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SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-Q
/x/ QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
ACT OF 1934
For the quarterly period ended: June 30, 2004
Commission file number: 1-11083
BOSTON SCIENTIFIC CORPORATION
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(Exact name of registrant as specified in its charter)
DELAWARE 04-2695240
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(State or other jurisdiction (I.R.S. Employer
of incorporation or organization) Identification No.)
One Boston Scientific Place, Natick, Massachusetts 01760-1537
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(Address of principal executive offices) (Zip Code)
Registrant's telephone number, including area code: (508) 650-8000
Former name, former address and former fiscal year, if changed since last
report.
Indicate by check mark whether the registrant (1) has filed all reports required
to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during
the preceding 12 months (or for such shorter period that the registrant was
required to file such reports), and (2) has been subject to such filing
requirements for the past 90 days.
Yes [X] No [_]
Indicate by check mark whether the registrant is an accelerated filer (as
defined in Rule 12b-2 of the Exchange Act).
Yes [X] No [_]
Indicate the number of shares outstanding of each of the issuer's classes of
common stock, as of the last practicable date.
Shares Outstanding
Class as of June 30, 2004
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Common Stock, $.01 Par Value 842,167,705
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TABLE OF CONTENTS
PART I FINANCIAL INFORMATION PAGE NO.
ITEM 1. Condensed Consolidated Financial Statements 3
Condensed Consolidated Balance Sheets 3
Condensed Consolidated Statements of Operations 5
Condensed Consolidated Statements of Cash Flows 6
Notes to Condensed Consolidated Financial Statements 7
ITEM 2. Management's Discussion and Analysis of Financial
Condition and Results of Operations 21
ITEM 3. Quantitative and Qualitative Disclosures About
Market Risk 39
ITEM 4. Controls and Procedures 40
PART II OTHER INFORMATION 42
ITEM 1. Legal Proceedings 42
ITEM 4. Submission of Matters to a Vote of Security Holders 42
ITEM 6. Exhibits and Reports on Form 8-K 43
SIGNATURES 44
2
Part I
Financial Information
Item 1: Condensed Consolidated Financial Statements
BOSTON SCIENTIFIC CORPORATION AND SUBSIDIARIES
Condensed Consolidated Balance Sheets
(Unaudited)
June 30, December 31,
in millions 2004 2003
- --------------------------------------------------------------------------------------------------
ASSETS
Current assets:
Cash and cash equivalents $ 1,000 $ 671
Short-term investments 263 81
Trade accounts receivable, net 814 542
Inventories 279 281
Other current assets 318 305
--------------------------
Total current assets 2,674 1,880
Property, plant and equipment 1,483 1,337
Less: accumulated depreciation 669 593
--------------------------
814 744
Goodwill 1,699 1,275
Other intangible assets, net 1,634 1,186
Investments 510 558
Other assets 101 56
--------------------------
$ 7,432 $ 5,699
==========================
See notes to the unaudited condensed consolidated financial statements.
3
BOSTON SCIENTIFIC CORPORATION AND SUBSIDIARIES
Condensed Consolidated Balance Sheets (continued)
(Unaudited)
June 30, December 31,
in millions, except share data 2004 2003
- --------------------------------------------------------------------------------------------------
LIABILITIES AND STOCKHOLDERS' EQUITY
Current liabilities:
Commercial paper $ 279 $ 547
Notes payable and current maturities of long-term debt 513 6
Accounts payable and accrued expenses 696 675
Other current liabilities 98 165
--------------------------
Total current liabilities 1,586 1,393
Long-term debt 1,762 1,172
Deferred income taxes 268 151
Other long-term liabilities 112 121
Commitments and contingencies
Stockholders' equity:
Preferred stock, $ .01 par value - authorized 50,000,000 shares,
none issued and outstanding
Common stock, $ .01 par value - authorized 1,200,000,000 shares,
842,167,705 shares issued at June 30, 2004; 829,764,826
shares issued at December 31, 2003 8 8
Additional paid-in capital 1,505 1,225
Treasury stock, at cost - 3,502,850 shares at December 31, 2003 (111)
Retained earnings 2,235 1,789
Accumulated other comprehensive loss (44) (49)
--------------------------
Total stockholders' equity 3,704 2,862
--------------------------
$ 7,432 $ 5,699
==========================
See notes to the unaudited condensed consolidated financial statements.
4
BOSTON SCIENTIFIC CORPORATION AND SUBSIDIARIES
Condensed Consolidated Statements of Operations
(Unaudited)
Three Months Ended Six Months Ended
June 30, June 30,
in millions, except per share data 2004 2003 2004 2003
- --------------------------------------------------------------------------------------------------------------
Net sales $ 1,460 $ 854 $ 2,542 $ 1,661
Cost of products sold 363 235 655 461
-------------------------- --------------------------
Gross profit 1,097 619 1,887 1,200
Selling, general and administrative expenses 375 292 723 563
Amortization expense 26 21 48 41
Royalties 52 13 74 25
Research and development expenses 132 108 266 211
Litigation-related charges 7
Purchased research and development 64 12 64 25
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649 446 1,175 872
-------------------------- --------------------------
Operating income 448 173 712 328
Other income (expense):
Interest expense (14) (12) (25) (23)
Other, net (2) (4)
-------------------------- --------------------------
Income before income taxes 432 161 687 301
Income taxes 119 47 180 90
-------------------------- --------------------------
Net income $ 313 $ 114 $ 507 $ 211
========================== ==========================
Net income per common share - basic $ 0.37 $ 0.14 $ 0.61 $ 0.26
========================== ==========================
Net income per common share - assuming dilution $ 0.36 $ 0.13 $ 0.59 $ 0.25
========================== ==========================
See notes to the unaudited condensed consolidated financial statements.
5
BOSTON SCIENTIFIC CORPORATION AND SUBSIDIARIES
Condensed Consolidated Statements of Cash Flows
(Unaudited)
Six Months Ended
June 30,
in millions 2004 2003
- ---------------------------------------------------------------------------------------------------------------
Cash provided by operating activities $ 574 $ 354
Investing activities:
Purchases of property, plant and equipment, net (135) (74)
Purchases of held-to-maturity short-term investments (307) (25)
Purchases of available-for sale securities (13) (88)
Maturities of held-to-maturity short term investments 99 17
Sales of available-for-sale securities 62
Sales of privately held equity securities 28
Acquisitions of businesses, net of cash acquired (804) (13)
Payments related to prior year acquisitions (81) (242)
Payments for acquisitions of and/or investments in certain technologies, net (90) (81)
--------------------------
Cash used for investing activities (1,241) (506)
Financing activities:
Net increase in commercial paper 43 509
Net proceeds from (payments on) revolving borrowings, 188 (109)
Proceeds from (payments on) notes payable, capital leases
and long-term borrowings 589 (9)
Purchases of common stock for treasury (244)
Proceeds from issuances of shares of common stock 177 126
--------------------------
Cash provided by financing activities 997 273
Effect of foreign exchange rates on cash (1) 4
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Net increase in cash and cash equivalents 329 125
Cash and cash equivalents at beginning of period 671 260
--------------------------
Cash and cash equivalents at end of period $ 1,000 $ 385
==========================
Supplemental Schedule of Noncash Investing and Financing Activities:
Payments due in connection with prior year acquisitions $ 13 $ 39
See notes to the unaudited condensed consolidated financial statements.
6
NOTES TO THE CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
NOTE A - BASIS OF PRESENTATION
The accompanying unaudited condensed consolidated financial statements of Boston
Scientific Corporation (Boston Scientific or the Company) have been prepared in
accordance with accounting principles generally accepted in the United States
for interim financial information and with the instructions to Form 10-Q and
Article 10 of Regulation S-X. Accordingly, they do not include all of the
information and footnotes required by accounting principles generally accepted
in the United States for complete financial statements. In the opinion of
management, all adjustments (consisting only of normal recurring adjustments)
considered necessary for a fair presentation have been included. Operating
results for the three and six months ended June 30, 2004 are not necessarily
indicative of the results that may be expected for the year ending December 31,
2004. For further information, refer to the consolidated financial statements
and footnotes thereto incorporated by reference in Boston Scientific's Annual
Report on Form 10-K for the year ended December 31, 2003.
Certain prior year's amounts have been reclassified to conform to the current
year presentation.
NOTE B - STOCK COMPENSATION ARRANGEMENTS
The Company accounts for its stock compensation arrangements under the intrinsic
value method in accordance with Accounting Principles Board Opinion No. 25,
ACCOUNTING FOR STOCK ISSUED TO EMPLOYEES, and related Interpretations. The
Company has adopted the disclosure-only provisions of Financial Accounting
Standards Board (FASB) Statement No. 123, ACCOUNTING FOR STOCK-BASED
COMPENSATION.
If the Company had elected to recognize compensation expense for the granting of
options under stock option plans based on the fair values at the grant dates
consistent with the methodology prescribed by Statement No. 123, net income and
net income per share would have been reported as the following pro forma
amounts:
7
Three Months Ended Six Months Ended
June 30, June 30,
(in millions, except per share data) 2004 2003 2004 2003
- ------------------------------------------------------------- -------- -------- -------- --------
Net income, as reported $ 313 $ 114 $ 507 $ 211
Add: Stock-based employee compensation expense included
in net income, net of related tax effects 1 1
Less: Total stock-based employee compensation expense
determined under fair value based method for all awards, net
of related tax effect (16) (13) (31) (26)
-------- -------- -------- --------
Pro forma net income $ 297 $ 102 $ 476 $ 186
======== ======== ======== ========
Net income per common share:
Basic:
Reported $ 0.37 $ 0.14 $ 0.61 $ 0.26
Pro forma $ 0.35 $ 0.12 $ 0.57 $ 0.23
Assuming dilution:
Reported $ 0.36 $ 0.13 $ 0.59 $ 0.25
Pro forma $ 0.35 $ 0.12 $ 0.56 $ 0.22
The fair value of the stock compensation used to calculate the pro forma net
income and earnings per share amounts above was estimated using the
Black-Scholes option pricing model.
NOTE C - COMPREHENSIVE INCOME
The following table sets forth the Company's comprehensive income for the three
months and the six months ended June 30, 2004 and 2003:
Three Months Ended Six Months Ended
June 30, June 30,
(in millions) 2004 2003 2004 2003
- ------------------------------------------------------------- -------- -------- -------- --------
Net income $ 313 $ 114 $ 507 $ 211
Foreign currency translation adjustment 8 16 (11) 26
Net change in equity investments (16) 18 (22) 19
Net change in derivative financial instruments 36 (3) 38 (5)
-------- -------- -------- --------
Comprehensive income $ 341 $ 145 $ 512 $ 251
======== ======== ======== ========
NOTE D - EARNINGS PER SHARE
The following table sets forth the computations of basic and diluted earnings
per share:
8
Three Months Ended Six Months Ended
June 30, June 30,
(in millions, except per share data) 2004 2003 2004 2003
- ----------------------------------------------- -------- -------- -------- --------
Basic:
Net income $ 313 $ 114 $ 507 $ 211
Weighted average shares outstanding 839.4 820.6 835.3 821.3
Net income per common share $ 0.37 $ 0.14 $ 0.61 $ 0.26
======== ======== ======== ========
Assuming dilution:
Net income $ 313 $ 114 $ 507 $ 211
Weighted average shares outstanding 839.4 820.6 835.3 821.3
Net effect of dilutive stock-based compensation 20.5 24.2 22.3 23.1
-------- -------- -------- --------
Total 859.9 844.8 857.6 844.4
Net income per common share $ 0.36 $ 0.13 $ 0.59 $ 0.25
======== ======== ======== ========
NOTE E - BUSINESS COMBINATIONS
On June 1, 2004, the Company completed its acquisition of 100 percent of the
fully diluted equity of Advanced Bionics Corporation (Advanced Bionics) for an
initial payment of approximately $740 million in cash, plus earn out payments
that are contingent upon Advanced Bionics products reaching future performance
milestones. Advanced Bionics has developed or is developing implantable
microelectronic technologies for treating numerous neurological disorders. Its
neuromodulation technology includes a range of neurostimulators (or implantable
pulse generators), programmable drug pumps and cochlear implants. The
acquisition was intended to expand the Company's technology portfolio into the
implantable microelectronic device market. The Advanced Bionics acquisition was
structured to include earnout payments that are primarily contingent on the
achievement of future performance milestones, with certain milestone payments
also tied to profitability. The performance milestones are segmented by Advanced
Bionics' four principal technology platforms (cochlear implants, implantable
pulse generators, drug pumps and bion microstimulators), each milestone with a
72-month earnout horizon from the date of the anticipated product launch. Base
earnout payments on these performance milestones approximate two and a quarter
times incremental sales for each annual period. There are also bonus earnout
payments available based on the attainment of certain aggregate sales
performance targets and a certain gross margin level. The milestones associated
with the contingent consideration must be reached in certain future periods
ranging from 2004 through 2013.
On April 2, 2004, the Company completed its acquisition of the remaining
outstanding shares of Precision Vascular Systems, Inc. (PVS) for an initial
payment of approximately $75 million in cash, plus earnout payments that are
contingent upon PVS products reaching future performance milestones. PVS
develops and manufactures guidewires and microcatheter technology for use in
accessing the brain, the heart and other areas of the anatomy. The acquisition
of PVS was intended to provide the Company with expanded vascular access
technology and an expanded intellectual property portfolio.
Certain of the Company's business combinations involve contingent consideration.
These payments, if and when made, are allocated to specific intangible asset
categories, including purchased research and development, with the remainder
assigned to goodwill as if the
9
consideration had been paid as of the date of acquisition. Payment of the
additional consideration is generally contingent upon the acquired companies
reaching certain performance milestones, including achieving specified revenue
levels, product development targets or regulatory approvals. At June 30, 2004
and December 31, 2003, the Company had accruals for acquisition-related
obligations of approximately $13 million and $79 million, respectively. These
accruals were recorded primarily as adjustments to goodwill and purchased
research and development. In addition, at June 30, 2004, the estimated maximum
potential amount of future contingent consideration (undiscounted) that the
Company could be required to make associated with its business combinations is
approximately $3.2 billion, some of which may be payable in the Company's common
stock. Certain earnout payments are based on multiples of the acquired company's
revenue during the earnout period, and consequently, the total payments are not
currently determinable. However, the Company has developed an estimate of the
maximum potential contingent consideration for each of its acquisitions with an
outstanding earnout obligation. The milestones associated with the contingent
consideration must be reached in certain future periods ranging from 2004
through 2013. The estimated cumulative specified revenue level associated with
these maximum future contingent payments is approximately $7.0 billion.
The Company has recorded approximately $411 million of intangible assets not
subject to amortization associated with its 2004 acquisitions, which is
comprised solely of goodwill. The goodwill is not deductible for tax purposes,
and has been primarily allocated to the Company's U.S. reportable segment.
The following table summarizes the purchase price assigned to the intangible
assets subject to amortization acquired in connection with the 2004 acquisitions
and the weighted average amortization periods:
Weighted Average
Amount Amortization
(in millions) Assigned Period
- --------------------------------------------- ---------- ----------
Technology - core $ 406 20 years
Technology - developed 42 7 years
Other 10 15 years
---------- ----------
Total $ 458 19 years
========== ==========
The Company also recorded $64 million of purchased research and development, $45
million of deferred tax assets and $169 million of deferred tax liabilities in
connection with the acquisitions of Advanced Bionics and PVS. The deferred tax
assets are primarily attributable to net operating loss carryforwards. The
deferred tax liabilities mainly relate to the tax impact of amortization that is
attributable to the identified intangibles acquired in the acquisition. The
remaining net tangible assets acquired were not significant. The amounts paid
for each acquisition have been allocated to the assets acquired and liabilities
assumed based on their fair values at the date of acquisition. The estimated
excess of purchase price over the fair value of the net tangible assets acquired
was allocated to identifiable intangible assets based on detailed valuations.
The Company's purchased research and development charges are based upon these
valuations. The valuation of purchased research and development represents the
estimated fair value at the date of acquisition related to in-process projects.
As of the date of acquisition, the in-process projects had not yet reached
technological feasibility and had no alternative future
10
uses. The primary basis for determining the technological feasibility of these
projects is obtaining regulatory approval to market the products in an
applicable geographical region. Accordingly, the value attributable to these
projects, which had not yet obtained regulatory approval, was expensed in
conjunction with the acquisition. If the projects are not successful, or
completed in a timely manner, the Company may not realize the financial benefits
expected for these projects.
The income approach was used to establish the fair values of purchased research
and development. This approach establishes fair value by estimating the
after-tax cash flows attributable to the in-process project over its useful life
and then discounting these after-tax cash flows back to a present value. Revenue
estimates were based on estimates of relevant market sizes, expected market
growth rates, expected trends in technology and expected product introductions
by competitors. In arriving at the value of the in-process research and
development projects, the Company considered, among other factors, the
in-process project's stage of completion, the complexity of the work completed
as of the acquisition date, the costs already incurred, the projected costs to
complete, the contribution of core technologies and other acquired assets, the
expected introduction date and the estimated useful life of the technology. The
discount rate used to arrive at a present value as of the date of acquisition
was based on the time value of money and medical technology investment risk
factors. For the purchased research and development programs acquired in
connection with the Company's 2004 acquisitions, risk-adjusted discount rates
ranging from 18 percent to 27 percent were utilized to discount the projected
cash flows. The Company believes that the estimated purchased research and
development amounts so determined represent the fair value at the date of
acquisition and do not exceed the amount a third party would pay for the
projects.
The most significant in-process projects acquired in connection with the
Company's 2004 acquisitions include Advanced Bionics' bion(TM) microstimulator
and drug delivery pump, which collectively represent approximately 77 percent of
the 2004 in-process projects value. The bion microstimulator is an implantable
neurostimulation device that may be used to treat a variety of neurological
conditions, including urge incontinence, epilepsy, sleep apnea, erectile
dysfunction and migraine headaches. The cost to complete the bion
microstimulator is estimated to be between $35 million and $45 million. The drug
delivery pump is an implanted programmable device used to treat chronic pain.
The cost to complete the drug delivery pump is estimated to be between $30
million and $40 million. As of the date of acquisition, the products were
expected to be commercially available on a worldwide basis within three to four
years.
The Company's condensed consolidated financial statements include Advanced
Bionics' and PVS' operating results from the date of acquisition. The following
unaudited pro forma information presents a summary of consolidated results of
operations of the Company and Advanced Bionics as if the acquisition had
occurred at the beginning of each of 2003 and 2004, with pro forma adjustments
to give effect to amortization of intangible assets, an increase in interest
expense on acquisition financing and certain other adjustments together with
related tax effects:
11
Three Months Ended: Six Months Ended:
June 30, June 30,
(in millions, except per share data) 2004 2003 2004 2003
- ------------------------------------------- -------- -------- -------- --------
Net sales $ 1,482 $ 863 $ 2,583 $ 1,679
Net income 298 99 478 183
Net income per share - basic $ 0.36 $ 0.12 $ 0.57 $ 0.22
Net income per share - assuming dilution $ 0.35 $ 0.12 $ 0.56 $ 0.22
Pro forma information is not presented for PVS, as PVS' results of operations
prior to its date of acquisition are not significant in relation to the
Company's consolidated results.
NOTE F - BORROWINGS AND CREDIT ARRANGEMENTS
During the first half of 2004, the Company refinanced its existing $1,200
million credit facilities. At June 30, 2004, the Company's revolving credit
facilities totaled $2,020 million, consisting of a $1,500 million credit
facility that terminates in May 2009; a $500 million 364-day credit facility
that terminates in May 2005 and contains an option to convert into a one-year
term loan maturing in May 2006; and a $20 million uncommitted credit facility.
Use of the borrowings is unrestricted and the borrowings are unsecured.
The revolving credit facilities provide borrowing capacity and support the
Company's commercial paper. The Company had approximately $1,046 million and
$1,003 million of commercial paper outstanding at June 30, 2004 and December 31,
2003, respectively, at weighted average interest rates of 1.33 percent and 1.20
percent, respectively.
In addition, the Company increased its borrowing capacity under its revolving
credit and security facility, which is secured by the Company's domestic trade
receivables, from $200 million to $400 million. The Company had approximately
$382 million and $194 million of borrowings outstanding under its revolving
credit and security facility at June 30, 2004 and December 31, 2003,
respectively, at weighted average interest rates of 1.46 percent and 1.44
percent, respectively. The Company expects to renew the revolving credit and
security facility for an additional 364 days upon its maturity in August 2004.
The Company has the ability and intent to refinance a portion of its short-term
debt on a long-term basis through its revolving credit facilities. At June 30,
2004, the Company expects that a minimum of approximately $1,150 million of its
short-term obligations will remain outstanding beyond the next twelve months
and, accordingly, has classified this portion as long-term borrowings, as
compared to $650 million of short-term bank obligations classified as long-term
at December 31, 2003.
The Company had $500 million of senior notes outstanding at June 30, 2004 and
December 31, 2003 that are due March of 2005. These notes are registered
securities, bear a semi-annual coupon of 6.625 percent and are not redeemable
prior to maturity or subject to any sinking fund requirements. The Company has
classified these notes as a current liability at June 30, 2004.
In June 2004, due to favorable market conditions, the continued increase of
non-U.S. cash balances and to support the Company's strategic growth objectives,
the Company issued $600
12
million of senior notes due June 2014 under a Public Debt Registration Statement
previously filed with the U.S. Securities and Exchange Commission (SEC). These
notes bear a semi-annual coupon of 5.45 percent, are redeemable prior to
maturity and are not subject to any sinking fund requirements. The Company
entered a fixed-to-floating interest rate swap to hedge against changes in the
fair value of these notes. The Company recorded changes in the fair value of
these notes since the inception of the interest rate swap. Interest payments
made or received under the interest rate swap agreement are recorded as interest
expense. Interest is payable at the six-month LIBOR rate plus zero percent,
which was approximately 1.94 percent at June 30, 2004.
NOTE G - INVENTORIES
The components of inventory consist of the following:
June 30, December 31,
(in millions) 2004 2003
- ------------------------------------------------- -------- --------
Finished goods $ 175 $ 175
Work-in-process 45 63
Raw materials 59 43
-------- --------
Total $ 279 $ 281
======== ========
In the second quarter of 2004, the Company recorded inventory write-downs of $43
million (pre-tax) in conjunction with the recall of certain units of the
Company's Taxus(TM) Express(2)(TM) paclitaxel-eluting coronary stent systems and
Express(2)(TM) coronary stent systems.
NOTE H - NEW ACCOUNTING STANDARDS
During the first quarter of 2004, the Company adopted FASB Interpretation No.
46, CONSOLIDATION OF VARIABLE INTEREST ENTITIES. Interpretation No. 46 clarifies
the conditions under which the assets, liabilities and activities of another
entity should be consolidated into the financial statements of a company.
Interpretation No. 46 requires the consolidation of a variable interest entity
by a company that bears the majority of the risk of loss from the variable
interest entity's activities or is entitled to receive the majority of the
variable interest entity's residual returns. The Company's adoption of
Interpretation No. 46 had no material impact on the Company's consolidated
financial statements.
NOTE I - COMMITMENTS AND CONTINGENCIES
The Company is involved in various legal proceedings, including patent
infringement and product liability suits, from time to time in the normal course
of business. In management's opinion, the Company is not currently involved in
any legal proceeding other than those specifically identified in this Quarterly
Report, the Quarterly Report on Form 10-Q for the quarter ended March 31, 2004
and the Company's Annual Report on Form 10-K for the year ended December 31,
2003, which, individually or in the aggregate, could have a material effect on
the financial condition, operations and/or cash flows of the Company.
13
LITIGATION WITH JOHNSON & JOHNSON
On October 22, 1997, Cordis Corporation (Cordis), a subsidiary of Johnson &
Johnson, filed a suit for patent infringement against the Company and SCIMED
Life Systems, Inc. (SCIMED), a subsidiary of the Company, alleging that the
importation and use of the NIR(R) stent infringes two patents owned by Cordis.
On April 13, 1998, Cordis filed a suit for patent infringement against the
Company and SCIMED alleging that the Company's NIR(R) stent infringes two
additional patents owned by Cordis. The suits were filed in the U.S. District
Court for the District of Delaware seeking monetary damages, injunctive relief
and that the patents be adjudged valid, enforceable and infringed. A trial on
both actions was held in late 2000. A jury found that the NIR(R) stent does not
infringe three Cordis patents, but does infringe one claim of one Cordis patent
and awarded damages of approximately $324 million to Cordis. On March 28, 2002,
the Court set aside the damage award, but upheld the remainder of the verdict,
and held that two of the four patents had been obtained through inequitable
conduct in the U.S. Patent and Trademark Office. On May 16, 2002, the Court also
set aside the verdict of infringement, requiring a new trial. The case had been
stayed until October 10, 2003, pending the outcome of a related case. On October
14, 2003, Cordis filed a motion to revise and vacate the Court's decision to
grant the Company a new trial and asked the Court to enter judgment against the
Company. The Company filed an opposition to Cordis' motion and, on February 14,
2004, the motion was denied. A status conference is scheduled for August 30,
2004.
On March 13, 1997, the Company (through its subsidiaries) filed suits against
Johnson & Johnson (through its subsidiaries) in The Netherlands and Belgium, and
on March 17, 1997, filed suit in France, seeking a declaration of
noninfringement for the NIR(R) stent relative to two European patents licensed
to Ethicon, Inc. (Ethicon), a Johnson & Johnson subsidiary, as well as a
declaration of invalidity with respect to those patents. On October 28, 1998,
the Company's motion for a declaration of noninfringement in France was
dismissed for failure to satisfy statutory requirements; the French invalidity
suits were not affected. On January 16, 2002, the French Court found one of the
patents to be valid and the other to be invalid and the parties appealed the
Court's decision. On June 9, 2004, the French Court of Appeals confirmed the
lower court's ruling. On March 21, 1997, the Company (through its subsidiaries)
filed a suit against Johnson & Johnson (through its subsidiaries) in Italy
seeking a declaration of noninfringement for the NIR(R) stent relative to one of
the European patents licensed to Ethicon and a declaration of invalidity. A
technical expert was appointed by the Court and a hearing was held on January
30, 2002. Both parties have had an opportunity to comment on the expert report.
On May 8, 2002, the Court closed the evidentiary phase of the case and a hearing
was held on April 29, 2004. A decision has not yet been received.
Ethicon and other Johnson & Johnson subsidiaries filed a cross-border suit in
The Netherlands on March 17, 1997, alleging that the NIR(R) stent infringes one
of the European patents licensed to Ethicon. In this action, the Johnson &
Johnson entities requested relief, including provisional relief (a preliminary
injunction), covering Austria, Belgium, France, Greece, Italy, The Netherlands,
Norway, Spain, Sweden and Switzerland. On April 2, 1997, the Johnson & Johnson
entities filed a similar cross-border proceeding in The Netherlands with respect
to a second European patent licensed to Ethicon. In October 1997, Johnson &
Johnson's request for provisional cross-border relief on both patents was denied
by the Dutch Court, on the ground that it is "very likely" that the NIR(R) stent
will be found not to infringe the patents. Johnson &
14
Johnson appealed this decision with respect to the second patent; the appeal has
been denied on the grounds that there is a "ready chance" that the patent will
be declared null and void. In January 1999, Johnson & Johnson amended the claims
of the second patent, changed the action from a cross-border case to a Dutch
national action, and indicated its intent not to pursue its action on the first
patent. On June 23, 1999, the Dutch Court affirmed that there were no remaining
infringement claims with respect to either patent. In late 1999, Johnson &
Johnson appealed this decision. On March 11, 2004, the Court of Appeals
nullified the Dutch Court's June 23, 1999 decision and the proceedings have been
returned to the lower court. A hearing has not yet been scheduled.
On February 14, 2002, the Company and certain of its subsidiaries filed suit for
patent infringement against Johnson & Johnson and Cordis alleging that certain
balloon catheters, stent delivery systems, and guide catheters sold by Johnson &
Johnson and Cordis infringe five U.S. patents owned by the Company. The
complaint was filed in the U.S. District Court for the Northern District of
California seeking monetary and injunctive relief. On October 15, 2002, Cordis
filed a counterclaim alleging certain balloon catheters and stent delivery
systems sold by the Company infringe three U.S. patents owned by Cordis and
seeking monetary and injunctive relief. On December 6, 2002, the Company filed
an amended complaint alleging that two additional patents owned by the Company
are infringed by the Cordis products. A summary judgment hearing was held on
April 9, 2004, and Cordis' motions for summary judgment were denied. A Markman
hearing was held on April 27, 2004, and a trial is expected to begin in January
2005.
On March 26, 2002, the Company and Target Therapeutics, Inc. (Target), a wholly
owned subsidiary of the Company, filed suit for patent infringement against
Cordis alleging that certain detachable coil delivery systems and/or pushable
coil vascular occlusion systems (coil delivery systems) infringe three U.S.
patents, owned by or exclusively licensed to Target. The complaint was filed in
the U.S. District Court for the Northern District of California seeking monetary
and injunctive relief. A summary judgment hearing was held on April 19, 2004,
and on June 25, 2004, the Court granted summary judgment relating to
infringement of one of the patents. Trial is expected to begin in October 2004.
On January 13, 2003, Cordis filed suit for patent infringement against the
Company and SCIMED alleging the Company's Express(2)(TM) coronary stent
infringes a U.S. patent owned by Cordis. The suit was filed in the U.S. District
Court for the District of Delaware seeking monetary and injunctive relief. On
February 14, 2003, Cordis filed a motion requesting a preliminary injunction.
The Company answered the complaint, denying the allegations, and filed a
counterclaim against Cordis, alleging that certain products sold by Cordis
infringe a patent owned by the Company. A hearing on the preliminary injunction
motion was held and on November 21, 2003, the Court denied the motion for a
preliminary injunction. Cordis appealed the denial of its motion and a hearing
was held on April 5, 2004. On May 28, 2004, the Court of Appeals affirmed the
denial of the preliminary injunction. On August 4, 2004, the Court granted a
Cordis motion to add the Company's Liberte coronary stent and two additional
patents to the complaint. The trial is currently scheduled to begin June 13,
2005.
15
On March 13, 2003, the Company and Boston Scientific Scimed, Inc. filed suit for
patent infringement against Johnson & Johnson and Cordis, alleging that its
Cypher(TM) drug-eluting stent infringes a patent owned by the Company. The suit
was filed in the District Court of Delaware seeking monetary and injunctive
relief. On March 20, 2003, the Company filed a motion seeking a preliminary
injunction with respect to the sale of the Cypher drug-eluting stent in the
United States. Cordis answered the complaint, denying the allegations, and filed
a counterclaim against the Company alleging that the patent is not valid and is
unenforceable. The Company filed amended complaints alleging that the Cypher
drug-eluting stent infringes four additional patents owned by the Company. A
hearing on the preliminary injunction motion was held and, on November 21, 2003,
the Court denied the motion for a preliminary injunction. Following the
announcement on February 23, 2004 by Guidant Corporation (Guidant) of an
agreement with Johnson & Johnson and Cordis to sell the Cypher drug-eluting
stent, the Company moved to amend its complaint on February 25, 2004 to include
Guidant and certain of its subsidiaries as co-defendants. The trial on the first
patent is scheduled to begin on June 13, 2005. The trial on the remaining four
patents is scheduled for October 2005.
On December 24, 2003, the Company (through its subsidiary Schneider Europe GmbH)
filed suit against the Belgian subsidiaries of Johnson & Johnson, Cordis and
Janssen Pharmaceutica alleging that Cordis' Bx Velocity(R) stent, Bx Sonic(R)
stent, Cypher stent, Cypher Select stent, Aqua T3(TM) balloon and U-Pass balloon
infringe one of the Company's European patents. The suit was filed in the
District Court of Brussels, Belgium seeking preliminary cross-border, injunctive
and monetary relief and sought an expedited review of the claims by the Court. A
separate suit was filed in the District Court of Brussels, Belgium against nine
additional Johnson & Johnson subsidiaries. On February 9, 2004, the Belgium
Court linked all Johnson & Johnson entities into a single action. A hearing was
held on June 7, 2004, and on June 21, 2004, the Court dismissed the case for
failure to satisfy the requirements for expedited review without commenting on
the merits of the claims. On August 5, 2004, the Company re-filed the suit on
the merits against the same Johnson & Johnson subsidiaries in the District Court
of Brussels, Belgium seeking cross-border, injunctive and monetary relief for
infringement of the same European patent.
On May 12, 2004, the Company (through its subsidiary Schneider Europe GmbH)
filed suit against two of Johnson & Johnson's Dutch subsidiaries, alleging that
Cordis' Bx Velocity(R) stent, Bx Sonic(R) stent, Cypher stent, Cypher Select
stent, Aqua T3(TM) balloon and U-Pass balloon infringe one of the Company's
European patents. The suit was filed in the District Court of the Hague in The
Netherlands seeking cross-border, injunctive and monetary relief.
On December 15, 2003, the Company and SCIMED filed suit for patent infringement
against Cordis and Johnson & Johnson alleging Cordis' Cypher drug-eluting stent
coating infringes two U.S. patents owned by the Company. The suit was filed in
the District Court of Delaware seeking monetary and injunctive relief. Following
the announcement on February 23, 2004 by Guidant of an agreement with Johnson &
Johnson and Cordis to sell the Cypher drug-eluting stent, the Company amended
its complaint on February 25, 2004 to include Guidant and certain of its
subsidiaries as co-defendants. A trial is scheduled to begin in October 2005.
16
LITIGATION RELATING TO COOK, INC.
On September 10, 2001, the Company delivered a Notice of Dispute to Cook, Inc.
(Cook) asserting that Cook breached the terms of a certain License Agreement
among Angiotech Pharmaceuticals, Inc. (Angiotech), Cook and the Company (the
Agreement) relating to an improper arrangement between Cook and Guidant. On
December 13, 2001, Cook filed suit in the U.S. District Court for the Northern
District of Illinois seeking declaratory and injunctive relief. The Company
answered the complaint on December 26, 2001, denying the allegations and filed
counterclaims seeking declaratory and injunctive relief. On June 27, 2002, the
Court found in favor of the Company, ruling that Cook breached the Agreement. On
October 1, 2002, the Court granted the Company's request for a permanent
injunction prohibiting certain activities under the Agreement and enjoining the
use of the clinical data and technologies developed by Cook or Guidant in
violation of the Agreement. Cook appealed the decision to the U.S. Court of
Appeals for the Seventh Circuit. On June 19, 2003, the Court of Appeals affirmed
the District Court's decision. The Court of Appeals modified the District
Court's injunction by deleting language that would have prohibited the use of
clinical data to obtain regulatory approval, but continued to enjoin the sale of
products. On February 19, 2004, Cook filed a motion to dissolve the Court's
injunction, or in the alternative to modify the injunction to permit Cook to use
clinical data previously obtained to pursue regulatory approval to market a
paclitaxel-eluting stent. A hearing was held on March 1, 2004, followed by the
Court's request that both parties brief the issue. On April 15, 2004, the Court
denied Cook's motion to dissolve the injunction.
OTHER PATENT LITIGATION
On July 28, 2000, Dr. Tassilo Bonzel filed a complaint naming certain of the
Company's Schneider Worldwide subsidiaries and Pfizer Inc. (Pfizer) and certain
of its affiliates as defendants, alleging that Pfizer failed to pay Dr. Bonzel
amounts owed under a license agreement involving Dr. Bonzel's patented
Monorail(TM) technology. The suit was filed in the District Court for the State
of Minnesota seeking monetary relief. On September 26, 2001, Dr. Bonzel and the
Company reached a contingent settlement involving all but one claim asserted in
the complaint. The contingency has been satisfied and the settlement is now
final. On December 17, 2001, the remaining claim was dismissed without prejudice
with leave to refile the suit in Germany. Dr. Bonzel filed an appeal of the
dismissal of the remaining claim. On July 29, 2003, the Appellate Court affirmed
the lower court's dismissal, and on October 24, 2003, the Minnesota Supreme
Court denied Dr. Bonzel's petition for further review. On March 26, 2004, Dr.
Bonzel filed a similar complaint against the Company, certain of its
subsidiaries and Pfizer in the Federal District Court for the District of
Minnesota. The Company and its subsidiaries answered, denying the allegations of
the complaint. The Company filed a motion to dismiss the case and a hearing on
the motion is scheduled for August 27, 2004.
On December 16, 2003, The Regents of the University of California (The Regents)
filed suit against Micro Therapeutics, Inc. (Micro Therapeutics) and Dendron
GmbH (Dendron) alleging that Micro Therapeutics' Sapphire (TM) detachable coil
delivery systems infringe twelve patents licensed by the Company and owned by
The Regents. The complaint was filed in the U.S. District Court for the Northern
District of California seeking monetary and injunctive relief. On January 8,
2004, Micro Therapeutics and Dendron filed a third party complaint to include
the Company and Target as third party defendants seeking a declaratory judgment
of invalidity and
17
non-infringement with respect to the patents and antitrust violations. On
February 17, 2004, the Company, as a third party defendant, filed a motion to
dismiss the Company from the case. On July 9, 2004, the Court granted the
Company's motion in part and dismissed the Company and Target from the claims
relating only to patent infringement, while denying dismissal of an antitrust
claim.
LITIGATION RELATING TO ADVANCED NEUROMODULATION SYSTEMS, INC.
On April 21, 2004, Advanced Neuromodulation Systems, Inc. (ANSI) filed suit
against Advanced Bionics, a subsidiary of the Company, alleging that its
Precision(TM) spinal cord stimulation system infringes a U.S. patent owned by
ANSI. The suit also includes allegations of misappropriation of trade secrets
and tortious interference with a contract. The suit was filed in the U.S.
District Court for the Eastern District of Texas and seeks monetary and
injunctive relief. The Company has answered, denying the allegations of the
complaint. On June 1, 2004, the Company acquired Advanced Bionics and assumed
the defense of the litigation. On June 25, 2004, the Company filed a motion to
dismiss and request for transfer of venue to California.
LITIGATION WITH MEDINOL LTD.
On April 22, 2002, Medinol filed suit against Boston Scientific Medizintechnik
GmbH (GmbH), a German subsidiary of the Company, alleging that the Company's
Express stent infringes certain German patents and utility models owned by
Medinol. The suit was filed in Dusseldorf, Germany. Hearings were held in May
2003, and on June 24, 2003, the German court found that the Express(R) stent
infringes one German patent and one utility model asserted by Medinol and
enjoined sales in Germany. The Company has appealed and a hearing on the appeal
is scheduled to begin in January 2005. On March 31, 2004, the European Patent
Office declared the patent invalid. A hearing on the validity of the utility
model is also scheduled for January 2005. A hearing on damages is scheduled for
February 22, 2005.
On July 2, 2003, Medinol filed a motion against the Company seeking a
preliminary injunction with respect to the sale of the Express stent in Germany.
The German Court granted Medinol's motion effective September 23, 2003. The
Company appealed the German Court's decision. On March 31, 2004, the European
Patent Office declared the patent invalid. The decision is final and not
appealable. Medinol has withdrawn its motion seeking a preliminary injunction.
On April 30, 2004, Medinol filed suit against the Company alleging that the
Company's Express and TAXUS stent systems infringe a utility model owned by
Medinol. The suit was filed in Dusseldorf, Germany. A hearing is scheduled for
April 21, 2005.
On January 21, 2003, Medinol filed suit against several of the Company's
international subsidiaries in the District Court of The Hague, Netherlands
seeking cross-border, monetary and injunctive relief covering The Netherlands,
Austria, Belgium, United Kingdom, Ireland, Switzerland, Sweden, Spain, France,
Portugal and Italy, alleging the Company's Express stent infringes four European
patents owned by Medinol. A hearing was held on October 10, 2003, and a decision
was rendered on December 17, 2003 finding the Company infringes one patent. The
Court, however, granted no cross-border relief. The Company appealed the finding
and filed nullity actions against one of the patents in Ireland, France, Italy,
Spain, Sweden, Portugal, and
18
Switzerland. On March 31, 2004, the European Patent Office declared this patent
invalid. The Court's injunction and damages order have been dismissed. Medinol
appealed the Court's decision with respect to the remaining three patents
seeking an expedited review of the claims by the Court. On May 6, 2004, Medinol
filed a kort geding proceeding against the Company's same international
subsidiaries alleging that the sale of the Express and TAXUS coronary stent
systems infringe one of the patents on appeal from the 2003 suit. The suit was
filed in the District Court of the Hague, The Netherlands seeking preliminary
injunctive relief. On August 5, 2004, the Court denied Medinol's request for
preliminary injunctive relief.
On September 10, 2002, the Company filed suit against Medinol alleging Medinol's
NIRFlex(TM) and NIRFlex(TM) Royal products infringe two patents owned by the
Company. The suit was filed in Dusseldorf, Germany seeking monetary and
injunctive relief. A hearing was held on September 23, 2003. On October 28,
2003, the German Court found that Medinol infringed one of the two patents owned
by the Company. On December 8, 2003, the Company filed an appeal relative to the
other patent. Subsequently, Medinol filed an appeal relative to the one patent
found to be infringed. A hearing on both appeals is scheduled for April 14,
2005.
DEPARTMENT OF JUSTICE INVESTIGATION
In October 1998, the Company recalled its NIR ON(R) Ranger(TM) with Sox(TM)
coronary stent delivery system following reports of balloon leaks. Since
November 1998, the U.S. Department of Justice has been conducting an
investigation primarily regarding: the shipment, sale and subsequent recall of
the NIR ON(R) Ranger(TM) with Sox(TM) stent delivery system; aspects of the
Company's relationship with Medinol, the vendor of the stent; and related
events. The Company and two senior officials have been advised that they are
targets of the federal grand jury investigation, but that no final decision has
been made as to whether any potential charges would be brought. Although the
Company has contested certain procedural matters related to the conduct of the
investigation, the Company and the two senior officials have agreed to extend
the applicable statute of limitations, which may result in the investigation
continuing into the fall of 2004 or beyond. There can be no assurance that the
investigation will result in an outcome favorable to the Company, that charges
would not be brought, or that the Company would not agree to a further extension
of the statute. The Company believes that it will ultimately be demonstrated
that the Company and its officials acted responsibly and appropriately.
NOTE J - SEGMENT REPORTING
The Company has four reportable operating segments based on geographic regions:
the United States, Europe, Japan and Inter-Continental. Each of the Company's
reportable segments generates revenue from the sale of minimally invasive
medical devices. The reportable segments represent an aggregate of operating
divisions. Sales and operating results of reportable segments are based on
internally derived standard foreign exchange rates, which may differ from year
to year and do not include inter-segment profits. The segment information
presented for 2003 sales and operating results has been restated based on the
Company's standard foreign exchange rates used for 2004. Because of the
interdependence of the reportable segments, the operating profit as presented
may not be representative of the geographic distribution that would occur if the
segments were not interdependent.
19
United Inter-
(in millions) States Europe Japan Continental Total
- ------------------------------------------------------ -------- -------- -------- -------- --------
Three months ended June 30, 2004
Net sales $ 944 $ 218 $ 156 $ 121 $ 1,439
Operating income allocated to reportable segments 519 104 91 55 769
Three months ended June 30, 2003
Net sales $ 482 $ 164 $ 144 $ 74 $ 864
Operating income allocated to reportable segments 183 75 82 28 368
Six months ended June 30, 2004
Net sales $ 1,520 $ 428 $ 305 $ 230 $ 2,483
Operating income allocated to reportable segments 730 210 182 106 1,228
Six months ended June 30, 2003
Net sales $ 961 $ 314 $ 280 $ 136 $ 1,691
Operating income allocated to reportable segments 370 141 160 49 720
A reconciliation of the totals reported for the reportable segments to the
applicable line items in the consolidated financial statements is as follows:
Three Months Ended Six Months Ended
June 30, June 30,
(in millions) 2004 2003 2004 2003
- ------------------------------------------------------------ -------- -------- -------- --------
Net sales:
Total net sales for reportable segments $ 1,439 $ 864 $ 2,483 $ 1,691
Foreign exchange 21 (10) 59 (30)
-------- -------- -------- --------
$ 1,460 $ 854 $ 2,542 $ 1,661
======== ======== ======== ========
Income before income taxes:
Total operating income allocated to reportable segments $ 769 $ 368 $ 1,228 $ 720
Manufacturing operations (82) (72) (164) (143)
Corporate expenses and foreign exchange (175) (111) (288) (217)
Litigation-related charges (7)
Purchased research and development (64) (12) (64) (25)
-------- -------- -------- --------
448 173 712 328
Other income (expense), net (16) (12) (25) (27)
-------- -------- -------- --------
$ 432 $ 161 $ 687 $ 301
======== ======== ======== ========
20
ITEM 2: MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS
OVERVIEW
Boston Scientific Corporation (Boston Scientific or the Company) is a worldwide
developer, manufacturer and marketer of medical devices that are used in a broad
range of interventional medical specialties. The Company's mission is to improve
the quality of patient care and the productivity of health care delivery through
the development and advocacy of less-invasive medical devices and procedures.
This is accomplished through the continuing refinement of existing products and
procedures and the investigation and development of new technologies that can
reduce risk, trauma, cost, procedure time and the need for aftercare. The
Company's approach to innovation combines internally developed products and
technologies with those obtained externally through strategic acquisitions and
alliances.
The Company's products are used in a broad range of interventional medical
specialties, including interventional cardiology, peripheral interventions,
vascular surgery, neurovascular intervention, electrophysiology, endoscopy,
oncology, urology and gynecology.
RESULTS OF OPERATIONS
FINANCIAL SUMMARY
THREE MONTHS ENDED JUNE 30, 2004
Net sales for the three months ended June 30, 2004 were $1,460 million as
compared to $854 million for the three months ended June 30, 2003, an increase
of 71 percent. Excluding the favorable impact of $31 million of foreign currency
fluctuations, net sales increased 67 percent. The reported net income for the
three months ended June 30, 2004 was $313 million, or $0.36 per share (diluted),
as compared to $114 million, or $0.13 per share, for the three months ended June
30, 2003. The reported results for the three months ended June 30, 2004 included
after-tax charges of $64 million, or $0.07 per share, consisting of purchased
research and development costs attributable to the recent acquisitions of
Advanced Bionics Corporation (Advanced Bionics) and Precision Vascular Systems,
Inc. (PVS). The reported results for the three months ended June 30, 2003
included after-tax charges of $12 million, or $0.01 per share, consisting of
purchased research and development costs attributable to acquisitions that
closed in the first quarter of 2003.
21
SIX MONTHS ENDED JUNE 30, 2004
Net sales for the six months ended June 30, 2004 were $2,542 million as compared
to $1,661 million for the six months ended June 30, 2003, an increase of 53
percent. Excluding the favorable impact of $89 million due to foreign currency
fluctuations, net sales increased approximately 48 percent. The reported net
income for the six months ended June 30, 2004 was $507 million, or $0.59 per
share (diluted), as compared to $211 million, or $0.25 per share, for the six
months ended June 30, 2003. The reported results for the six months ended June
30, 2004 included after-tax charges of $64 million, or $0.07 per share,
consisting of purchased research and development costs attributable to the
Company's recent acquisitions. The reported results for the six months ended
June 30, 2003 included after-tax charges of $32 million, or $0.04 per share,
consisting of purchased research and development costs of $25 million
attributable to acquisitions that closed in the first quarter of 2003 and a $7
million charge related to litigation.
The results for the three and six months ended June 30, 2004 included the net
impact of the recall of certain units of the Company's Taxus(TM) Express(2)(TM)
paclitaxel-eluting coronary stent systems and Express(2)(TM) coronary stent
systems, in the amount of $57 million (after-tax). The recall impact consists of
the establishment of a sales returns reserve of $35 million and an inventory
write-down of $43 million.
NET SALES
The following tables provide worldwide net sales by region and relative change
on an as reported and constant foreign currency basis for the three and six
months ended June 30, 2004 and 2003, respectively:
22
Three Months Change
Ended June 30, As Reported Constant
(in millions) 2004 2003 Currency Basis Currency Basis
-------- -------- -------- --------
UNITED STATES $ 944 $ 482 96% 96%
EUROPE 236 165 43% 34%
JAPAN 157 134 17% 8%
INTER-CONTINENTAL 123 73 68% 63%
-------- -------- -------- --------
INTERNATIONAL 516 372 39% 30%
-------- -------- -------- --------
WORLDWIDE $ 1,460 $ 854 71% 67%
======== ======== ======== ========
Six Months Change
Ended June 30, As Reported Constant
2004 2003 Currency Basis Currency Basis
-------- -------- -------- --------
UNITED STATES $ 1,520 $ 961 58% 58%
EUROPE 471 310 52% 37%
JAPAN 312 260 20% 10%
INTER-CONTINENTAL 239 130 84% 70%
-------- -------- -------- --------
INTERNATIONAL 1,022 700 46% 33%
-------- -------- -------- --------
WORLDWIDE $ 2,542 $ 1,661 53% 48%
======== ======== ======== ========
United States (U.S.) revenues increased primarily due to $468 million and $566
million in sales of the TAXUS stent system during the three and six months ended
June 30, 2004, respectively. The Company commenced its tiered U.S. launch of the
TAXUS stent system late in the first quarter of 2004. The increase was offset by
declines in bare metal stent revenue of approximately $49 million and $96
million during the three and six months ended June 30, 2004, respectively, as
physicians continued to convert interventional procedures from bare metal to
drug-eluting stent technology, including the TAXUS stent system. The Company
estimates that, as of June 30, 2004, physicians have converted more than 80
percent of the stents used in interventional procedures in the U.S. from bare
metal stent systems to drug-eluting stent systems, as compared to approximately
50 percent at December 31, 2003. The remainder of the increase in U.S. revenues
was related to sales growth in each of the Company's other five U.S. divisions.
International revenues increased primarily due to $129 million and $247 million
in sales for the three and six months ended June 30, 2004, respectively, of the
TAXUS stent system in the Company's Europe and Inter-Continental markets as
compared to $32 million and $39 million, respectively, in the same periods in
the prior year. The TAXUS stent system was launched in these markets late in the
first quarter of 2003. The increase in international revenues was also
attributable to revenue growth of approximately $23 million and $52 million in
Japan during the three and six months ended June 30, 2004,
23
respectively, following the launch of the Express(2) coronary stent system in
the first quarter of 2004.
Worldwide coronary stent sales increased approximately 430 percent and 293
percent, respectively, to $652 million and $936 million for the three and six
months ended June 30, 2004, respectively, as compared to the same periods in the
prior year. The increase was primarily due to $597 million and $813 million in
sales of the TAXUS stent system for the three and six months ended June 30,
2004, respectively, as compared to $32 million and $39 million in the same
periods in the prior year. The increase was offset by declines in bare metal
stent revenue of $36 million and $76 million for the three and six months ended
June 30, 2004, respectively, as physicians continued to convert interventional
procedures from bare metal to drug-eluting stent technology, including the TAXUS
stent system.
The following tables provide worldwide net sales by division and relative change
on an as reported and constant foreign currency basis for the three and six
months ended June 30, 2004 and 2003, respectively:
24
Three Months Change
Ended June 30, As Reported Constant
(in millions) 2004 2003 Currency Basis Currency Basis
-------- -------- -------- --------
Cardiovascular $ 1,092 $ 532 105% 100%
Electrophysiology 31 28 11% 12%
Neurovascular 62 55 13% 8%
-------- -------- -------- --------
CARDIOVASCULAR 1,185 615 93% 88%
Oncology 45 41 10% 8%
Endoscopy 159 144 10% 7%
Urology 64 54 19% 14%
-------- -------- -------- --------
ENDOSURGERY 268 239 12% 9%
Neuromodulation 7 N/A N/A
-------- -------- -------- --------
WORLDWIDE $ 1,460 $ 854 71% 67%
======== ======== ======== ========
Six Months Change
Ended June 30, As Reported Constant
2004 2003 Currency Basis Currency Basis
-------- -------- -------- --------
Cardiovascular $ 1,815 $ 1,034 76% 69%
Electrophysiology 63 55 15% 11%
Neurovascular 126 106 19% 13%
-------- -------- -------- --------
CARDIOVASCULAR 2,004 1,195 68% 61%
Oncology 91 79 15% 11%
Endoscopy 317 282 12% 8%
Urology 123 105 17% 13%
-------- -------- -------- --------
ENDOSURGERY 531 466 14% 10%
Neuromodulation 7 N/A N/A
-------- -------- -------- --------
WORLDWIDE $ 2,542 $ 1,661 53% 48%
======== ======== ======== ========
The Company's international operating regions and divisions are managed on a
constant currency basis, while market risk from changes in currency exchange
rates is managed at the corporate level and is reflected in operating results.
25
GROSS PROFIT
Three Months Ended Six Months Ended
June 30, June 30,
2004 2003 2004 2003
-------------------------- ------------------------- --------------------------- ------------------------
(in millions) $ % of Net Sales $ % of Net Sales $ % of Net Sales $ % of Net Sales
- ----------------- ----- -------------- ----- -------------- ----- -------------- ----- --------------
Gross Profit 1,097 75.1 619 72.5 1,887 74.2 1,200 72.2
The increase in gross profit during the three months ended June 30, 2004 was
primarily due to an approximately 700 basis point increase as a result of shifts
in the Company's product sales mix toward higher margin products, primarily
drug-eluting coronary stents. The increase in the Company's gross profit
percentage was offset by approximately 300 basis points related to the $43
million (pre-tax) write-down of inventory in conjunction with the recall of
coronary stent systems. In addition, gross profit as a percentage of net sales
was reduced by approximately 50 basis points attributable to other expenses
primarily associated with the increase in the number of units manufactured; and
by approximately 40 basis points due to currency translation hedging that was
offset by foreign currency fluctuations.
The increase in gross profit during the six months ended June 30, 2004 was
primarily due to an approximately 560 basis point increase as a result of shifts
in the Company's product sales mix toward higher margin products, primarily
drug-eluting coronary stents. The increase in the Company's gross profit
percentage was offset by approximately 220 basis points related to $57 million
(pre-tax) in inventory write-downs, primarily attributable to the recall of
coronary stent systems of $43 million (pre-tax) recorded in the second quarter
of 2004 and the write-down of TAXUS inventory of $14 million (pre-tax) recorded
in the first quarter of 2004 due to shelf-life dating. In addition, gross profit
as a percentage of net sales was reduced by approximately 70 basis points
attributable to other expenses primarily associated with the increase in the
number of units manufactured; and by approximately 40 basis points due to
currency translation hedging that was offset by foreign currency fluctuations.
OPERATING EXPENSES
The following is a summary of certain operating expenses for the three months
and the six months ended June 30, 2004 and 2003:
Three Months Ended Six Months Ended
June 30, June 30,
2004 2003 2004 2003
------------- ------------- ------------- -------------
% of Net % of Net % of Net % of Net
(in millions) $ Sales $ Sales $ Sales $ Sales
- -------------------------------------------- ---- ---- ---- ---- ---- ---- ---- ----
Selling, general and administrative expenses 375 25.7 292 34.2 723 28.4 563 33.9
Amortization expense 26 1.8 21 2.5 48 1.9 41 2.5
Royalties 52 3.6 13 1.5 74 2.9 25 1.5
Research and development expenses 132 9.0 108 12.6 266 10.5 211 12.7
26
SELLING, GENERAL AND ADMINISTRATIVE (SG&A) EXPENSES
For the three and six months ended June 30, 2004, the increase in SG&A expenses
was primarily related to approximately $45 million and $80 million,
respectively, in additional marketing programs, increased headcount and higher
employee compensation, primarily attributable to the TAXUS stent program, and,
to a lesser degree, to support the Company's other product franchises; and
approximately $10 million and $20 million, respectively, in increased expense
due to foreign currency fluctuations. The Company also experienced increases in
general and administrative expenses of approximately $20 million and $40 million
in the three and six months ended June 30, 2004, respectively, as compared to
the same periods in the prior year. The decrease in SG&A expenses as a
percentage of net sales was primarily attributable to the Company's efforts to
grow SG&A spending at a slower rate than revenue.
AMORTIZATION EXPENSE
The increase in amortization expense in the three and six months ended June 30,
2004 was primarily attributable to the amortization of intangible assets from
the acquisitions of Advanced Bionics and PVS. Amortization relating to these two
acquisitions for the remainder of 2004 will be approximately $15 million.
ROYALTIES
The increase in royalties for the three and six months ended June 30, 2004 was
due to increased sales of royalty-bearing products. Royalties attributable to
sales of the Company's TAXUS stent system increased by approximately $40 million
and $50 million for the three and six months ended June 30, 2004, respectively,
as compared to the same periods in the prior year.
RESEARCH AND DEVELOPMENT EXPENSES
The increase in research and development expenses reflects spending on new
product development programs as well as regulatory compliance and clinical
research. During the three and six months ended June 30, 2004, the Company
continued to invest heavily in its research and development efforts. The growth
in dollar spending reflects investment across multiple programs and divisions.
INTEREST EXPENSE AND OTHER, NET
Interest expense was $14 million and $12 million for the three months ended June
30, 2004 and 2003, respectively, and $25 million and $23 million for the six
months ended June 30, 2004 and 2003, respectively. The increase in interest
expense for the three and six months ended June 30, 2004 was primarily due to
the increase in average debt levels, which were partially offset by a decrease
in average interest rates.
Other, net, was expense of $2 million and income of less than $1 million for the
three months ended June 30, 2004 and 2003, respectively, and was expense of less
than $1 million and expense of $4 million for the six months ended June 30, 2004
and 2003, respectively. Included in other, net for the three and six months
ended June 30, 2004 were realized gains of $17 million and $32 million,
respectively, related to sales of investments and write-downs of $9 million and
$25 million, respectively, related to other
27
than temporary declines in the book value of certain investments in privately
held entities. The Company does not believe that these write-downs of assets
will have a material impact on future operations. Other, net was also impacted
by foreign currency transaction gains and losses that were not individually
significant.
TAX RATE
The Company's reported tax rate was 28 percent and 29 percent for the three
months ended June 30, 2004 and 2003, respectively, and was 26 percent and 30
percent for the six months ended 2004 and 2003, respectively. The decrease in
the Company's reported tax rate was due primarily to more revenue being
generated from products manufactured in lower tax jurisdictions during the three
and six months ended June 30, 2004, as compared to the same periods in the prior
year. The decrease was partially offset by an increase in purchased research and
development charges to $64 million for both the three and six months ended June
30, 2004 as compared to $12 million and $25 million for the three and six months
ended June 30, 2003, respectively. These charges are not deductible for tax
purposes. Management currently estimates that the 2004 effective tax rate will
remain at approximately 24 percent, net of special charges. However, the
effective tax rate could be impacted positively or negatively by geographic
changes in the manufacturing of products sold by the Company or by business
acquisitions.
The Company had recognized net deferred tax liabilities aggregating $39 million
at June 30, 2004 and net deferred tax assets aggregating $94 million at December
31, 2003. The fluctuation in the Company's deferred tax accounts is primarily
due to the intangible assets obtained in connection with the acquisition of
Advanced Bionics and PVS. In light of the Company's historical financial
performance, the Company believes that its deferred tax assets will be
substantially recovered.
PURCHASED RESEARCH AND DEVELOPMENT
The Company's purchased research and development charges recorded during the six
months ended June 30, 2004 relate to the acquisitions of Advanced Bionics and
PVS.
On June 1, 2004, the Company completed its acquisition of 100 percent of the
fully diluted equity of Advanced Bionics for an initial payment of approximately
$740 million in cash, plus earn out payments that are contingent upon Advanced
Bionics products reaching future performance milestones. Advanced Bionics has
developed or is developing implantable microelectronic technologies for treating
numerous neurological disorders. Its neuromodulation technology includes a range
of neurostimulators (or implantable pulse generators), programmable drug pumps
and cochlear implants. The acquisition was intended to expand the Company's
technology portfolio into the implantable microelectronic device market. The
Advanced Bionics acquisition was structured to include earnout payments that are
primarily contingent on the achievement of future performance milestones, with
certain milestone payments also tied to profitability. The performance
milestones are segmented by Advanced Bionics' four principal technology
platforms (cochlear implants, implantable pulse generators, drug pumps and bion
microstimulators), each milestone with a 72-month earnout horizon from the date
of the anticipated product launch. Base earnout payments on these performance
milestones approximate two and a quarter times incremental sales for each annual
period. There are
28
also bonus earnout payments available based on the attainment of certain
aggregate sales performance targets and a certain gross margin level. The
milestones associated with the contingent consideration must be reached in
certain future periods ranging from 2004 through 2013.
On April 2, 2004, the Company completed its acquisition of the remaining
outstanding shares of PVS for an initial payment of approximately $75 million in
cash, plus earnout payments that are contingent upon PVS products reaching
future performance milestones. PVS develops and manufactures guidewires and
microcatheter technology for use in accessing the brain, the heart and other
areas of the anatomy. The acquisition of PVS was intended to provide the Company
with expanded vascular access technology and an expanded intellectual property
portfolio.
The Company's condensed consolidated financial statements include Advanced
Bionics' and PVS' operating results from the date of acquisition. See Note E for
pro forma information that presents a summary of consolidated results of
operations of the Company and Advanced Bionics as if the acquisition had
occurred at the beginning of each of 2003 and 2004. Pro forma information is not
presented for PVS, as PVS' results of operations prior to its date of
acquisition are not significant in relation to the Company's consolidated
results.
The amounts paid for each acquisition have been allocated to the assets acquired
and liabilities assumed based on their fair values at the date of acquisition.
The estimated excess of purchase price over the fair value of the net tangible
assets acquired was allocated to identifiable intangible assets based on
detailed valuations. The Company's purchased research and development charges
are based upon these valuations. The valuation of purchased research and
development represents the estimated fair value at the date of acquisition
related to in-process projects. As of the date of acquisition, the in-process
projects had not yet reached technological feasibility and had no alternative
future uses. The primary basis for determining the technological feasibility of
these projects is obtaining regulatory approval to market the products in an
applicable geographical region. Accordingly, the value attributable to these
projects, which had not yet obtained regulatory approval, was expensed in
conjunction with the acquisition. If the projects are not successful, or
completed in a timely manner, the Company may not realize the financial benefits
expected for these projects.
The income approach was used to establish the fair values of purchased research
and development. This approach establishes fair value by estimating the
after-tax cash flows attributable to the in-process project over its useful life
and then discounting these after-tax cash flows back to a present value. Revenue
estimates were based on estimates of relevant market sizes, expected market
growth rates, expected trends in technology and expected product introductions
by competitors. In arriving at the value of the in-process research and
development projects, the Company considered, among other factors, the
in-process project's stage of completion, the complexity of the work completed
as of the acquisition date, the costs already incurred, the projected costs to
complete, the contribution of core technologies and other acquired assets, the
expected introduction date and the estimated useful life of the technology. The
discount rate used to arrive at a
29
present value as of the date of acquisition was based on the time value of money
and medical technology investment risk factors. For the purchased research and
development programs acquired in connection with the Company's 2004
acquisitions, risk-adjusted discount rates ranging from 18 percent to 27 percent
were utilized to discount the projected cash flows. The Company believes that
the estimated purchased research and development amounts so determined represent
the fair value at the date of acquisition and do not exceed the amount a third
party would pay for the projects.
The most significant in-process projects acquired in connection with the
Company's 2004 acquisitions include Advanced Bionics' bion(TM) microstimulator
and drug delivery pump, which collectively represent approximately 77 percent of
the 2004 in-process projects value. The bion microstimulator is an implantable
neurostimulation device that may be used to treat a variety of neurological
conditions, including urge incontinence, epilepsy, sleep apnea, erectile
dysfunction and migraine headaches. The cost to complete the bion
microstimulator is estimated to be between $35 million and $45 million. The drug
delivery pump is an implanted programmable device used to treat chronic pain.
The cost to complete the drug delivery pump is estimated to be between $30
million and $40 million. As of the date of acquisition, the products were
expected to be commercially available on a worldwide basis within three to four
years.
The Company's research and development projects acquired in connection with its
previous business combinations are generally progressing in line with the
estimates set forth in the Company's 2003 Annual Report on Form 10-K. The
Company expects to continue to pursue these research and development efforts and
believes it has a reasonable chance of completing the projects.
OUTLOOK
During the second quarter of 2004, the Company increased its revenue by 71
percent, its reported net income by 175 percent and its operating cash flow by
117 percent relative to the second quarter of 2003, primarily due to sales of
its TAXUS stent system that was approved for sale in the U.S. on March 4, 2004.
The Company estimates that the 2004 worldwide coronary stent market will
approach $4.7 billion, and may grow to approximately $5 billion in 2005. The
Company believes it can maintain and expand its position within this market for
a variety of reasons, including its years of scientifically rigorous research
and development, the results of its TAXUS clinical program, the combined
strength of the components of its technology, its overall market leadership, and
its sizeable interventional cardiology sales force. In addition, in order to
capitalize on this opportunity, the Company has made significant investments in
its sales, clinical, marketing and manufacturing capabilities.
On July 2, the Company announced the voluntary recall of approximately 200 TAXUS
Express(2) coronary stent systems, due to characteristics in the delivery
catheters that have the potential to impede balloon deflation during a coronary
angioplasty procedure. Further analysis and investigation of the TAXUS
Express(2) (paclitaxel-eluting) and Express(2) (bare metal) stent systems, both
of which share the same delivery catheter, revealed that certain additional
production lots exhibited these same characteristics. As
30
a result, on July 16, the Company announced that it was voluntarily expanding
the recall. The recall involved approximately 85,000 TAXUS stent systems and
approximately 11,000 Express(2) stent systems. On August 5, as a result of
ongoing monitoring, the Company announced that it was expanding the recall to
include approximately 3,000 additional TAXUS stent systems. The additional stent
systems remained within the parameters of the July 16 action. Overall, the
Company has shipped more than 600,000 TAXUS stent systems and more than 600,000
Express(2) stent systems. The Company continues to work with the Food and Drug
Administration (FDA) to monitor the deflation problem and will take additional
actions as necessary in the interest of patient safety.
As a result of its investigation, the Company has implemented reviews of its
manufacturing process, additional inspections, and an FDA-approved modification
to the manufacturing process for these products. The Company believes these
measures will be effective in reducing the occurrence of balloon non-deflation.
Following the recall, the Company increased its production of coronary stents
and used its existing supply of coronary stents not subject to the recall to
replenish the U.S. market. In addition, the Company believes that it will be
able to replenish the Europe and Inter-Continental markets during the third
quarter of 2004. However, the Company's ability to achieve the level of
interventional cardiology sales it had attained prior to the recall, and to
build on this sales level, may be impacted by physician confidence in the TAXUS
stent system, their return to historical purchasing patterns, and the
availability of TAXUS stent systems and competing drug-eluting stent products.
The worldwide coronary stent market is dynamic and highly competitive with
significant market share volatility. A material decline in the Company's
coronary stent revenue would likely have a material adverse impact on the future
operating results of the Company. The most significant variables impacting the
size of the coronary stent market and the Company's position within this market
include the adoption rate of drug-eluting stent technology, reimbursement
policies, the timing of new competitive launches, the average selling prices of
drug-eluting stent systems, delayed or limited regulatory approvals, unexpected
variations in clinical results or product performance, continued physician
acceptance, the availability of inventory to meet customer demand, the average
number of stents used per procedure, third-party intellectual property and the
outcome of litigation. Inconsistent clinical data from ongoing or future trials
conducted by the Company, or additional clinical data presented by the Company's
competitors, may impact the Company's position in and share of the drug-eluting
stent market.
Physicians have rapidly adopted drug-eluting technology in the U.S. The Company
believes that the more gradual adoption rates in Europe as compared to the U.S.
are primarily due to the timing of local reimbursement and funding levels. A
more gradual physician adoption rate may limit the number of procedures in which
the technology may be used and the price at which institutions may be willing to
purchase the technology.
The Company's drug-eluting stent system is currently one of only two
drug-eluting products in the market. The Company expects its share of the
drug-eluting stent market as well as unit prices to be adversely impacted as
additional competitors enter the drug-eluting stent market, which the Company
anticipates during 2004 and 2005
31
internationally and during 2006 in the U.S. During the second quarter of 2004,
one of the Company's competitors launched its drug-eluting stent in Japan. Until
the Company launches its drug-eluting stent in Japan, which is expected in 2006,
it is likely that its Japan coronary stent business will be subject to
significant share pressure. The Company anticipates launching its next
generation drug-eluting stent product, the Taxus(TM) Liberte(TM) coronary stent
system, in certain international markets in 2005 and in the U.S. in 2006,
subject to regulatory approval.
The manufacture of the TAXUS stent system involves the integration of multiple
technologies and complex processes. During 2004, the Company increased the
amount of TAXUS inventory on hand to meet the forecasted demand for the product.
Expected inventory levels may be impacted by replenishing recalled units,
significant favorable or unfavorable changes in forecasted demand and
disruptions associated with the TAXUS manufacturing process. In addition,
variability in expected demand, product mix and shelf-life may result in excess
or expired inventory positions and additional future inventory charges.
Further, there continues to be significant intellectual property litigation in
the coronary stent market. The Company is currently involved in a number of
legal proceedings with its competitors, including Johnson & Johnson, Medtronic
and Medinol Ltd. There can be no assurance that an adverse outcome in one or
more of these proceedings would not impact the Company's ability to meet its
objectives in the market. See the notes to the unaudited condensed consolidated
financial statements contained in this Quarterly Report, the Quarterly Report on
Form 10-Q for the quarter ended March 31, 2004 and the 2003 Annual Report filed
on Form 10-K for a description of these legal proceedings.
Since early 2001, the Company has consummated several business acquisitions.
Management believes it has developed a sound plan to integrate these businesses.
However, the failure to successfully integrate these businesses could impair the
Company's ability to realize the strategic and financial objectives of these
transactions. In connection with these acquisitions and other strategic
alliances, the Company has acquired numerous in-process research and development
platforms. As the Company continues to undertake strategic initiatives, it is
reasonable to assume that it will acquire additional in-process research and
development platforms.
In addition, the Company has entered a significant number of strategic alliances
with privately held and publicly traded companies. Many of these alliances
involve equity investments by the Company. The Company enters these strategic
alliances to broaden its product technology portfolio and to strengthen and
expand the Company's reach into existing and new markets. The success of these
alliances is an important element of the Company's growth strategy. However, the
full benefit of these alliances is often dependent on the strength of the other
companies' underlying technology. The inability to achieve regulatory approvals,
competitive product offerings, or litigation related to this technology may,
among other factors, prevent the Company from realizing the benefit of these
alliances. The Company regularly reviews its investments to determine whether
these investments are impaired. If so, the carrying value is written down to
fair value in the period identified. The Company's exposure to loss related to
its strategic
32
alliances is generally limited to its equity investments, notes receivable and
intangible assets associated with these alliances.
The Company expects to continue to invest significantly in its drug-eluting
stent program to achieve sustained worldwide market leadership positions. In
addition, the Company anticipates increasing its focus and spending on internal
research and development and other programs not associated with its TAXUS
drug-eluting stent technology. Further, the Company will continue to seek market
opportunities and growth through investments in strategic alliances and
acquisitions. Potential future acquisitions, including companies with whom
Boston Scientific currently has strategic alliances, may be dilutive to the
Company's earnings and may require additional financing, depending on their size
and nature.
International markets are also being affected by economic pressure to contain
reimbursement levels and health care costs. The Company's profitability from its
international operations may be limited by risks and uncertainties related to
economic conditions in these regions, foreign currency fluctuations, regulatory
and reimbursement approvals, competitive offerings, infrastructure development,
rights to intellectual property and the ability of the Company to implement its
overall business strategy. Any significant changes in the competitive,
political, regulatory, reimbursement or economic environment where the Company
conducts international operations may have a material impact on revenues and
profits, especially in Japan, given its high profitability relative to its
contribution to revenues. Further, the trend in countries around the world,
including Japan, toward more stringent regulatory requirements for product
clearance, changing reimbursement models, and more vigorous enforcement
activities has generally caused or may cause medical device manufacturers to
experience more uncertainty, greater risk and higher expenses. In addition, the
Company is required to renew regulatory approvals in certain international
jurisdictions, which may require additional testing and documentation. A
decision not to dedicate sufficient resources, or the failure to timely renew
these approvals, may limit the Company's ability to market its full line of
existing products within these jurisdictions.
These factors may impact the rate at which the Company can grow. However,
management believes that it continues to position the Company to take advantage
of opportunities that exist in the markets it serves.
33
LIQUIDITY AND CAPITAL RESOURCES
Key performance indicators used by management to assess the liquidity of the
Company are as follows:
Six Months Ended
June 30,
(in millions) 2004 2003
- ------------------------------------------------- -------- --------
Cash provided by operating activities $ 574 $ 354
Cash used for investing activities 1,241 506
Cash provided by financing activities 997 273
EBITDA(1) 825 411
EBITDA for the six months ended June 30, 2004 and 2003 included pre-tax charges
of $64 million and $32 million, respectively. These pre-tax charges consisted of
purchased research and development costs attributable to acquisitions and a
litigation charge.
OPERATING ACTIVITIES
The increase in cash generated by operating activities was primarily
attributable to the increase in EBITDA offset by changes in operating assets and
liabilities. The increase in EBITDA in the six months ended June 30, 2004 as
compared to the same period in the prior year was primarily due to the first
quarter launch of the TAXUS stent system in the U.S. and sales of the TAXUS
stent system in the Company's Europe and Inter-Continental markets. A portion of
the cash generated from TAXUS sales was invested in the Company's sales,
clinical and manufacturing capabilities and in other research and development
projects.
- --------------------------------------------------------------------------------
(1) The following represents a reconciliation between EBITDA and net income:
Six Months Ended
June 30,
(in millions) 2004 2003
- ------------------------------------------------- -------- --------
Net income $ 507 $ 211
Income taxes 180 90
Interest expense 25 23
Interest income (5) (2)
Depreciation and amortization 118 89
EBITDA $ 825 $ 411
Management uses EBITDA to assess operating performance and believes it may
assist users of the financial statements in analyzing the underlying trends in
the Company's business over time. Users of the Company's financial statements
should consider this non-GAAP financial information in addition to, not as a
substitute for, or as superior to, financial information prepared in accordance
with GAAP.
34
Significant cash flow effects from operating assets and liabilities in the six
months ended June 30, 2004 included decreases in cash flow of approximately $260
million attributable to accounts receivable, partially offset by an increase in
accounts payable and accrued expenses of approximately $65 million. The increase
in trade accounts receivable was primarily due to sales growth, where payment is
not due until the third quarter of 2004. The increase in accounts payable and
accrued expenses was primarily the result of the increase in amounts due for
royalties attributable to sales growth of royalty-bearing products, including
TAXUS stent systems, and an increase in employee-related accruals.
INVESTING ACTIVITIES
The Company made capital expenditures of $135 million during the six months
ended June 30, 2004 as compared to $74 million for the same period in the prior
year. The increase in capital expenditures was primarily due to spending of $45
million related to the purchase of an office complex in the U.S. during the six
months ended June 30, 2004. The Company expects to incur capital expenditures of
approximately $200 million during the remainder of 2004, which includes
additional investments in the Company's facility network both in the U.S. and
abroad.
During 2004, the Company continued to invest in securities with maturity dates
that exceeded 90 days to benefit from higher returns. During the six months
ended June 30, 2004, the Company purchased approximately $307 million of these
investments and approximately $99 million of these investments matured. The
Company's investing activities during the six months ended June 30, 2004 also
included $90 million of cash proceeds from sales of privately held and publicly
traded equity securities; $804 million of payments attributable to the current
year acquisitions, net of cash acquired; $81 million of acquisition-related
payments primarily associated with Embolic Protection, Inc. and Inflow Dynamics,
Inc.; and $103 million of payments for strategic alliances with both privately
held and publicly traded entities.
FINANCING ACTIVITIES
During the six months ended June 30, 2004, the Company received proceeds from
borrowings of $820 million. Proceeds from debt issuances were used principally
to fund the acquisitions of Advanced Bionics and PVS, and other strategic
alliances. The Company's net debt (borrowings less cash, cash equivalents, and
investments in debt securities) increased by $293 million to $1,266 million at
June 30, 2004 from $973 million at December 31, 2003. In addition, during the
six months ended June 30, 2004, the Company received proceeds of $177 million in
connection with the issuance of shares of its common stock pursuant to its stock
option and employee stock purchase plans as compared to $126 million for the
same period in the prior year.
The Company's cash and cash equivalents primarily relate to non-U.S. operations.
The repatriation of cash balances from certain of the Company's non-U.S.
operations could have adverse tax consequences; however, those balances are
generally available without legal restrictions to fund ordinary business
operations. During 2003, the Company determined that it is likely to repatriate
cash from certain non-U.S. operations; the repatriated cash available for use
will be net of the related provisions for taxes.
35
BORROWINGS AND CREDIT ARRANGEMENTS
During the first half of 2004, the Company refinanced its existing $1,200
million credit facilities. At June 30, 2004, the Company's revolving credit
facilities totaled $2,020 million, consisting of a $1,500 million credit
facility that terminates in May 2009; a $500 million 364-day credit facility
that terminates in May 2005 and contains an option to convert into a one-year
term loan maturing in May 2006; and a $20 million uncommitted credit facility.
Use of the borrowings is unrestricted and the borrowings are unsecured.
The revolving credit facilities provide borrowing capacity and support the
Company's commercial paper. The Company had approximately $1,046 million and
$1,003 million of commercial paper outstanding at June 30, 2004 and December 31,
2003, respectively, at weighted average interest rates of 1.33 percent and 1.20
percent, respectively.
In addition, the Company increased its borrowing capacity under its revolving
credit and security facility, which is secured by the Company's domestic trade
receivables, from $200 million to $400 million. The Company had approximately
$382 million and $194 million of borrowings outstanding under its revolving
credit and security facility at June 30, 2004 and December 31, 2003,
respectively, at weighted average interest rates of 1.46 percent and 1.44
percent, respectively. The Company expects to renew the revolving credit and
security facility for an additional 364 days upon its maturity in August 2004.
The Company has the ability and intent to refinance a portion of its short-term
debt on a long-term basis through its revolving credit facilities. At June 30,
2004, the Company expects that a minimum of approximately $1,150 million of its
short-term obligations will remain outstanding beyond the next twelve months
and, accordingly, has classified this portion as long-term borrowings, as
compared to $650 million of short-term bank obligations classified as long-term
at December 31, 2003.
The Company had $500 million of senior notes outstanding at June 30, 2004 and
December 31, 2003 that are due March of 2005. These notes are registered
securities, bear a semi-annual coupon of 6.625 percent and are not redeemable
prior to maturity or subject to any sinking fund requirements. The Company has
classified these notes as a current liability at June 30, 2004.
In June 2004, due to favorable market conditions, the continued increase of
non-U.S. cash balances and to support the Company's strategic growth objectives,
the Company issued $600 million of senior notes due June 2014 under a Public
Debt Registration Statement previously filed with the U.S. Securities and
Exchange Commission (SEC). These notes bear a semi-annual coupon of 5.45
percent, are redeemable prior to maturity and are not subject to any sinking
fund requirements. The Company entered a fixed-to-floating interest rate swap to
hedge against changes in the fair value of these notes. The Company recorded
changes in the fair value of these notes since the inception of the interest
rate swap. Interest payments made or received under the interest rate swap
agreement are recorded as interest expense. Interest is payable at the six-month
LIBOR rate plus zero percent, which was approximately 1.94 percent at June 30,
2004.
36
In the second half of 2004, the Company expects to file a Public Registration
Statement with the SEC for the issuance of up to $1,500 million in various debt
and equity securities. The Company may seek to issue approximately $500 million
in debt securities under this Public Registration Statement during the remainder
of 2004.
CONTRACTUAL OBLIGATIONS AND COMMITMENTS
Certain of the Company's business combinations involve contingent consideration.
These payments, if and when made, are allocated to specific intangible asset
categories, including purchased research and development, with the remainder
assigned to goodwill as if the consideration had been paid as of the date of
acquisition. Payment of the additional consideration is generally contingent
upon the acquired companies reaching certain performance milestones, including
achieving specified revenue levels, product development targets or regulatory
approvals. At June 30, 2004 and December 31, 2003, the Company had accruals for
acquisition-related obligations of approximately $13 million and $79 million,
respectively. These accruals were recorded primarily as adjustments to goodwill
and purchased research and development. In addition, at June 30, 2004, the
estimated maximum potential amount of future contingent consideration
(undiscounted) that the Company could be required to make associated with its
business combinations is approximately $3.2 billion, some of which may be
payable in the Company's common stock. Certain earnout payments are based on
multiples of the acquired company's revenue during the earnout period, and
consequently, the total payments are not currently determinable. However, the
Company has developed an estimate of the maximum potential contingent
consideration for each of its acquisitions with an outstanding earnout
obligation. The milestones associated with the contingent consideration must be
reached in certain future periods ranging from 2004 through 2013. The estimated
cumulative specified revenue level associated with these maximum future
contingent payments is approximately $7.0 billion.
PRODUCT LIABILITY CLAIMS
The Company is substantially self-insured with respect to general and product
liability claims. In the normal course of its business, product liability claims
are asserted against the Company. The Company accrues anticipated costs of
litigation and loss for product liability claims based on historical experience,
or to the extent they are probable and estimable. Losses for claims in excess of
the limits of purchased insurance are recorded in earnings at the time and to
the extent they are probable and estimable. Product liability claims against the
Company will likely be asserted in the future related to events not known to
management at the present time. The absence of third-party insurance coverage
increases the Company's exposure to unanticipated claims or adverse decisions.
However, based on product liability losses experienced in the past, the election
to become substantially self-insured is not expected to have a material impact
on future operations.
Management believes that the Company's risk management practices, including
limited insurance coverage, are reasonably adequate to protect against
anticipated general and product liability losses. However, unanticipated
catastrophic losses could have a material adverse impact on the Company's
financial position, results of operations and liquidity.
37
CAUTIONARY STATEMENTS FOR PURPOSES OF THE SAFE HARBOR PROVISIONS OF THE PRIVATE
SECURITIES LITIGATION REFORM ACT OF 1995
This report contains forward-looking statements. The Company desires to take
advantage of the Safe Harbor Provisions of the Private Securities Litigation
Reform Act of 1995 and is including this statement for the express purpose of
availing itself of the protections of the safe harbor with respect to all
forward-looking statements. Forward-looking statements discussed in this report
include, but are not limited to, statements with respect to, and the Company's
performance may be affected by:
o volatility in the coronary stent market, competitive offerings and the
timing of receipt of regulatory approvals to market existing and
anticipated drug-eluting stent technology and other coronary and peripheral
stent platforms;
o the Company's ability to continue significant growth in revenue, gross
profit, earnings and cash flow resulting from the sale of the TAXUS
drug-eluting stent system in the U.S., and to launch the TAXUS stent system
in Japan in 2006;
o the timing and continued availability of the TAXUS stent system in
sufficient quantities and mix, the Company's ability to prevent disruptions
to its TAXUS manufacturing processes and to maintain or replenish inventory
levels consistent with forecasted demand around the world;
o the impact of new drug-eluting stents on the size of the coronary stent
market and distribution of share within the coronary stent market in the
U.S. and around the world;
o the overall performance and continued physician confidence in drug-eluting
stents and the results of drug-eluting stent clinical trials undertaken by
the Company or its competitors;
o the Company's ability to capitalize on the opportunity in the drug-eluting
stent market for continued growth in revenue and earnings and to maintain
worldwide market leadership positions through reinvestment in the Company's
drug-eluting stent program;
o the Company's ability to take advantage of its position as one of two early
entrants in the U.S. drug-eluting stent market, to anticipate competitor
products as they enter the market and to take advantage of opportunities
that exist in the markets it serves;
o the ability of the Company to manage inventory levels, accounts receivable
and gross margins relating to the Company's TAXUS stent system and to react
effectively to worldwide economic and political conditions;
o the Company's ability to successfully develop programs not associated with
its TAXUS drug-eluting stent technology;
o the Company's ability to manage research and development and other
operating expenses in light of significant expected revenue growth;
o the Company's ability to achieve benefits from its increased focus on
internal research and development and its ability to capitalize on
opportunities across its businesses;
o the Company's ability to integrate the acquisitions and other strategic
alliances it has consummated since early 2001;
38
o the Company's ability to successfully complete planned clinical trials and
to develop and launch products on a timely basis within cost estimates,
including the successful completion of in-process projects from purchased
research and development;
o the timing, size and nature of strategic initiatives, market opportunities
and research and development platforms available to the Company and the
ultimate cost and success of these initiatives;
o the Company's ability to maintain a 24 percent effective tax rate,
excluding net special charges, during 2004 and to substantially recover its
deferred tax assets;
o the ability of the Company to meet its projected cash needs over the next
twelve months, to maintain borrowing flexibility and to renew or refinance
its borrowings beyond the next twelve months;
o the Company's ability to issue debt or equity securities on terms
reasonably acceptable to the Company;
o risks associated with international operations including compliance with
local legal and regulatory requirements;
o the potential effect of foreign currency fluctuations and interest rate
fluctuations on revenues, expenses and resulting margins;
o the effect of litigation, risk management practices including self
insurance, and compliance activities on the Company's loss contingency,
legal provision and cash flow; and
o the impact of stockholder, patent, product liability, Medinol Ltd. and
other litigation, as well as the ultimate outcome of the U.S. Department of
Justice investigation.
Several important factors, in addition to the specific factors discussed in
connection with each forward-looking statement individually, could affect the
future results and growth rates of the Company and could cause those results and
rates to differ materially from those expressed in the forward-looking
statements contained in this report. These additional factors include, among
other things, future economic, competitive, reimbursement and regulatory
conditions, new product introductions, demographic trends, third-party
intellectual property, financial market conditions and future business decisions
of the Company and its competitors, all of which are difficult or impossible to
predict accurately and many of which are beyond the control of the Company.
Therefore, the Company wishes to caution each reader of this report to consider
carefully these factors as well as the specific factors discussed with each
forward-looking statement in this report and as disclosed in the Company's
filings with the Securities and Exchange Commission. These factors, in some
cases, have affected, and in the future (together with other factors) could
affect, the ability of the Company to implement its business strategy and may
cause actual results to differ materially from those contemplated by the
statements expressed in this report.
ITEM 3: QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
The Company had currency derivative instruments outstanding in the notional
amount of $3,107 million and $1,724 million at June 30, 2004 and December 31,
2003, respectively. The Company recorded $37 million of assets and $34 million
of liabilities to recognize the fair value of these instruments at June 30,
2004, compared to $15 million of assets
39
and $84 million of liabilities to recognize the fair value of these instruments
at December 31, 2003. A 10 percent appreciation in the U.S. dollar's value
relative to the hedged currencies would increase the derivative instruments'
fair value by $120 million and $105 million at June 30, 2004 and December 31,
2003, respectively. A 10 percent depreciation in the U.S. dollar's value
relative to the hedged currencies would decrease the derivative instruments'
fair value by $122 million and $128 million at June 30, 2004 and December 31,
2003, respectively. Any increase or decrease in the fair value of the Company's
currency exchange rate sensitive derivative instruments would be substantially
offset by a corresponding decrease or increase in the fair value of the hedged
underlying asset, liability or cash flow.
The Company's earnings and cash flow exposure to interest rates consists of
fixed and floating rate debt instruments that are denominated primarily in U.S.
dollars and Japanese yen. The Company uses interest rate derivative instruments
to manage its exposure to interest rate movements and to reduce borrowing costs
by converting floating rate debt into fixed rate debt or fixed rate debt into
floating rate debt. The Company had interest rate derivative instruments
outstanding in the notional amount of $1,100 million and $500 million at June
30, 2004 and December 31, 2003, respectively. The fair values of these
instruments recorded on the Company's consolidated balance sheets at June 30,
2004 and December 31, 2003 are not material. A 100 basis point increase in
global interest rates would decrease the derivative instruments' fair value by
$51 million at June 30, 2004, compared to $7 million at December 31, 2003. A 100
basis point decrease in global interest rates would increase the derivative
instruments' fair value by $56 million at June 30, 2004, compared to $7 million
at December 31, 2003. Any increase or decrease in the fair value of the
Company's interest rate sensitive derivative instruments would be substantially
offset by a corresponding decrease or increase in the fair value of the hedged
underlying liability.
ITEM 4: CONTROLS AND PROCEDURES
EVALUATION OF DISCLOSURE CONTROLS AND PROCEDURES
The Company's management, with the participation of the Company's President and
Chief Executive Officer and Senior Vice President - Finance & Administration and
Chief Financial Officer, evaluated the effectiveness of the Company's disclosure
controls and procedures as of June 30, 2004 pursuant to Rule 13a-15(b) of the
Exchange Act. Disclosure controls ensure that material information required to
be disclosed by the Company in the report that it files or submits under the
Exchange Act is recorded, processed, summarized and reported within the time
periods specified in the SEC's rules and forms and ensure that such material
information is accumulated and communicated to the Company's management,
including the Company's Chief Executive Officer and Chief Financial Officer, as
appropriate to allow timely decisions regarding required disclosure. Based on
their evaluation, the Company's Chief Executive Officer and Chief Financial
Officer concluded that as of June 30, 2004, the Company's disclosure controls
and procedures were effective. It should be noted that any system of controls is
designed to provide reasonable, but not absolute, assurances that the system
will achieve its stated goals under all potential circumstances.
40
CHANGES IN INTERNAL CONTROL OVER FINANCIAL REPORTING
During the quarter ended June 30, 2004, there were no changes in the Company's
internal controls over financial reporting that have materially affected, or are
reasonably likely to materially affect, the Company's internal control over
financial reporting.
41
PART II
OTHER INFORMATION
ITEM 1: LEGAL PROCEEDINGS
Note I - Commitments and Contingencies to the Company's unaudited
condensed consolidated financial statements contained elsewhere in this
Quarterly Report is incorporated herein by reference.
ITEM 4: SUBMISSIONS OF MATTERS TO A VOTE OF SECURITY HOLDERS
The Annual Meeting of Stockholders of the Company was held on May
11, 2004, at which the Company's stockholders voted on:
(i) the election of four Class III Directors of the Company to
hold office until the 2007 Annual Meeting of Stockholders;
and
(ii) the ratification of the appointment of Ernst & Young LLP as
the Company's independent auditors for the fiscal year
ending December 31, 2004.
A total of 680,918,461 shares, or approximately 82%, of the
Company's common stock were present or represented by proxy at the
meeting. The matters listed above were voted upon as follows:
(i) The individuals named below were re-elected to a three-year
term as Class III directors:
--------------------------------------- --------------------------
VOTES VOTES
NOMINEES FOR WITHHELD
--------------------------------------- --------------------------
Class III
--------------------------------------- ------------- ------------
Ursula M. Burns 667,544,495 13,373,966
--------------------------------------- ------------- ------------
Marye Anne Fox 658,547,902 22,370,559
--------------------------------------- ------------- ------------
N.J. Nicholas, Jr. 653,033,560 27,884,901
--------------------------------------- ------------- ------------
John E. Pepper 648,615,795 32,302,666
--------------------------------------- ------------- ------------
John E. Abele, Joel L. Fleishman, Ray J. Groves, Ernest Mario,
Peter M. Nicholas, Uwe E. Reinhardt, Senator Warren B. Rudman and
James R. Tobin all continue to serve as directors of the Company.
(ii) The ratification of the appointment of Ernst & Young LLP as
the Company's independent auditors for the fiscal year
ending December 31, 2004 was approved by a vote of
647,961,784 shares voting for, 29,213,338 shares voting
against and 3,743,339 abstaining.
42
ITEM 6: EXHIBITS AND REPORTS ON FORM 8-K
(a) Exhibits
10.1 Form of Amendment #4 to Credit and Security
Agreement dated as of May 20, 2004
10.2 Form of $1,500,000,000 Multi-Year Revolving Credit
Agreement dated as of May 14, 2004
10.3 Form of $500,000,000 364-Day Revolving Credit
Agreement dated as of May 14, 2004
31.1 Certification of the Chief Executive Officer
pursuant to Section 302 of the Sarbanes-Oxley Act of
2002
31.2 Certification of the Chief Financial Officer
pursuant to Section 302 of the Sarbanes-Oxley Act of
2002
32.1 Certification Pursuant to Section 906 of the
Sarbanes-Oxley Act of 2002, President and Chief
Executive Officer
32.2 Certification Pursuant to Section 906 of the
Sarbanes-Oxley Act of 2002, Senior Vice President
and Chief Financial Officer
(b) Reports on Form 8-K
The following reports were filed during the quarter ended
June 30, 2004:
Form 8-K Date of Event Description
-------- ------------- -----------
Items 2, 9 June 1, 2004 Announcement of execution
of Merger Agreement to
acquire 100 percent of the
fully diluted equity of
Advanced Bionics
Corporation
Item 2, 7 June 4, 2004 Announcement of completion
of acquisition of Advanced
Bionics Corporation
Item 5 June 22, 2004 Announcement of launch of
public debt offering
Item 5, 7 June 25, 2004 Announcement of issuance
of $600 million aggregate
principal amount of 5.45%
senior notes under the
Company's existing shelf
registration statement
43
SIGNATURE
Pursuant to the requirements of the Securities Exchange Act of 1934, the
registrant has duly caused this report to be signed on its behalf by the
undersigned thereunto duly authorized on August 9, 2004.
BOSTON SCIENTIFIC CORPORATION
By: /s/ Lawrence C. Best
--------------------------------------
Name: Lawrence C. Best
Title: Chief Financial Officer and Senior
Vice President - Finance and
Administration
44