Boston Scientific Corporation — Q3 2011 Form 10-Q
Reporting period: Three and nine months ended September 30, 2011. Boston Scientific develops and sells medical devices across cardiovascular, CRM, endoscopy, peripheral intervention, neuromodulation, urology/women’s health and electrophysiology markets.
Financial performance
| Metric | Q3 2011 | Q3 2010 | Nine months 2011 | Nine months 2010 |
|---|---|---|---|---|
| Net sales | $1.874 billion | $1.916 billion | $5.774 billion | $5.804 billion |
| Gross profit | $1.194 billion | $1.293 billion | $3.775 billion | $3.865 billion |
| Gross margin | 63.7% | 67.5% | 65.4% | 66.6% |
| Operating income (loss) | $174 million | $251 million | $734 million | $(1.004) billion |
| Net income (loss) | $142 million | $190 million | $334 million | $(1.301) billion |
| Diluted EPS | $0.09 | $0.12 | $0.22 | $(0.86) |
| Operating cash flow | $366 million | $(126) million | $659 million | $(124) million |
Management’s adjusted, non-GAAP net income was $223 million ($0.15 per share) in Q3 2011 versus $296 million ($0.19 per share) in Q3 2010. For the first nine months, adjusted net income was $822 million ($0.54 per share), versus $737 million ($0.48 per share). These measures exclude specified impairment, acquisition, divestiture, restructuring, tax and amortization items and are not substitutes for GAAP results.
Q3 reported sales declined 2%; excluding foreign exchange and sales from divested businesses, sales declined 3%. For the first nine months, reported sales declined 1%, and sales excluding foreign exchange and divested businesses declined 1%. Q3 constant-currency declines in CRM and Interventional Cardiology were partly offset by growth in Endoscopy, Neuromodulation and Peripheral Interventions. CRM sales fell 9% reported and 12% on a constant-currency basis in Q3, reflecting contraction in the U.S. ICD market and lower U.S. market share.
Q3 gross margin fell 3.8 percentage points year over year. The Neurovascular divestiture and lower-margin transition supply sales, inventory charges, foreign exchange and CRM pricing weighed on margin. Nine-month margin benefited from a $50 million retroactive PROMUS supply-pricing credit; Q3 included a $21 million transition-related inventory charge.
Cash, debt and liquidity
- At September 30, 2011, cash and cash equivalents were $276 million, total debt was $4.263 billion, and working capital was $1.326 billion. Total debt was down from $5.438 billion at December 31, 2010.
- Nine-month investing cash flow was $827 million, primarily reflecting $1.426 billion of upfront Neurovascular divestiture proceeds, offset by $370 million for acquisitions and $221 million of capital expenditures. Financing cash flow was a $1.420 billion use, including debt repayments and $192 million of share repurchases.
- The company repaid the remaining $1.0 billion term loan and $250 million of senior notes during the first nine months. It had no borrowings outstanding under its $2.0 billion revolving facility at quarter-end.
- Debt covenants were met: leverage ratio 1.5x versus a 3.5x maximum; interest coverage 9.0x versus a 3.0x minimum. Fitch upgraded the company to BBB- investment grade; Moody’s moved its Ba1 outlook to positive.
Material changes, outlook and commentary
- Boston Scientific sold its Neurovascular business to Stryker in January for $1.5 billion in cash consideration. It recorded a $760 million pre-tax gain ($530 million after tax). Up to $50 million of additional consideration depends on facility transfers; escrow and transition-related proceeds and gain recognition remain outstanding. The company continues transitional supply and services, at lower sales and margins.
- A $697 million non-deductible goodwill impairment was recorded in Q1 for U.S. CRM, reflecting a smaller projected U.S. ICD market and reduced growth forecasts. Management identified U.S. CRM, U.S. Cardiovascular, U.S. Neuromodulation and EMEA goodwill as more exposed to future impairment; small adverse changes in assumptions could trigger further testing or charges.
- A new restructuring plan approved in July is expected to cost $155–$210 million pre-tax, with $150–$200 million in future cash outlays, and be substantially complete within 24 months. Management expects annual pre-tax expense reductions of $225–$275 million exiting 2013, with some savings reinvested in growth areas.
- Management expected 2011 capital expenditures of approximately $300 million. Product expectations included U.S. and Japan PROMUS Element launches by mid-2012, next-generation U.S. defibrillator approvals in late 2011 or early 2012, and U.S. INGENIO pacemaker launch in the first half of 2012. These are expectations, not guaranteed outcomes. The filing does not provide a clear consolidated revenue or earnings forecast.
- Risks include persistent U.S. CRM market weakness, competitive and pricing pressure, clinical or regulatory setbacks, product reliability and recall exposure, dependence on Abbott for U.S. and Japan PROMUS supply through June 2012, and execution risk in acquisitions, launches and restructuring. Foreign exchange, reimbursement, healthcare policy and emerging-market conditions also affect results.
Contingencies and unusual items
- Legal reserves were $269 million at September 30, down from $588 million at year-end, principally after a $296 million DOJ payment. The company is substantially self-insured for product liability and intellectual-property claims; additional losses could materially affect results, cash flow or covenant compliance.
- IRS transfer-pricing disputes include proposed additional tax liabilities of $525 million plus interest for Guidant 2001–2003 and $154 million plus interest for Boston Scientific 2006–2007. The company contests the assessments and believes reserves are adequate, but states resolution could materially affect financial condition or results.
- Acquisition-related contingent consideration liabilities were $376 million; maximum undiscounted potential payments for post-2008 acquisitions were approximately $760 million. The filing also cites approximately $260 million maximum potential contingent consideration for certain pre-2009 acquisitions, for which liabilities are generally not recognized until contingencies are resolved.
- Ongoing patent litigation, notably involving Johnson & Johnson and drug-eluting stents, and newly unsealed qui tam complaints could affect product sales, margins or cash requirements. Several other matters were resolved or dismissed during the period.
Important facts for investors to verify
- Whether U.S. CRM demand and Boston Scientific’s market share recover, and whether planned CRM launches occur on time.
- Underlying sales and margin trends excluding currency movements, the Neurovascular divestiture and one-time PROMUS pricing adjustments.
- Cash generation after restructuring, litigation, acquisition commitments, share repurchases and capital spending; and continued covenant headroom.
- Progress on PROMUS Element manufacturing and regulatory approvals, including the transition away from Abbott-supplied products.
- Developments in IRS transfer-pricing disputes, patent and product-liability cases, and the risk of further goodwill impairment.