settlement, and charges related to discontinuing the automated glucose monitoring program. The company also recorded a $3.5 million impairment of an investment and committed $17 million to purchase its Draper, Utah facility.
- Management said available liquidity was sufficient for the next 12 months. It expected increased competition for transcatheter valves as competitors introduced products in the United States and Europe; the filing provided no specific numerical sales or earnings guidance.
Risks and contingencies
- Product litigation and other legal claims may result in charges exceeding reserves; management said it could not estimate losses for certain unreserved matters. It did not expect currently pending lawsuits to materially affect financial position, results, or liquidity.
- Tax matters include uncertain tax positions and unresolved U.S.-Switzerland transfer-pricing negotiations. The company reported $180.6 million of liabilities for uncertain tax positions before identified offsetting tax benefits; the final outcome of the transfer-pricing process is uncertain.
- Foreign-exchange, interest-rate, investment, and counterparty risks remain. Foreign-held cash and short-term investments were $889.9 million, most associated with earnings considered indefinitely reinvested; repatriation could involve restrictions and taxes.
Important facts for investors to verify
- Separate recurring operating performance from the $750 million Medtronic upfront settlement and related tax effects; assess the timing and amount of future royalties.
- Check whether valve-launch-driven growth persists as customers transition products and competitors enter, and whether gross margins recover from currency and manufacturing pressures.
- Review the quality and sustainability of operating cash flow, including the settlement inflow and increase in accrued liabilities.
- Monitor the transfer-pricing negotiations, uncertain tax positions, and any developments in product litigation or other claims.
- Assess the implications of the $50 million foundation contribution, share repurchases, and the Utah facility purchase for capital allocation and liquidity.