Attached files
| file | filename |
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| 8-K - FORM 8K DATED DECEMBER 10, 2009 - BOSTON SCIENTIFIC CORP | form8-k_16657.htm |
| EX-23 - CONSENT OF ERNST & YOUNG LLP - BOSTON SCIENTIFIC CORP | exhibit23_16657.htm |
| EX-99.3 - ITEM 8. FINANCIAL STATEMENTS - BOSTON SCIENTIFIC CORP | exhibit99-3_16657.htm |
| EX-99.1 - ITEM 1. BUSINESS - BOSTON SCIENTIFIC CORP | exhibit99-1_16657.htm |
EXHIBIT
99.2
ITEM
7. MANAGEMENT’S
DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF
OPERATIONS
The
following discussion and analysis should be read in conjunction with the
consolidated financial statements and accompanying notes contained in Item 8 of
this Annual Report.
Introduction
Boston
Scientific Corporation is a worldwide developer, manufacturer and marketer of
medical devices that are used in a broad range of interventional medical
specialties. Our business strategy is to lead global markets for less-invasive
medical devices by developing and delivering products and therapies that address
unmet patient needs, provide superior clinical outcomes and demonstrate
compelling economic value. We intend to achieve leadership, drive profitable
sales growth and increase shareholder value by focusing on:
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Customers
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Innovation
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Quality
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People
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Financial
Strength
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In the
first quarter of 2008, we completed the divestiture of certain non-strategic
businesses. Our operating results for the years ended December 31, 2007 and 2006
include a full year of results of these businesses. Our operating results for
the year ended December 31, 2008 include the results of these businesses through
the date of separation. We are involved in several post-closing separation
activities through transition service agreements, some from which we continue to
generate net sales. These transition service agreements expire throughout 2009
and the first half of 2010. Refer to the Strategic Initiatives section
and Note F – Divestitures and
Assets Held for Sale to our consolidated financial statements contained
in Item 8 of this Annual Report for a description of
these business divestitures.
On April
21, 2006, we consummated the acquisition of Guidant Corporation. With this
acquisition, we became a major provider in the cardiac rhythm management (CRM)
market, enhancing our overall competitive position and long-term growth
potential, and further diversifying our product portfolio. We also now share
certain drug-eluting stent technology with Abbott Laboratories, which gives us
access to a second drug-eluting stent program, and complements our
TAXUS® stent system program. See Note D- Acquisitions to our 2008
consolidated financial statements included in Item 8 of this Annual Report
for further details on the Guidant acquisition and Abbott transaction. Our
operating results for the years ended December 31, 2008 and 2007 include a full
year of results of our CRM business that we acquired from Guidant. Our operating
results for the year ended December 31, 2006 include the results of the CRM
business beginning on the date of acquisition. We have included supplemental pro
forma financial information in
Note D – Acquisitions to our 2008 consolidated financial statements
included in Item 8 of this Annual Report which gives effect to the
acquisition as though it had occurred at the beginning of 2006.
Executive
Summary
Financial Highlights and
Trends
Net sales
in 2008 were $8.050 billion, which included sales from divested businesses
of $69 million, as compared to net sales of $8.357 billion in 2007, which
included sales from divested business of $553 million, a decrease of $307
million or four percent. Foreign currency fluctuations increased our net sales
by $213 million in 2008, as compared to 2007. Excluding the impact of foreign
currency and sales from divested businesses, our net sales were flat with the
prior year.
Worldwide
net sales of our CRM products increased eight percent in 2008, including an
eight percent
increase
in our U.S. CRM net sales and a seven percent increase in international CRM
product net sales. These increases were driven by multiple product launches
in both our U.S. and international markets, highlighted by the launch
of our COGNIS® cardiac resynchronization therapy defibrillator (CRT-D) system
and our TELIGEN® implantable cardioverter defibrillator (ICD) system. In
addition, net sales from our Endosurgery businesses grew eight percent and our
Neuromodulation division increased net sales by twenty percent in 2008, as
compared to 2007. Partially offsetting these increases, was a decline in
worldwide net sales from our Cardiovascular division of four percent during
2008, due principally to the impact of new competition in the U.S. drug-eluting
stent market. However, we realized increased U.S. drug-eluting stent
market share in the fourth quarter of 2008, as compared to the third quarter of
2008, and exited the year with an estimated 49 percent share of the U.S.
drug-eluting stent market for the month of December.
Our
reported net loss for 2008 was $2.036 billion, or $1.36 per share, on
approximately 1.5 billion weighted-average shares outstanding, as compared to a
net loss for 2007 of $495 million, or $0.33 per share, also on 1.5 billion
weighted-average shares outstanding. Our reported results for 2008 included
goodwill and intangible asset impairment charges and acquisition-, divestiture-,
litigation- and restructuring-related net charges; and discrete tax items of
$2.796 billion (after-tax), or $1.87 per share, consisting of:
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$2.756 billion
($2.790 billion pre-tax) of goodwill and intangible asset impairment
charges, associated primarily with a write-down of
goodwill;
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a
$184 million gain ($250 million pre-tax) related to the receipt of an
acquisition-related milestone payment from
Abbott;
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$44
million ($43 million pre-tax) of net purchased research and development
charges, associated primarily with the acquisitions of Labcoat, Ltd. and
CryoCor, Inc.;
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$100 million of
costs ($133 million pre-tax) associated with our on-going expense and head
count reduction initiatives;
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a
$185 million gain ($250 million pre-tax), associated with the sale of
certain non-strategic
businesses;
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$54
million of net losses ($80 million pre-tax) in connection with the sale of
certain non-strategic
investments;
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$238 million of
litigation-related charges ($334 million pre-tax) resulting primarily from
a ruling by a federal judge in a patent infringement case brought against
us by Johnson & Johnson;
and
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$27
million of discrete tax benefits related to certain tax positions
associated with prior period acquisition-, divestiture-, litigation- and
restructuring-related
charges.
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During
the fourth quarter of 2008, we recorded a $2.613 billion goodwill impairment
charge associated with our acquisition of Guidant. The decline in our stock
price and our market capitalization during the fourth quarter created an
indication of potential impairment of our goodwill balance; therefore, we
performed an interim impairment test. Key factors contributing to the impairment
charge included disruptions in the credit and equity markets, and the resulting
impacts to weighted-average costs of capital, and changes in CRM market demand
relative to our original assumptions at the time of acquisition. Refer to Note E – Goodwill and Other
Intangible Assets to our consolidated financial statements contained in
Item 8 of this Annual Report for more information.
Our
reported results for 2007 included goodwill and intangible asset impairment
charges and acquisition-, divestiture-, litigation- and restructuring-related
charges of $1.110 billion (after-tax), or $0.74 per share. Refer to
Liquidity and Capital
Resources for a discussion of these charges.
We
continued to generate substantial cash flow during 2008. Cash provided by
operating activities was $1.216 billion in 2008 as compared to $934 million
in 2007. At December 31, 2008, we had total debt of $6.745 billion, cash and
cash equivalents of $1.641 billion and working capital of $2.219 billion. During
2008, we prepaid $1.425 billion of debt under our term loan and our credit
facility secured by our U.S. trade receivables and, in February 2009, prepaid an
additional $500 million. As a result, our next scheduled debt maturity is $325
million due in April 2010.
Strategic
Initiatives
In 2007,
we announced several new initiatives designed to enhance short- and long-term
shareholder value, including the restructuring of several of our businesses and
product franchises; the sale of non-strategic businesses and investments; and
significant expense and head count reductions. Our goal was, and continues to
be, to better align expenses with revenues, while preserving our ability to make
needed investments in quality, research and development (R&D), capital
improvements and our people that are essential to our long-term success. These
initiatives have helped to provide better focus on our core businesses and
priorities, which we believe will strengthen Boston Scientific for the future
and position us for increased, sustainable and profitable sales growth. The
execution of this plan enabled us to reduce R&D and selling, general and
administrative (SG&A) expenses by an annualized run rate of approximately
$500 million exiting 2008.
Restructuring
In
October 2007, our Board of Directors approved, and we committed to, an expense
and head count reduction plan, which resulted in the elimination of
approximately 2,300 positions worldwide. We initiated activities under the plan
in the fourth quarter of 2007 and expect to be substantially complete worldwide
in 2010. Refer to Results of
Operations and Note H – Restructuring-related
Activities to our consolidated financial statements included in Item 8 of
this Annual Report for information on restructuring-related activities and
estimated costs.
Plant
Network Optimization
On
January 27, 2009, our Board of Directors approved, and we committed to, a plant
network optimization plan, which is intended to simplify our manufacturing plant
structure by transferring certain production lines from one facility to another
and by closing certain facilities. The plan is a complement to our previously
announced expense and head count reduction plan, and is intended to improve
overall gross profit margins. Activities under the plan will be initiated in
2009 and are expected to be substantially completed by the end of 2011. Refer
to Results of Operations
and Note H –
Restructuring-related Activities to our consolidated financial statements
included in Item 8 of this Annual Report for information on
restructuring-related activities and estimated costs.
Divestitures
During
2007, we determined that our Auditory, Vascular Surgery, Cardiac Surgery, Venous
Access and Fluid Management businesses were no longer strategic to our on-going
operations. Therefore, we initiated the process of selling these businesses in
2007, and completed their sale in the first quarter of 2008, as discussed below.
We received pre-tax proceeds of approximately $1.3 billion from the sale of
these businesses and our TriVascular Endovascular Aortic Repair (EVAR) program,
and eliminated 2,000 positions in connection with these
divestitures.
In
January 2008, we completed the sale of a controlling interest in our Auditory
business and drug pump development program, acquired with Advanced Bionics
Corporation in 2004, to entities affiliated with the principal former
shareholders of Advanced Bionics for an aggregate purchase price of $150 million
in cash. In
connection with the sale, we recorded a loss of $367 million (pre-tax) in 2007,
attributable primarily to the write-down of goodwill. In addition, we recorded a
tax benefit of $7 million during 2008 in connection with the closing of the
transaction. Also in January 2008, we completed the sale of our Cardiac Surgery
and Vascular Surgery businesses for net cash proceeds of approximately $700
million. In connection with the sale, we recorded a pre-tax loss of $193 million
in 2007, representing primarily a write-down of goodwill. In addition, we
recorded a tax expense of $19 million during 2008 in connection with the closing
of the transaction. In February 2008, we completed the sale of our Fluid
Management and Venous Access businesses for net cash proceeds of approximately
$400 million. We recorded a pre-tax gain of $234 million ($161
million after-tax) during 2008 associated with this transaction.
Further,
in March 2008, we sold our EVAR program obtained in connection with our 2005
acquisition of TriVascular, Inc. for $30 million in cash. We discontinued our
EVAR program in 2006. In connection with the sale, we recorded a pre-tax gain of
$16 million ($36 million after-tax) during 2008.
During
2007, in connection with our strategic initiatives, we announced our intent to
sell the majority of our investment portfolio in order to monetize those
investments determined to be non-strategic. In June 2008, as part of our
initiative to monetize non-strategic investments, we signed separate definitive
agreements with Saints Capital and Paul Capital Partners to sell the majority of
our investments in, and notes receivable from, certain publicly traded and
privately held entities for gross proceeds of approximately $140 million. In
connection with these agreements, we received proceeds of $95 million during
2008. In addition, we received $54 million of proceeds from other transactions
to monetize certain other non-strategic investments and notes receivable. We
recorded net pre-tax losses of approximately $80 million during 2008 related to
these monetization initiatives and the write-down of certain non-strategic
investments. We expect to receive $45 million of remaining proceeds from the
Saints and Paul transactions during 2009, and do not expect to record
significant gains or losses in 2009 related to these definitive agreements.
Refer to our Other, net
discussion, as well as Note G – Investments and Notes
Receivable to our consolidated financial statements included in Item 8 of
this Annual Report for more information on our investment portfolio
activity.
Corporate Warning
Letter
In
January 2006, legacy Boston Scientific received a corporate warning letter from
the U.S. Food and Drug Administration (FDA) notifying us of serious regulatory
problems at three of our facilities and advising us that our corporate-wide
corrective action plan relating to three site-specific warning letters issued to
us in 2005 was inadequate. We have identified solutions to the quality system
issues cited by the FDA and have made significant progress in transitioning our
organization to implement those solutions. During 2008, the FDA reinspected a
number of our facilities and, in October 2008, informed us that our quality
system is now in substantial compliance with its Quality System Regulations. The
FDA has approved all of our requests for final approval of Class III product
submissions previously on hold due to the corporate warning letter and has
approved all currently eligible requests for Certificates to Foreign Governments
(CFGs). Since October 2008, we have received approval to market the following
new products in the U.S.:
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our
TAXUS® Express2®
Atom™ paclitaxel-eluting coronary stent system, designed for treating
small coronary vessels;
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our
TAXUS® Liberté® paclitaxel-eluting coronary stent system, our
second-generation drug-eluting stent
system;
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our
Carotid WALLSTENT® Monorail® Endoprosthesis, a less-invasive alternative
to surgery for treating carotid artery
disease;
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our
Apex™ Percutaneous Transluminal Coronary Angioplasty
(PTCA) dilatation catheter, for treating the most challenging
atherosclerotic
lesions;
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our
Express® SD Renal Monorail® stent system, the first low-profile,
pre-mounted stent approved in the U.S. for use in renal arteries;
and
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our
Sterling™ Monorail®
and Over-the-Wire balloon dilatation catheter for use in the renal and
lower extremity
arteries.
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The FDA
also approved the use of our TAXUS® Express2®
paclitaxel-eluting coronary stent system for the treatment of in-stent
restenosis1
(ISR) in bare-metal stents, the first ISR approval granted by the
FDA.
The
corporate warning letter remains in place pending final remediation of certain
Medical Device Report (MDR) filing issues, which we are actively working with
the FDA to resolve. This remediation has resulted and may continue to result in
incremental medical device and vigilance reporting, which could adversely impact
physician perception of our products.
1 In-stent restenosis is re-narrowing of
the vessel inside a stent.
Business
and Market Overview
Cardiac Rhythm
Management
We
estimate that the worldwide CRM market approximated $10.8 billion in 2008, as
compared to approximately $10.0 billion in 2007, and estimate that U.S. ICD
system sales represented approximately 40 percent of the worldwide CRM market in
both years. Worldwide CRM market growth rates over the past three years,
including the U.S. ICD market, have been below those experienced in prior years,
resulting primarily from previous industry field actions and from a lack of new
indications for use. In 2008, however, we began to see renewed growth of the
worldwide CRM market with steadily increasing implant volumes.
Net sales
of our CRM products represented approximately 28 percent of our consolidated net
sales for 2008 and 25 percent in 2007. The following are the components of our
worldwide CRM product sales:
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(in
millions)
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Year
Ended
December
31, 2008
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Year
Ended
December
31, 2007
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U.S.
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International
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Total
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U.S.
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International
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Total
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ICD
systems
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$ | 1,140 | $ | 541 | $ | 1,681 | $ | 1,053 | $ | 489 | $ | 1,542 | ||||||||||||
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Pacemaker
systems
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340 | 265 | 605 | 318 | 264 | 582 | ||||||||||||||||||
| $ | 1,480 | $ | 806 | $ | 2,286 | $ | 1,371 | $ | 753 | $ | 2,124 | |||||||||||||
Our U.S.
sales of CRM products in 2008 increased $109 million, or eight percent, as
compared to 2007. Our U.S. sales benefited from growth in the U.S.
CRM market and from the successful launch of our next-generation COGNIS® CRT-D
and TELIGEN® ICD systems, as well as the launches of our CONFIENT® ICD system, the
LIVIAN® CRT-D
system, and the ALTRUA™ family of pacemaker systems. We experienced ten
percent growth in U.S. CRM sales during each of the second, third and fourth
quarters of 2008, largely as a result of these new product
launches.
Our
international CRM product sales increased $53 million, or seven percent in 2008,
as compared to 2007, due primarily to an increase in the size of the
international ICD market. However, our net sales and market share in Japan have
been negatively impacted as we move to a direct sales model for our CRM products
in Japan and, until we fully implement this model, our net sales and market
share in Japan may continue to be negatively impacted.
During
2008, we received more than a dozen new CRM product approvals. We will continue
to execute on our product pipeline and expect to begin offering our LATITUDE®
Patient Management System in certain European countries in 2009. This
technology, which enables physicians to monitor device performance remotely
while patients are in their homes, is a key component of many of our implantable
device systems. We also plan to launch our next-generation pacemaker, the
INGENIO™ pacemaker system, in the U.S., our EMEA (Europe/Middle East/Africa)
region and certain Inter-Continental countries in the first half of 2011.
We believe that these launches position us for sustainable growth within the
worldwide CRM market.
Net sales
from our CRM products represent a significant source of our overall net sales.
Therefore, increases or decreases in net sales from our CRM products could have
a significant impact on our results of operations. While we believe that the
size of the CRM market will increase above existing levels, there can be no
assurance as to the timing or extent of this increase. We believe we are well
positioned within the CRM market; however, the following variables may impact
the size of the CRM market and/or our share of that market:
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our
continued ability to improve the trust and confidence of the implanting
physician community, the referring physician community and prospective
patients in our
technology;
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future product field
actions or new physician advisories by us or our
competitors;
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our
ability to successfully launch next-generation products and
technology;
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the
successful conclusion and positive outcomes of on-going clinical trials
that may provide opportunities to expand indications for
use;
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variations in
clinical results, reliability or product performance of our and our
competitors’ products;
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delayed or limited
regulatory approvals and unfavorable reimbursement
policies;
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our
ability to retain key members of our sales force and other key
personnel;
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new
competitive launches;
and
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average selling
prices and the overall number of procedures
performed.
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Coronary
Stents
The size
of the coronary stent market is driven primarily by the number of percutaneous
coronary intervention (PCI) procedures performed, as well as the percentage of
those that are actually stented; the number of devices used per procedure;
average drug-eluting stent selling prices; and the drug-eluting stent
penetration rate (a measure of the mix between bare-metal and drug-eluting
stents used across procedures). We estimate that the worldwide coronary stent
market approximated $5.0 billion in 2008 and 2007, and estimate that
drug-eluting stents represented approximately 80 percent of the dollar
value of worldwide coronary stent market sales in both years. Uncertainty
regarding the efficacy of drug-eluting stents, as well as the increased
perceived risk of late stent thrombosis2
following the use of drug-eluting stents, contributed to a decline in the
worldwide drug-eluting stent market size during 2006 and 2007. However, data
addressing this risk and supporting the safety of drug-eluting stent systems
positively affected trends in the growth of the drug-eluting stent market in
2008, as referring cardiologists regained confidence in this
technology.
Net sales
of our coronary stent systems represented approximately 23 percent of our
consolidated net sales for 2008 and 24 percent in 2007. We are the only company
in the industry to offer a two-drug platform strategy with our TAXUS®
paclitaxel-eluting stent system and the PROMUS® everolimus-eluting stent system.
The following are the components of our worldwide coronary stent system
sales:
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(in
millions)
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Year
Ended
December
31, 2008
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Year
Ended
December
31, 2007
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U.S.
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International
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Total
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U.S.
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International
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Total
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TAXUS®
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$ | 621 | $ | 697 | $ | 1,318 | $ | 1,006 | $ | 754 | $ | 1,760 | ||||||||||||
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PROMUS®
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212 | 104 | 316 | 28 | 28 | |||||||||||||||||||
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Drug-eluting
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833 | 801 | 1,634 | 1,006 | 782 | 1,788 | ||||||||||||||||||
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Bare-metal
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88 | 129 | 217 | 104 | 135 | 239 | ||||||||||||||||||
| $ | 921 | $ | 930 | $ | 1,851 | $ | 1,110 | $ | 917 | $ | 2,027 | |||||||||||||
During 2008, U.S. sales of our drug-eluting stent systems declined $173 million, or 17 percent, due primarily to an increase in competition following recent competitive launches. We believe that our average share of the
2 Late stent thrombosis is the formation
of a clot, or thrombus, within the stented area one year or more after
implantation of the stent.
U.S.
drug-eluting stent market declined to 46 percent during 2008, as compared to 55
percent in 2007. In addition, pricing pressure resulted in a
reduction in the average selling price of our TAXUS® stent system in the U.S. by
approximately five percent as compared to the prior year. However, increasing
penetration rates have had a positive effect on the size of the U.S.
drug-eluting stent market. Average drug-eluting stent penetration rates in the
U.S. were 68 percent during 2008 (exiting 2008 at 73 percent for the month of
December), as compared to 65 percent during 2007 (exiting 2007 at 62 percent for
the month of December). We believe this is a strong indicator that the recovery
of the U.S. drug-eluting stent market is continuing and the market is
strengthening. In addition, the launch of our TAXUS® Express2® Atom™
and TAXUS® Liberté® stent systems in the U.S. during the fourth quarter of 2008
had a positive effect on our market share. We believe that exiting 2008, we were
the market leader with 49 percent share of the U.S. drug-eluting stent market
for the month of December, and are well positioned entering 2009.
Our
international drug-eluting stent system sales increased $19 million, or two
percent, in 2008 as compared to 2007, due to a full year of drug-eluting stent
sales in Japan and growth in the size of the international drug-eluting stent
market as a result of increased PCI procedural volume and higher penetration
rates. In May of 2007, we launched our TAXUS® Express2® coronary
stent system in Japan, and, in
January 2009, we received approval from the Japanese Ministry of Health, Labor
and Welfare to market our second-generation TAXUS® Liberté® drug-eluting stent
system in Japan. We are planning to launch our TAXUS® Liberté® stent system in
Japan during the first quarter of 2009 and the PROMUS® everolimus-eluting
coronary stent system in the second half of 2009, subject to regulatory
approval.
In July
2008, Abbott launched its XIENCE V™ everolimus-eluting coronary stent system,
and, simultaneously, we launched the PROMUS® everolimus-eluting coronary stent
system, supplied to us by Abbott. As of the closing of Abbott’s acquisition of
Guidant’s vascular intervention and endovascular solutions businesses, we
obtained a perpetual license to use the intellectual property used
in Guidant’s drug-eluting stent system program purchased by Abbott. We
believe that being the only company to offer two distinct drug-eluting stent
platforms provides us a considerable advantage in the drug-eluting stent market
and has enabled us to sustain our worldwide leadership position. However, under
the terms of our supply arrangement with Abbott, the gross profit and operating
profit margin of a PROMUS® stent system is significantly lower than that of our
TAXUS® stent system. Our PROMUS® stent systems have operating profit margins
that approximate half of our TAXUS® stent system operating profit margin.
Therefore, if sales of our PROMUS® stent system continue to increase in relation
to our total drug-eluting stent system sales, our profit margins will continue
to decrease. Refer to our Gross Profit discussion for
more information on the impact this sales mix has had on our gross profit
margins. Further,
the price we pay Abbott for our supply of PROMUS® stent systems is determined by
our contracts with them. Our cost is based, in part, on previously
fixed estimates of Abbott’s manufacturing costs for PROMUS® stent systems and
third-party reports of our average selling price of PROMUS® stent systems.
Amounts paid pursuant to this pricing arrangement are subject to a retroactive
adjustment at pre-determined intervals based on Abbott’s actual costs to
manufacture these stent systems for us and our average selling price of PROMUS®
stent systems. During 2009, we may make a payment to or receive a payment from
Abbott based on the differences between their actual manufacturing costs and the
contractually stipulated manufacturing costs and differences between our actual
average selling price and third-party reports of our average selling price, in
each case, with respect to our purchases of PROMUS® stent systems from Abbott
during 2008, 2007 and 2006. As a result, during 2009, our profit margins on the
PROMUS® stent system may increase or decrease.
We are
reliant on Abbott for our supply of PROMUS® stent systems. Any production or
capacity issues that affect Abbott’s manufacturing capabilities or the process
for forecasting, ordering and receiving shipments may impact our ability to
increase or decrease the level of supply to us in a timely manner; therefore,
our supply of PROMUS® stent systems may not align with customer demand, which
could have an adverse effect on our operating results. At present, we
believe that our supply of PROMUS® stent systems from Abbott is sufficient to
meet customer demand. Further, our supply agreement with Abbott for PROMUS®
stent systems extends through the middle of the fourth quarter of 2009 in
Europe, and is currently being reviewed by the European Commission for possible
extension, and through the end of the second quarter of 2012 in the U.S. and
Japan. We are incurring incremental costs and expending incremental resources in
order to develop and commercialize an internally developed and manufactured
next-generation everolimus-eluting stent system. We expect that this stent
system, the PROMUS® Element™ stent system, will have gross profit margins more
comparable to our TAXUS® stent system and will improve our overall
gross
profit and operating profit margins once launched. We expect to launch PROMUS®
Element in our EMEA region and certain Inter-Continental countries in late
2009 and in the U.S. and Japan in mid-2012. We expect to launch our
first-generation PROMUS® everolimus-eluting coronary stent system during the
second half of 2009 in Japan. Our product pipeline also includes the TAXUS®
Element™ coronary stent system. We expect to launch our TAXUS® Element stent
system in EMEA and certain Inter-Continental countries during the fourth quarter
of 2009 and in the U.S. and Japan in mid-2011.
Historically,
the worldwide coronary stent market has been dynamic and highly competitive with
significant market share volatility. In addition, in the ordinary course of our
business, we conduct and participate in numerous clinical trials with a variety
of study designs, patient populations and trial end points. Unfavorable or
inconsistent clinical data from existing or future clinical trials conducted by
us, by our competitors or by third parties, or the market’s perception of these
clinical data, may adversely impact our position in, and share of the
drug-eluting stent market and may contribute to increased volatility in the
market.
We
believe that we can sustain our leadership position within the worldwide
drug-eluting stent market for a variety of reasons, including:
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our
two drug-eluting stent platform
strategy;
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the
broad and consistent long-term results of our TAXUS® clinical trials, and
the favorable results of the XIENCE V™/PROMUS®
stent system clinical trials to
date;
|
|
•
|
the
performance benefits of our current and future
technology;
|
|
•
|
the
strength of our pipeline of drug-eluting stent
products;
|
|
•
|
our
overall position in the worldwide interventional medicine market and our
experienced interventional cardiology sales force;
and
|
|
•
|
the
strength of our clinical, marketing and manufacturing
capabilities.
|
However,
a further decline in net sales from our drug-eluting stent systems could have a
significant adverse impact on our operating results and operating cash flows.
The most significant variables that may impact the size of the drug-eluting
stent market and our position within this market include:
|
•
|
our
ability to successfully launch next-generation products and technology
features;
|
|
•
|
physician and
patient confidence in our technology and attitudes toward drug-eluting
stents, including the continued abatement of prior concerns regarding the
risk of late stent
thrombosis;
|
|
•
|
changes in
drug-eluting stent penetration rates, the overall number of PCI procedures
performed, average number of stents used per procedure, and average
selling prices of drug-eluting stent
systems;
|
|
•
|
the
outcome of intellectual property
litigation;
|
|
•
|
variations in
clinical results or perceived product performance of our or our
competitors’ products;
|
|
•
|
delayed or limited
regulatory approvals and unfavorable reimbursement
policies;
|
|
•
|
our
ability to retain key members of our sales force and other key personnel;
and
|
|
•
|
changes in FDA
clinical trial data and post-market surveillance requirements and the
associated impact on new product launch schedules and the cost of product
approvals and
compliance.
|
There
continues to be significant intellectual property litigation in the coronary
stent market. We are currently involved in a number of legal proceedings with
certain of our existing competitors, including Johnson & Johnson, and other
independent patent holders. There can be no assurance that an adverse outcome in
one or more proceedings would not materially impact our ability to meet our
objectives in the coronary stent market, and our liquidity and results of
operations. We previously had several active lawsuits pending between us and
Medtronic, Inc. However, on January 23, 2009, we reached an agreement to stop
all litigation between us and Medtronic with respect to interventional
cardiology and endovascular repair cases. See Note L - Commitments and
Contingencies to our 2008 consolidated financial statements included
in Item 8 of this Annual Report for a description of these legal
proceedings.
Other
Businesses
Interventional
Cardiology (excluding coronary stent systems)
In
addition to coronary stent systems, our Interventional Cardiology business
markets balloon catheters, rotational atherectomy systems, guide wires, guide
catheters, embolic protection devices, and diagnostic catheters used in
percutaneous transluminal coronary angioplasty (PTCA) procedures; and ultrasound
and imaging systems. Our net sales of these products increased to $1.028
billion in 2008, as compared to $989 million in 2007, an increase of $39 million
or four percent. This increase was driven primarily by growth in our
ultrasound and imaging system franchise; including increased sales of our iLab®
Ultrasound Imaging System, which enhances the diagnosis and treatment of blocked
vessels and heart disorders. In addition, in November 2008, the FDA
approved our Apex™ PTCA dilatation catheter, used in treating atherosclerotic
lesions.
Peripheral
Interventions
Our
Peripheral Interventions business product offerings include stents, balloon
catheters, sheaths, wires and vena cava filters, which are used to diagnose and
treat peripheral vascular disease. Our 2008 net sales of these products
decreased slightly to $589 million in 2008, as compared to $597 million in
2007. The decrease was a result of U.S. sales declines of $34 million
in 2008 to $294 million, from $328 million in 2007, primarily as a result of
increased competition across most of the vascular interventional product
categories. Our international Peripheral Interventions business grew $26
million in 2008, as compared to 2007, due primarily to foreign currency
fluctuations. We continue to hold a strong worldwide position in the Peripheral
Interventions market and we are the market leader in multiple product
categories. Further, in the fourth quarter of 2008, we received FDA
approval for three new products: our Carotid WALLSTENT® Monorail®
Endoprosthesis for the treatment of patients with carotid artery disease who are
at high risk for surgery; our Express® SD Renal Monorail® premounted stent
system for use as an adjunct to percutaneous transluminal renal angioplasty in
certain lesions of the renal arteries; and our Sterling™ Monorail® and Over-the-Wire
balloon dilatation catheter for use in the renal and lower extremity
arteries.
Neurovascular
We market
a broad line of products used in treating diseases of the neurovascular system.
Our Neurovascular net sales increased to $360 million in 2008, as compared to
$352 million in 2007, an increase of $8 million or two percent. Our U.S. net
sales were $131 million in 2008, as compared to $127 million in 2007, and our
international net sales were $229 million in 2008, as compared to $225 million
in 2007. We plan to launch a next-generation family of detachable coils,
including an enhanced delivery system with reduced coil detachment times, in the
U.S. in the second half of 2009. Within our product pipeline, we are also
developing next-generation technologies for the treatment of aneurysms,
intracranial atherosclerotic disease and acute ischemic stroke, and are
involved in numerous clinical activities that are designed to expand the size of
the worldwide Neurovascular market.
Endosurgery
Our
Endosurgery group develops and manufactures devices to treat a variety of
medical conditions, including diseases of the digestive and pulmonary systems
within our Endoscopy division, and urological and gynecological disorders within
our Urology division. Our Endosurgery group net sales grew eight percent in 2008
to $1.374 billion, and accounted for 17 percent of our total net sales in 2008,
as compared to 15 percent in 2007. The following are the components
of our worldwide Endosurgery business:
|
(in
millions)
|
Year
Ended
December
31, 2008
|
Year
Ended
December
31, 2007
|
||||||||||||||||||||||
|
U.S.
|
International
|
Total
|
U.S.
|
International
|
Total
|
|||||||||||||||||||
|
Endoscopy
|
$ | 477 | $ | 466 | $ | 943 | $ | 453 | $ | 413 | $ | 866 | ||||||||||||
|
Urology
|
335 | 96 | 431 | 316 | 87 | 403 | ||||||||||||||||||
| $ | 812 | $ | 562 | $ | 1,374 | $ | 769 | $ | 500 | $ | 1,269 | |||||||||||||
Our Endoscopy net sales grew nine percent in 2008 to $943 million from $866 million in 2007. Key sales growth drivers within Endoscopy included our biliary franchise, which grew $45 million, or 16 percent, to $324 million on the strength of our SpyGlass® Direct Visualization System for single-operator duodenoscope assisted cholangiopancreatoscopy, or visual examination of the bile ducts, which was launched in the second quarter of 2007. In addition, our hemostasis franchise grew $16 million, or 18 percent, to $107 million on the strength of our Resolution® Clip Device, which is the only currently-marketed mechanical clip designed to open and close (up to five times) before deployment to enable a physician to see the effects of the clip before committing to deployment. Our Urology net sales grew seven percent in 2008 to $431 million from $403 million in 2007. This growth was primarily due to our pelvic floor franchise, which grew 17 percent, or $14 million, to $95 million, led by our line of sling-based devices and kits, which are used in the treatment of a variety of stress- and age-related disorders of the lower female anatomy. The remaining Urology growth was spread across the other components of our business, including our stone management and gynecology franchises. During 2009, we intend to launch a number of new products across multiple franchises in both our Endoscopy and Urology businesses.
Neuromodulation
Despite
new product launches during the year by both of our major competitors, our
Neuromodulation net sales increased to $245 million in 2008, as compared to $204
million in 2007, an increase of $41 million or 20 percent. Our U.S. net sales
were $234 million in 2008, as compared to $198 million in 2007, and our
international net sales were $11 million in 2008, as compared to $6 million in
2007. We continued to maintain our strong position within the U.S. market with
our Precision® Spinal Cord Stimulation (SCS) system, used for the treatment of
chronic pain of the lower back and legs. We believe that we continue to have a
technology advantage over our competitors with proprietary features such as
Multiple Independent Current Control, which allows the physician to target
specific areas of pain more precisely. In addition, we are currently
assessing the use of our SCS system to treat other sources of pain. These
factors, coupled with the move of our Neuromodulation business to a new
state-of-the-art facility during 2008, position us well for continued growth in
this market.
Innovation
Our
approach to innovation combines internally developed products and technologies
with those we obtain externally through strategic acquisitions and alliances.
Our research and development efforts are focused largely on the development of
next-generation and novel technology offerings across multiple programs and
divisions.
We expect to continue to invest in our CRM and drug-eluting stent technologies,
and will also invest selectively in areas outside of these markets. We expect to
continue to invest in our paclitaxel drug-eluting stent program, along with our
internally developed and manufactured everolimus-eluting stent program (the
PROMUS® Element™ stent system), to sustain our leadership position in the
worldwide drug-eluting stent market. There can be no assurance that these
technologies will achieve technological feasibility, obtain regulatory approvals
or gain market acceptance. A delay in the development or approval of these
technologies may adversely impact our future growth.
Our
strategic acquisitions are intended to expand further our ability to offer our
customers safe, effective, high-quality medical devices that satisfy their
interventional needs. Management believes it has developed a sound plan to
integrate acquired businesses. However, our failure to integrate these
businesses successfully could impair our ability to realize the strategic and
financial objectives of these transactions. Potential future acquisitions
may be dilutive to our earnings and may require additional debt or equity
financing, depending on their size and nature.
We have
entered strategic alliances with both publicly traded and privately held
companies. We enter these alliances to broaden our product technology portfolio
and to strengthen and expand our reach into existing and new markets. During
2008, we monetized certain investments and alliances no longer determined to be
strategic (see the Strategic
Initiatives section for more information). While we believe our remaining
strategic investments are within attractive markets with an outlook for
sustained growth, the full benefit of these alliances is highly dependent on the
strength of the other companies’ underlying technology and ability to execute.
An inability to achieve regulatory approvals and launch competitive product
offerings, or litigation related to these technologies, among other factors, may
prevent us from realizing the benefit of these strategic alliances.
Reimbursement and
Funding
Our
products are purchased principally by hospitals, physicians and other healthcare
providers worldwide that typically bill various third-party payors, such as
governmental programs (e.g., Medicare and Medicaid), private insurance plans and
managed-care programs for the healthcare services provided to their patients.
Third-party payors may provide or deny coverage for certain technologies and
associated procedures based on independently determined assessment criteria.
Reimbursement by third-party payors for these services is based on a wide range
of methodologies that may reflect the services’ assessed resource costs,
clinical outcomes and economic value. These reimbursement methodologies confer
different, and sometimes conflicting, levels of financial risk and incentives to
healthcare providers and patients, and these methodologies are subject to
frequent refinements. Third-party payors are also increasingly adjusting
reimbursement rates and challenging the prices charged for medical products and
services. There can be no assurance that our products will be automatically
covered by third-party payors, that reimbursement will be available or, if
available, that the third-party payors’ coverage policies will not adversely
affect our ability to sell our products profitably. Accordingly, the
outcome of these reimbursement decisions could have an adverse impact on our
business. In addition, the current economic climate may impose further
pressure on funds available for reimbursement of healthcare and on reimbursement
levels.
Manufacturing and Raw
Materials
We design
and manufacture the majority of our products in technology centers around the
world. Many components used in the manufacture of our products are readily
fabricated from commonly available raw materials or off-the-shelf items
available from multiple supply sources. Certain items are custom made to meet
our specifications. We believe that in most cases, redundant capacity exists at
our suppliers and that alternative sources of supply are available or could be
developed within a reasonable period of time. We also have an on-going program
to identify single-source components and to develop alternative back-up
supplies. However, in certain cases, we may not be able to quickly establish
additional or replacement suppliers for specific components or materials,
largely due to the regulatory approval system and the complex nature of our
manufacturing processes and those of our suppliers. A reduction or interruption
in supply, an inability to
develop
and validate alternative sources if required, or a significant increase in the
price of raw materials or components could adversely affect our operations and
financial condition, particularly materials or components related to our CRM
products and drug-eluting stent systems. In addition, our products require
sterilization prior to sale and we rely primarily on third party vendors to
perform this service. To the extent our third party sterilizers
are unable to process our products, whether due to raw
material, capacity, regulatory or other constraints, we may be unable
to transition to other providers in a timely manner, which could have an
adverse impact on our operations.
International
Markets
Our
profitability from our international operations may be limited by risks and
uncertainties related to economic conditions in these regions, currency
fluctuations, regulatory and reimbursement approvals, competitive offerings,
infrastructure development, rights to intellectual property and our ability to
implement our overall business strategy. Any significant changes in the
competitive, political, regulatory, reimbursement or economic environment where
we conduct international operations may have a material impact on our business,
financial condition or results of operations. International markets, including
Japan, are affected by economic pressure to contain reimbursement levels and
healthcare costs. Initiatives to limit the growth of healthcare costs, including
price regulation, are under way in many countries in which we do business.
Implementation of cost containment initiatives and healthcare reforms in
significant markets such as Japan, Europe and other international markets may
limit the price of, or the level at which reimbursement is provided for, our
products and may influence a physician’s selection of products used to treat
patients. We expect these practices to put increased pressure on reimbursement
rates in these markets.
In
addition, most international jurisdictions have adopted regulatory approval and
periodic renewal requirements for medical devices, and we must comply with these
requirements in order to market our products in these jurisdictions. Further,
some emerging markets rely on the FDA’s CFGs in lieu of their own regulatory
approval requirements. Although the corporate warning letter has not been
formally resolved, the FDA has approved all currently eligible requests for
CFGs. However, any limits on our ability to market our full line of existing
products and to launch new products within these jurisdictions could have an
adverse impact on our business.
Results
of Operations
Net
Sales
The
following table provides our worldwide net sales by region and the relative
change on an as reported and constant currency basis:
|
Year
Ended December 31,
|
2008
versus 2007
|
2007
versus 2006
|
||||||||||||||||||||||||||
|
(in
millions)
|
2008
|
2007
|
2006
|
As
Reported
Currency
Basis
|
Constant
Currency
Basis
|
As
Reported
Currency
Basis
|
Constant
Currency
Basis
|
|||||||||||||||||||||
|
United
States
|
$ | 4,487 | $ | 4,522 | $ | 4,415 | (1 | )% | (1 | )% | 2 | % | 2 | % | ||||||||||||||
|
EMEA
|
1,960 | 1,833 | 1,631 | 7 | % | 2 | % | 12 | % | 3 | % | |||||||||||||||||
|
Japan
|
861 | 797 | 560 | 8 | % | (2 | )% | 42 | % | 39 | % | |||||||||||||||||
|
Inter-Continental
|
673 | 652 | 739 | 3 | % | (1 | )% | (12 | )% | (13 | )% | |||||||||||||||||
|
International
|
3,494 | 3,282 | 2,930 | 6 | % | 0 | % | 12 | % | 6 | % | |||||||||||||||||
|
Subtotal
|
7,981 | 7,804 | 7,345 | 2 | % | 0 | % | 6 | % | 4 | % | |||||||||||||||||
|
Divested
businesses
|
69 | 553 | 476 | N/A | N/A | N/A | N/A | |||||||||||||||||||||
|
Worldwide
|
$ | 8,050 | $ | 8,357 | $ | 7,821 | (4 | )% | (6 | )% | 7 | % | 5 | % | ||||||||||||||
The
following table provides our worldwide net sales by division and the relative
change on an as reported basis:
|
2008
versus 2007
|
2007
versus 2006
|
|||||||||||||||||||||||||||
|
(in
millions)
|
2008
|
2007
|
2006
|
As
Reported
Currency
Basis
|
Constant
Currency
Basis
|
As
Reported
Currency
Basis
|
Constant
Currency
Basis
|
|||||||||||||||||||||
|
Interventional
Cardiology
|
$ | 2,879 | $ | 3,016 | $ | 3,509 | (5 | ) % | (7 | ) % | (14 | ) % | (15 | ) % | ||||||||||||||
|
Peripheral
Interventions
|
589 | 597 | 624 | (1 | ) % | (5 | ) % | (4 | ) % | (8 | ) % | |||||||||||||||||
|
Cardiovascular
|
3,468 | 3,613 | 4,133 | (4 | ) % | (7 | ) % | (13 | ) % | (14 | ) % | |||||||||||||||||
|
Cardiac
Rhythm Management
|
2,286 | 2,124 | 1,371 | 8 | % | 5 | % | 55 | % | 51 | % | |||||||||||||||||
|
Electrophysiology
|
153 | 147 | 134 | 4 | % | 2 | % | 10 | % | 8 | % | |||||||||||||||||
|
Cardiac
Rhythm Management
|
2,439 | 2,271 | 1,505 | 7 | % | 5 | % | 51 | % | 47 | % | |||||||||||||||||
|
Neurovascular
|
360 | 352 | 326 | 2 | % | (2 | ) % | 8 | % | 4 | % | |||||||||||||||||
|
Peripheral
Embolization
|
95 | 95 | 87 | 1 | % | (4 | ) % | 9 | % | 7 | % | |||||||||||||||||
|
Neurovascular
|
455 | 447 | 413 | 2 | % | (3 | ) % | 8 | % | 5 | % | |||||||||||||||||
|
Cardiovascular
Group
|
6,362 | 6,331 | 6,051 | - | % | 1 | % | 5 | % | 2 | % | |||||||||||||||||
|
Endoscopy
|
943 | 866 | 777 | 9 | % | 6 | % | 11 | % | 9 | % | |||||||||||||||||
|
Urology
|
431 | 403 | 371 | 7 | % | 6 | % | 9 | % | 8 | % | |||||||||||||||||
|
Endosurgery
Group
|
1,374 | 1,269 | 1,148 | 8 | % | 6 | % | 11 | % | 8 | % | |||||||||||||||||
|
Neuromodulation
|
245 | 204 | 146 | 20 | % | 20 | % | 40 | % | 40 | % | |||||||||||||||||
|
Subtotal
|
7,981 | 7,804 | 7,345 | 2 | % | - | % | 6 | % | 4 | % | |||||||||||||||||
|
Divested
businesses
|
69 | 553 | 476 | N/A | N/A | N/A | N/A | |||||||||||||||||||||
|
Worldwide
|
$ | 8,050 | $ | 8,357 | $ | 7,821 | (4 | ) % | (6 | ) % | 7 | % | 5 | % | ||||||||||||||
U.S.
Net Sales
Our U.S.
net sales, excluding sales from divested businesses, decreased $35 million,
or one percent in 2008, as compared to 2007. The decrease was due primarily to a
decrease in Cardiovascular division sales of $222 million, driven primarily by
declines in sales of our drug-eluting stent systems due to increased
competition. Partially offsetting this decrease was an increase in CRM product
sales of $109 million, as a result of numerous successful product launches
during the year. In addition, U.S. sales in our Endosurgery division grew
$43 million in 2008, as compared to 2007, driven by strength in our biliary and
hemostasis franchises, and our Neuromodulation division increased sales by $36
million, due to market growth and continued physician adoption of our Precision
Plus™ spinal cord stimulation technology. Refer to the Business and Market Overview
section for a more detailed discussion of our net sales by
division.
Our U.S.
net sales, excluding sales from divested businesses, increased $107 million, or
two percent, in 2007, as compared to 2006. The increase related primarily to an
increase in U.S. CRM product sales of approximately $450 million due to a full
year of consolidated operations in 2007. In addition, we achieved year-over-year
U.S. sales growth of approximately $60 million in our Endosurgery businesses and
$65 million in our Neuromodulation business. Offsetting these increases was a
decline in our U.S. Cardiovascular division sales of approximately $500 million,
driven primarily by lower sales of our TAXUS® drug-eluting stent system as a
result of a decrease in the size of the U.S. drug-eluting stent market. This
decrease was driven principally by declines in drug-eluting stent penetration
rates resulting from on-going concerns regarding the safety and efficacy of
drug-eluting stents.
International
Net Sales
Our
international net sales, excluding sales from divested businesses, increased
$212 million, or six percent, in 2008, as compared to 2007. The increase
was attributable primarily to the favorable impact of currency exchange rates,
which contributed $208 million to our international net sales, excluding sales
from divested businesses. Within our international business, sales in our
Cardiovascular division increased $77 million and CRM product sales increased
$53 million. In addition, sales in our Endosurgery franchises increased $63
million in 2008, as compared to 2007. Refer to the Business and Market Overview
section for a more detailed discussion of our net sales by
division.
Our
international net sales, excluding sales from divested businesses, increased
$352 million, or 12 percent, in 2007 as compared to 2006. Approximately $170
million was attributable to the favorable impact of currency exchange rates.
Within our international business, sales of our CRM products increased $290
million, due primarily to a full year of consolidated results in 2007. Sales in
our Cardiovascular division increased $50 million, due primarily to the May 2007
launch of our TAXUS® Express2® coronary
stent system in Japan.
Gross
Profit
In 2008,
our gross profit was $5.581 billion, as compared to $6.015 billion in 2007, a
decrease of $434 million or seven percent. As a percentage of net sales, our
gross profit decreased to 69.3 percent for 2008, as compared to 72.0 percent for
2007. For 2007, our gross profit was $6.015 billion, as compared to $5.614
billion for 2006. As a percentage of net sales, our gross profit increased
slightly to 72.0 percent in 2007, as compared to 71.8 percent in 2006. The
following is a reconciliation of our gross profit percentages from 2006 to 2007
and 2007 to 2008:
|
Year
Ended
|
|||||||||
|
December
31,
|
|||||||||
|
2008
|
2007
|
||||||||
|
Gross
profit - prior year
|
72.0 | % | 71.8 | % | |||||
|
Shifts
in product sales mix
|
(2.5 | ) % | (1.8 | ) % | |||||
|
Lower
Project Horizion spend
|
0.7 | % | 0.2 | % | |||||
|
Impact
of higher inventory charges and other period expenses
|
(0.5 | ) % | (1.0 | ) % | |||||
|
Inventory
step up charge in 2006
|
3.4 | % | |||||||
|
All
other
|
(0.4 | ) % | (0.6 | ) % | |||||
|
Gross
profit - current year
|
69.3 | % | 72.0 | % | |||||
Our gross
profit margin was also negatively impacted by higher inventory charges and other
period expenses during both years. In 2008, these charges consisted primarily of
a $23 million inventory write-off related to an FDA warning letter received by
one of our third party sterilizers, and approximately $20 million of CRM-related
inventory write-offs, resulting principally from the successful launch of
COGNIS® and TELIGEN®. In 2007, these charges included warranty-related and other
scrap charges.
Partially
offsetting these declines in our gross profit margin was lower spending
associated with Project Horizon, our corporate-wide initiative to improve and
harmonize our overall quality processes and systems, which ended as a formal
program as of December 31, 2007. In addition, included in cost of
products sold for 2006 was an adjustment of $267 million, representing the
step-up value of acquired Guidant inventory sold
during
the year. There were no amounts included in our 2007 or 2008 cost of
products sold related to the inventory step-up and, as of December 31, 2007, we
had no step-up value remaining in inventory.
Operating
Expenses
The
following table provides a summary of certain of our operating
expenses:
|
2008
|
2007
|
2006
|
||||||||||||||||||||||
|
(in
millions)
|
$
|
%
of Net
Sales
|
$
|
%
of Net
Sales
|
$
|
%
of Net
Sales
|
||||||||||||||||||
|
Selling,
general and administrative expenses
|
2,589 | 32.2 | 2,909 | 34.8 | 2,675 | 34.2 | ||||||||||||||||||
|
Research
and development expenses
|
1,006 | 12.5 | 1,091 | 13.1 | 1,008 | 12.9 | ||||||||||||||||||
|
Royalty
expense
|
203 | 2.5 | 202 | 2.4 | 231 | 3.0 | ||||||||||||||||||
|
Amortization
expense
|
543 | 6.7 | 620 | 7.4 | 474 | 6.1 | ||||||||||||||||||
Selling, General and Administrative (SG&A) Expenses
In 2008,
our SG&A expenses decreased by $320 million, or 11 percent, as compared to
2007. As a percentage of our net sales, SG&A expenses decreased to 32.2
percent in 2008 from 34.8 percent in 2007. The decrease in our SG&A expenses
related primarily to lower head count and spending resulting from our expense
and head count reduction plan, as well as a reduction of $160 million
attributable to our first quarter 2008 divestiture of certain non-strategic
businesses. Refer to the Strategic Initiatives section
for more discussion of these initiatives.
In 2007,
our SG&A expenses increased by $234 million, or nine percent, as compared to
2006. As a percentage of our net sales, SG&A expenses increased slightly to
34.8 percent in 2007 from 34.2 percent in 2006. The increase in our SG&A
expenses related primarily to $256 million in incremental SG&A expenditures
associated with a full year of consolidated CRM operations, offset partially by
lower head count and spending as a result of our expense and head count
reduction plan, which was initiated in the fourth quarter of 2007.
Research
and Development (R&D) Expenses
Our
investment in R&D reflects spending on new product development programs, as
well as regulatory compliance and clinical research. In 2008, our R&D
expenses decreased by $85 million, or eight percent, as compared to
2007. As a percentage of our net sales, R&D expenses decreased to
12.5 percent in 2008 from 13.1 percent in 2007. The decrease related
primarily to lower head count and spending of $75 million resulting from our
first quarter 2008 divestiture of certain non-strategic businesses. We remain
committed to advancing medical technologies and investing in meaningful research
and development projects in all of our businesses in order to maintain a healthy
pipeline of new products that will contribute to our short- and long-term
profitable sales growth.
In 2007,
our R&D expenses increased by $83 million, or 8 percent, as
compared to 2006. As a percentage of our net sales, R&D expenses increased
marginally to 13.1 percent in 2007 from 12.9 percent in 2006. The
increase related primarily to $131 million in incremental R&D expenditures
associated with a full year of consolidated CRM operations, offset partially by lower spending of approximately $37 million associated with the
cancellation of our Endovations™ single-use endoscope R&D
program. During the second quarter of 2007, we determined that our
Endovations system would not be a commercially viable product and terminated the
program. In addition, our 2006 R&D expenses included approximately $30
million in costs related to the cancellation of the TriVascular AAA stent-graft
program. We do not expect these program cancellations to materially impact our
future operations or cash flows.
Royalty
Expense
In 2008,
our royalty expense increased by $1 million, or less than one percent, as
compared to 2007. As a percentage of our net sales, royalty expense increased
slightly to 2.5 percent from 2.4 percent for 2007. Royalty expense attributable
to sales of our drug-eluting stent systems increased $8 million as compared to
2007, despite an overall decrease in drug-eluting stent system sales. This was
due to a shift in the mix of our drug-eluting stent system sales towards the
PROMUS® stent system, following its launch in 2008. The royalty rate applied to
sales of the PROMUS® stent system is, on average, higher than that associated
with sales of our TAXUS® stent system. Offsetting this increase was a decrease
in royalty expense of $6 million attributable to our first quarter 2008
divestiture of certain non-strategic businesses.
In 2007,
our royalty expense decreased by $29 million, or 13 percent, as compared to
2006, due primarily to lower sales of our TAXUS® drug-eluting stent system. As a
percentage of our net sales, royalty expense decreased to 2.4 percent from 3.0
percent for 2006. Royalty expense attributable to sales of our TAXUS® stent
system decreased $48 million as compared to 2006, due to a decrease in TAXUS®
stent system sales. Offsetting this decrease was an increase in royalty expense
attributable to Guidant-related products of $13 million, due to a full year of
consolidated results, as well as increases in royalties associated with our
other businesses.
Amortization
Expense
In 2008,
our amortization expense decreased by $77 million, or 12 percent, as compared to
2007. The decrease in our amortization expense related primarily to the disposal
of $581 million of amortizable intangible assets in connection with our first
quarter 2008 business divestitures, and to certain Interventional
Cardiology-related intangible assets reaching the end of their accounting useful
life during 2008.
In 2007,
our amortization expense increased by $146 million, or 31 percent, as compared
to 2006. The increase in our amortization expense related to incremental
amortization associated with intangible assets obtained as part of the Guidant
acquisition, due to a full year of amortization.
Goodwill
and Intangible Asset Impairment Charges
In 2008,
we recorded goodwill and intangible asset impairment charges of $2.790 billion,
including a $2.613 billion write-down of goodwill associated with our
acquisition of Guidant, a $131 million write-down of certain of our Peripheral
Interventions-related intangible assets, and a $46 million write-down of certain
Urology-related intangible assets. We do not believe that the write-down of
these assets will have a material impact on future operations or cash
flows. Refer
to Note E –Goodwill and Other
Intangible Assets to our 2008 consolidated financial statements included
in Item 8 of this Annual Report for more information.
In 2007,
we recorded intangible asset impairment charges of $21 million associated with
our acquisition of Advanced Stent Technologies (AST), due to our decision to
suspend further significant funding of R&D with respect to the Petal™
bifurcation stent. We do not
expect this decision to materially impact our future operations or cash
flows.
In 2006,
we recorded intangible asset impairment charges of $23 million attributable to
the cancellation of the AAA stent-graft program we acquired with TriVascular,
Inc. In addition, we recorded intangible asset write-offs of $21 million
associated with developed technology obtained as part of our 2005 acquisition of
Rubicon Medical Corporation, and $12 million associated with our Real-time
Position Management® System (RPM)™ technology, due to our decision to cease
investment in these technologies. We do not expect these decisions to materially
impact our future operations or cash flows.
Acquisition-related
Milestone
In
connection with Abbott‘s 2006 acquisition of Guidant’s vascular intervention and
endovascular solutions businesses, Abbott agreed to pay us a milestone payment
of $250 million upon receipt of FDA approval to sell an everolimus-eluting stent
in the U.S. In July 2008, Abbott received FDA approval and launched its
XIENCE V™
everolimus-eluting coronary stent system in the U.S., and paid us $250 million,
which we recorded as a gain in the accompanying consolidated statements of
operations. Under the terms of the agreement, we are entitled to receive a
second milestone payment of $250 million from Abbott upon receipt of an approval
from the Japanese Ministry of Health, Labor and Welfare to market the
XIENCE V™ stent system in Japan.
Purchased
Research and Development
In 2008,
we recorded $43 million of purchased research and development charges, including
$17 million associated with our acquisition of Labcoat, Ltd., $8 million
attributable to our acquisition of CryoCor, Inc., and $18 million associated
with entering certain licensing and development arrangements.
The $17
million of in-process research and development associated with our acquisition
of Labcoat, Ltd. relates to a novel technology Labcoat is developing for coating
drug-eluting stents. We intend to use this technology in future generations of
our drug-eluting stent products. The $8 million of in-process research and
development associated with CryoCor represents cryogenic technology for use in
the treatment of atrial fibrillation, the most common and difficult to treat
cardiac arrhythmia (abnormal heartbeat). We intend to use this technology
in order to further pursue therapeutic solutions for atrial fibrillation and
advance our existing CRM and Electrophysiology product lines.
In 2007,
we recorded $85 million of purchased research and development, including $75
million associated with our acquisition of Remon Medical Technologies, Inc., $13
million resulting from the application of equity method accounting for one of
our strategic investments, and $12 million associated with payments made for
certain early-stage CRM technologies. Additionally, in June 2007, we terminated
our product development agreement with Aspect Medical Systems relating to brain
monitoring technology that Aspect was developing to aid the diagnosis and
treatment of depression, Alzheimer’s disease and other neurological conditions.
As a result, we recognized a credit to purchased research and development of
approximately $15 million during 2007, representing future payments that we
would have been obligated to make prior to the termination of the agreement. We
do not expect the termination of the agreement to impact our future operations
or cash flows materially.
The $75
million of in-process research and development acquired with Remon consists of a
pressure-sensing system development project, which we intend to combine with our
existing CRM devices. As of December 31, 2008, we estimate that the total cost
to complete the development project is between $75 million and $80 million. We
expect to launch devices using pressure-sensing technology in 2012 in our EMEA
region and certain Inter-Continental countries, in the U.S. in 2015, and Japan
in 2016, subject to regulatory approvals. We expect material net cash inflows
from such products to commence in 2015, following the launch of this technology
in the U.S.
In 2006,
we recorded $4.119 billion of purchased research and development, including a
charge of approximately $4.169 billion associated with the in-process research
and development obtained in conjunction with the Guidant acquisition; a credit
of $67 million resulting primarily from the reversal of accrued contingent
payments due to the cancellation of the TriVascular AAA program; and an expense
of $17 million resulting primarily from the application of equity method
accounting for one of our investments.
The
$4.169 billion of purchased research and development associated with the Guidant
acquisition consists primarily of approximately $3.26 billion for acquired
CRM-related in-process technology and $540 million for drug-eluting stent
technology shared with Abbott. The purchased research and development value
associated with the Guidant acquisition also includes $369 million representing
the estimated fair value of the potential milestone payments of up to $500
million that we may receive from Abbott upon their receipt of regulatory
approvals for certain products. We recorded the amounts as purchased research
and development at the acquisition date because the receipt of the payments was
dependent on future research and development activity and regulatory approvals,
and the asset had no alternative future use as of the acquisition date. In 2008,
Abbott received FDA approval and launched its XIENCE V™ everolimus-eluting
coronary
stent system in the U.S., and paid us $250 million, which we recognized as a
gain in our consolidated financial statements. Under the terms of the agreement,
we are entitled to receive a second milestone payment of $250 million from
Abbott upon receipt of an approval from the Japanese Ministry of Health, Labor
and Welfare to market the XIENCE V™ stent system in Japan. If received, we
will record this receipt as a gain in our consolidated financial statements at
the time of receipt.
The most
significant in-process purchased research and development projects acquired from
Guidant included the next-generation CRM pulse generator platform and rights to
the everolimus-eluting stent technology that we share with Abbott. The
next-generation pulse generator platform incorporates new components and
software while leveraging certain existing intellectual property, technology,
manufacturing know-how and institutional knowledge of Guidant. We expect to
leverage this platform across all CRM product families, including ICD systems,
cardiac resynchronization therapy (CRT) devices and pacemaker systems to treat
electrical dysfunction in the heart. During 2008, we substantially completed the
in-process CRM pulse generator project with the regulatory approval and launch
of the COGNIS® CRT-D and TELIGEN® ICD devices in the U.S., EMEA, and certain
Inter-Continental countries. We expect to launch the INGENIO™ pacemaker system,
utilizing this platform in both EMEA and the U.S. in the first half of 2011. As
of December 31, 2008, we estimate that the total cost to complete the INGENIO™
technology is between $30 million and $35 million and expect material net cash
inflows from the INGENIO™ device to commence in the second half of
2011.
The $540
million attributable to everolimus-eluting stent technology represents the
estimated fair value of the rights to Guidant’s everolimus-based drug-eluting
stent technology we share with Abbott. In December 2006, we launched the PROMUS®
everolimus-eluting coronary stent system, supplied to us by Abbott, in certain
EMEA countries. In 2007, we expanded our launch in EMEA, as well as certain
Inter-Continental countries and, in July 2008, launched in the U.S. We expect to
launch an internally developed and manufactured next-generation everolimus-based
stent, our PROMUS® Element™ stent system, in Europe in late 2009 and in the U.S.
and Japan in mid-2012. We expect that net cash inflows from our internally
developed and manufactured everolimus-based drug-eluting stent will commence in
2010. As of December 31, 2008, we estimate that the cost to complete our
internally manufactured next-generation everolimus-eluting stent technology
project is between $150 million and $175 million.
Gain
on Divestitures
During
2008, we recorded a $250 million gain in connection with the sale of our Fluid
Management and Venous Access businesses and our TriVascular EVAR program. Refer
to the Strategic Initiatives
section and Note F –
Divestitures and Assets Held for Sale to our 2008 consolidated
financial statements included in Item 8 of this Annual Report for more
information on these transactions.
Loss
on Assets Held for Sale
During
2007, we recorded a $560 million loss attributable primarily to the write-down
of goodwill in connection with the sale of certain of our non-strategic
businesses. Refer to the Strategic Initiatives section
and Note F – Divestitures and
Assets Held for Sale to our 2008 consolidated financial statements
included in Item 8 of this Annual Report for more information on these
transactions.
Restructuring
In
October 2007, our Board of Directors approved, and we committed to, an expense
and head count reduction plan, which resulted in the elimination of
approximately 2,300 positions worldwide. We are
providing
affected employees with severance packages, outplacement services and other
appropriate assistance and support. The plan is intended to bring
expenses in line with revenues as part of our initiatives to enhance short-
and long-term shareholder value. Key activities under the plan include the
restructuring of several businesses, corporate functions and product franchises
in order to better utilize resources, strengthen competitive positions, and
create a more simplified and efficient business model; the elimination,
suspension or reduction of spending on certain R&D projects; and the
transfer of certain production lines from one facility to another. We initiated
these activities in the fourth quarter of 2007 and expect to be substantially
complete worldwide in 2010.
We expect
that the execution of this plan will result in total pre-tax expenses of
approximately $425 million to $450 million. We are recording a
portion of these expenses as restructuring charges and the remaining portion
through other lines within our consolidated statements of operations. We
expect the plan to result in cash payments of approximately $395 million to $415
million. The following provides a summary of our expected total costs
associated with the plan by major type of cost:
|
Type
of cost
|
Total
estimated amount expected to be incurred
|
|
Restructuring
charges:
|
|
|
Termination
benefits
|
$225
million to $230 million
|
|
Fixed
asset write-offs
|
$20
million
|
|
Other
(1)
|
$65
million to $70 million
|
|
Restructuring-related
expenses:
|
|
|
Retention
incentives
|
$75
million to $80 million
|
|
Accelerated
depreciation
|
$10
million to $15 million
|
|
Transfer
costs (2)
|
$30
million to $35 million
|
|
$425
million to $450 million
|
|
|
|
(1)
|
Consists
primarily of consulting fees and contractual
cancellations.
|
|
|
(2)
|
Consists
primarily of costs to transfer product lines from one facility to another,
including costs of transfer teams, freight and product line
validations.
|
During
2008, we recorded $78 million of restructuring charges. In addition,
we recorded $55 million of expenses within other lines of our consolidated
statements of operations related to our restructuring initiatives. The following
presents these costs by major type and line item within our consolidated
statements of operations:
|
(in
millions)
|
Termination
Benefits
|
Retention
Incentives
|
Asset
Write-offs
|
Accelerated
Depreciation
|
Transfer
Costs
|
Other
|
Total
|
|||||||||||||||||||||
|
Restructuring
charges
|
$ | 34 | $ | 10 | $ | 34 | $ | 78 | ||||||||||||||||||||
|
Restructuring-related
expenses:
|
||||||||||||||||||||||||||||
|
Cost
of products sold
|
$ | 9 | $ | 4 | $ | 4 | 17 | |||||||||||||||||||||
|
Selling,
general and administrative expenses
|
27 | 4 | 31 | |||||||||||||||||||||||||
|
Research
and development expenses
|
7 | 7 | ||||||||||||||||||||||||||
| 43 | 8 | 4 | 55 | |||||||||||||||||||||||||
| $ | 34 | $ | 43 | $ | 10 | $ | 8 | $ | 4 | $ | 34 | $ | 133 | |||||||||||||||
During 2007, we recorded $176 million of restructuring charges, and $8 million of restructuring-related expenses within other lines of our consolidated statements of operations. The following presents these costs by major type and line item within our consolidated statements of operations:
|
(in
millions)
|
Termination
Benefits
|
Retention
Incentives
|
Asset
Write-offs
|
Accelerated
Depreciation
|
Transfer
Costs
|
Other
|
Total
|
|||||||||||||||||||||
|
Restructuring
charges
|
$ | 158 | $ | 8 | $ | 10 | $ | 176 | ||||||||||||||||||||
|
Restructuring-related
expenses:
|
||||||||||||||||||||||||||||
|
Cost
of products sold
|
$ | 1 | $ | 1 | 2 | |||||||||||||||||||||||
|
Selling,
general and administrative expenses
|
2 | $ | 2 | 4 | ||||||||||||||||||||||||
|
Research
and development expenses
|
2 | 2 | ||||||||||||||||||||||||||
| 5 | 3 | 8 | ||||||||||||||||||||||||||
| $ | 158 | $ | 5 | $ | 8 | $ | 3 | $ | 10 | $ | 184 | |||||||||||||||||
The
termination benefits recorded during 2008 and 2007 represent amounts incurred
pursuant to our on-going benefit arrangements and amounts for “one-time”
involuntary termination benefits, and have been recorded in accordance with
Financial Accounting Standards Board (FASB) Statement No. 112, Employer’s Accounting for
Postemployment Benefits and FASB Statement No. 146, Accounting for Costs Associated with
Exit or Disposal Activities. We expect to record the additional
termination benefits in 2009 when we identify with more specificity the job
classifications, functions and locations of the remaining head count to be
eliminated. Retention incentives represent cash incentives, which are
being recorded over the future service period during which eligible employees
must remain employed with us in order to retain the payment. The
other restructuring costs, which, in 2008 and 2007, represented primarily
consulting fees, are being recognized and measured at their fair value in the
period in which the liability is incurred in accordance with FASB Statement No.
146.
We have
incurred cumulative restructuring and restructuring-related costs of $317
million since we committed to the plan in October 2007. The following presents
these costs by major type (in millions):
|
Termination
benefits
|
$ | 192 | ||
|
Retention
incentives
|
48 | |||
|
Fixed
asset write-offs
|
18 | |||
|
Accelerated
depreciation
|
11 | |||
|
Transfer
costs
|
4 | |||
|
Other
|
44 | |||
| $ | 317 |
In 2008,
we made cash payments of approximately $185 million associated with our
restructuring initiatives, which related to termination benefits and retention
incentives paid and other restructuring charges. We have made
cumulative cash payments of approximately $230 million since we committed to our
restructuring initiatives in October 2007. These payments were made using cash
generated from our operations. We expect to record the remaining
costs associated with these restructuring initiatives during 2009 and make the
remaining cash payments throughout 2009 and 2010 using cash generated from
operations.
As a
result of our restructuring- and divestiture-related initiatives, we have
reduced our R&D and SG&A expenses by an annualized run rate of
approximately $500 million exiting 2008. In addition, we expect annualized
run-rate reductions of manufacturing costs of approximately $35 million to $40
million, as a result of our transfers of production lines. Due to the
longer-term nature of these initiatives, we do not expect to achieve the full
benefit of these reductions in manufacturing costs until 2012. We have partially
reinvested our savings from our head count reductions into targeted head count
increases of 500 positions, primarily in direct sales, to drive sales
growth.
Plant Network
Optimization
On
January 27, 2009, our Board of Directors approved, and we committed to, a plant
network optimization plan, which is intended to simplify our manufacturing plant
structure by transferring certain production lines from one facility to another
and by closing certain facilities. The plan is a complement to our previously
announced
expense and head count reduction plan, and is intended to improve overall gross
profit margins. Activities under the plan will be initiated in 2009 and are
expected to be substantially completed by the end of 2011. We estimate that the
plan will result in annual reductions of manufacturing costs of approximately
$65 million to $80 million in 2012. These savings are in addition
to the estimated $35 million to $40 million of annual reductions of
manufacturing costs in 2012 from activities under our previously announced
expense and head count reduction plan.
We
estimate that the plan will result in total pre-tax charges of approximately
$135 million to $150 million, and that approximately $120 million to $130
million of these charges will result in future cash outlays. The
following provides a summary of our estimates of costs associated with the plan
by major type of cost:
|
Type
of cost
|
Total
estimated amount expected to be incurred
|
|
Restructuring
charges:
|
|
|
Termination
benefits
|
$45
million to $50 million
|
|
Restructuring-related
expenses:
|
|
|
Accelerated
depreciation
|
$15
million to $20 million
|
|
Transfer
costs (1)
|
$75
million to $80 million
|
|
$135
million to $150 million
|
|
|
(1)
|
Consists
primarily of costs to transfer product lines from one facility to another,
including costs of transfer teams, freight and product line
validations.
|
The
estimated restructuring charges relate primarily to termination benefits to be
recorded pursuant to FASB Statement No. 112, Employer’s Accounting for
Postemployment Benefits and FASB Statement No. 146, Accounting for Costs Associated with
Exit or Disposal Activities. The accelerated depreciation will be
recorded through cost of products sold over the new remaining useful life of the
related assets and the production line transfer costs will be recorded through
cost of products sold as incurred.
Litigation-Related
Charges
In 2008,
we recorded a charge of $334 million as a result of a ruling by a federal judge
in a patent infringement case brought against us by Johnson & Johnson. In
2007, we recorded a charge of $365 million associated with this case. See
further discussion of our material legal proceedings in Item 3. Legal Proceedings and
Note L — Commitments and
Contingencies to our 2008 consolidated financial statements included in
Item 8 of this Annual Report.
Interest
Expense
Our
interest expense decreased to $468 million in 2008 as compared to $570 million
in 2007. The decrease in our interest expense related primarily to a decrease in
our average debt levels, due to debt prepayments of $1.425 billion during the
year, as well as a decrease in our average borrowing rate.
Our
interest expense increased to $570 million in 2007 as compared to $435 million
in 2006. The increase in our interest expense related primarily to an increase
in our average debt levels, as well as an increase in our average borrowing
rate. Our average debt levels for 2007 increased compared to 2006 as a result of
carrying a full year of incremental debt due to the acquisition of Guidant in
April 2006.
Fair Value
Adjustment
We
recorded net expense of $8 million in 2007 and $95 million in 2006 to reflect
the change in fair value related to the sharing of proceeds feature of the
Abbott stock purchase, which is discussed in further detail in Note D - Acquisitions
to our 2008 consolidated financial statements included in Item 8 of
this Annual Report.
This
sharing of proceeds feature was marked-to-market through earnings based upon
changes in our stock price, among other factors. There was no fair value
associated with this feature as of December 31, 2007.
Other,
net
Our
other, net reflected expense of $58 million in 2008, income of $23 million in
2007, and expense of $56 million in 2006. The following are the components of
other, net:
|
Year
Ended December 31,
|
||||||||||||
|
(in
millions)
|
2008
|
2007
|
2006
|
|||||||||
|
Net
losses on investments and notes receivable
|
$ | (93 | ) | $ | (54 | ) | $ | (109 | ) | |||
|
Interest
income
|
47 | 79 | 67 | |||||||||
|
Other
|
(12 | ) | (2 | ) | (14 | ) | ||||||
| $ | (58 | ) | $ | 23 | $ | (56 | ) | |||||
Refer to
Note G – Investments and Notes
Receivable to our 2008 consolidated financial statements included in Item
8 of this Annual Report for more information regarding our investment portfolio.
Our interest income decreased in 2008, as compared to 2007, due primarily to
lower average investment rates. Our interest income increased in 2007, as
compared to 2006, due primarily to higher average cash balances, partially
offset by lower average investment rates.
Tax
Rate
The
following provides a summary of our reported tax rate:
|
Percentage
Point
Increase (Decrease)
|
||||||||||||||||||||
|
2008
|
2007
|
2006
|
2008 vs.
2007 |
2007 vs.
2006 |
||||||||||||||||
|
Reported
tax rate
|
0.2 | % | (13.0 | )% | 1.2 | % | 13.2 | % | (14.2 | )% | ||||||||||
|
Impact
of certain charges
|
18.9 | % | 25.6 | % | 20.2 | % | (6.7 | )% | 5.4 | % | ||||||||||
In 2008, the increase in our reported tax rate, as compared to 2007, related primarily to the impact of certain charges and gains that are taxed at different rates than our effective tax rate. These amounts related primarily to gains and losses associated with the divestiture of certain non-strategic businesses and investments, goodwill and intangible asset impairment charges, litigation-related charges, and changes in the geographic mix of our net sales. In 2007, the decrease in our reported tax rate as compared to 2006 related primarily to additional foreign tax credits, changes in the geographic mix of our net sales, and the impact of certain charges during 2007 that are taxed at different rates than our effective tax rate. These charges included litigation- and restructuring-related charges, changes to the reserve for uncertain tax positions relating to items originating in prior periods, purchased research and development, and losses associated with the divestiture of non-strategic businesses.
Effective
January 1, 2007, we adopted the provisions of FASB Interpretation No. 48, Accounting for Uncertainty in Income
Taxes. At December 31, 2008, we had $1.107 billion of gross unrecognized
tax benefits, $978 million of which, if recognized, would affect our effective
tax rate. At December 31, 2007, we had $1.180 billion of gross unrecognized tax
benefits, $415 million of which, if recognized, would affect our effective tax
rate. The net reduction in our unrecognized tax benefits is
attributable primarily to the resolution of certain unrecognized tax positions
in 2008. The amount of unrecognized tax benefits which, if recognized, would
affect our effective tax rate increased at December 31, 2008, as compared to
December 31, 2007, due to the adoption of FASB Statement No. 141(R), Business Combinations, as of
January 1, 2009, which requires that we
recognize
changes in acquired income tax uncertainties (applied to acquisitions before and
after the adoption date) as income tax expense or benefit.
We are
subject to U.S. federal income tax as well as income tax of multiple state and
foreign jurisdictions. We have concluded all U.S. federal income tax
matters through 2000 and substantially all material state, local, and foreign
income tax matters through 2001.
The
following provides a summary of key performance indicators that we use to assess
our liquidity and operating performance.
Net Debt3
|
As
of December 31,
|
||||||||
|
(in
millions)
|
2008
|
2007
|
||||||
|
Short-term
debt
|
$ | 2 | $ | 256 | ||||
|
Long-term
debt
|
6,743 | 7,933 | ||||||
|
Total
debt
|
6,745 | 8,189 | ||||||
|
Less:
cash and cash equivalents
|
1,641 | 1,452 | ||||||
|
Net
debt
|
$ | 5,104 | $ | 6,737 | ||||
EBITDA4
|
Year
Ended December 31,
|
||||||||||||
|
(in
millions)
|
2008
|
2007
|
2006
|
|||||||||
|
Net
loss
|
$ | (2,036 | ) | $ | (495 | ) | $ | (3,577 | ) | |||
|
Interest
income
|
(47 | ) | (79 | ) | (67 | ) | ||||||
|
Interest
expense
|
468 | 570 | 435 | |||||||||
|
Income
tax expense (benefit)
|
5 | (74 | ) | 42 | ||||||||
|
Depreciation
|
321 | 298 | 251 | |||||||||
|
Amortization
|
543 | 620 | 474 | |||||||||
|
EBITDA
|
$ | (746 | ) | $ | 840 | $ | (2,442 | ) | ||||
|
3
|
Management uses net debt to
monitor and evaluate cash and debt levels and believes it is a measure
that provides valuable information regarding our net financial position
and interest rate exposure. Users of our financial statements should
consider this non-GAAP financial information in addition to, not as a
substitute for, nor as superior to, financial information prepared in
accordance with GAAP.
|
|
4
|
Management
uses EBITDA to assess operating performance and believes that it may
assist users of our financial statements in analyzing the underlying
trends in our business over time. In addition, management considers
adjusted EBITDA as a component of the financial covenants included in our
credit agreements. Users of our financial statements should consider this
non-GAAP financial information in addition to, not as a substitute for,
nor as superior to, financial information prepared in accordance with
GAAP. Our EBITDA included goodwill and intangible asset impairment
charges; acquisition-, divestiture-, litigation- and restructuring-related
net charges (pre-tax) of $2.872 billion for 2008, $1.249 billion for 2007
and $4.622 billion for 2006. See Financial Summary for a
description of 2008 charges (credits). In 2007, these charges
included:
|
|
•
|
$21
million of intangible asset impairment charges related to our decision to
temporarily suspend further significant funding of the Petal™ bifurcation
stent project acquired with Advanced Stent
Technologies;
|
|
•
|
$122
million of acquisition-related charges, including purchased research and
development related primarily to our acquisition of Remon Medical
Technologies, Inc. and integration costs related to our acquisition of
Guidant;
|
|
•
|
$560
million, primarily non-cash, associated with the write-down of goodwill in
connection with the divestiture of non-strategic
businesses;
|
|
•
|
$365
million attributable to estimated potential losses associated with patent
litigation with Johnson &
Johnson;
|
|
•
|
$181
million of restructuring charges associated with our on-going expense and
head count reduction initiative, net of accelerated
depreciation.
|
|
|
In
2006, these charges represented costs associated with our acquisition of
Guidant Corporation and primarily included: purchased research and
development charges; a charge for the step-up value of Guidant inventory
sold; and a credit resulting primarily from the reversal of accrued
contingent payments due to the cancellation of the abdominal aortic
aneurysm (AAA) program that we obtained as part of our acquisition of
TriVascular, Inc.
|
Cash
Flow
|
Year
Ended December 31,
|
||||||||||||
|
(in
millions)
|
2008
|
2007
|
2006
|
|||||||||
|
Cash
provided by operating activities
|
$ | 1,216 | $ | 934 | $ | 1,845 | ||||||
|
Cash
provided by (used for) investing activities
|
324 | (474 | ) | (9,312 | ) | |||||||
|
Cash
(used for) provided by financing activities
|
(1,350 | ) | (680 | ) | 8,439 | |||||||
Operating
Activities
Cash
generated by our operating activities continues to be a major source of funds
for servicing our outstanding debt obligations and investing in our growth. The
increase in operating cash flow in 2008, as compared to 2007, is due primarily
to the receipt of a $250 million milestone payment from Abbott following the
July 2008 FDA approval of the XIENCE V™ everolimus-eluting coronary stent
system. In addition, we made lower interest payments of $129 million in 2008, as
compared to 2007, due to lower average debt balances. These increases were
partially offset by $187 million of payments made in 2008 towards the Guidant
multi-district litigation (MDL) settlement, described in Note L – Commitments and
Contingencies to
our consolidated financial statements included in Item 8 of this
Annual Report.
The
decrease in operating cash flow in 2007, as compared to 2006, is attributable
primarily to: approximately $400 million in tax payments made in the first
quarter of 2007, associated principally with the gain on Guidant’s sale of its
vascular intervention and endovascular solutions businesses to Abbott; an
increase in interest payments of $160 million due to higher average debt levels;
decreases in EBITDA, excluding acquisition-, divestiture-, litigation- and
restructuring-related charges of approximately $150 million; and an increase in
severance and other merger and restructuring-related payments of approximately
$100 million, including severance payments made in the first half of 2007 in
conjunction with our acquisition and integration of Guidant. See Note D – Acquisitions to our
consolidated financial statements included in Item 8 of this Annual Report for
further details.
Investing
Activities
We made
capital expenditures of $362 million in 2008, $363 million in 2007, and $341
million in 2006. We expect to incur capital expenditures of approximately
$375 million during 2009, which includes capital expenditures to upgrade
further our quality systems and information systems infrastructure, to enhance
our manufacturing capabilities in order to support a second drug-eluting stent
platform, and to support continued growth in our business units.
During
2008, our investing activities included proceeds of approximately $1.3 billion
associated with the divestiture of certain businesses, $95 million of proceeds
associated with definitive agreements with Saints Capital and Paul Capital
Partners to sell the majority of our investments in, and notes receivable from
certain publicly traded and privately held companies, and $54 million from the
sale of certain other investments and collections of notes receivable. These
cash inflows were partially offset by $675 million in payments related to prior
period acquisitions associated primarily with Advanced Bionics, and $39 million
of cash payments for investments in privately held companies, and acquisitions
of certain technology rights. In addition, we paid $21 million, net of cash
acquired, to acquire CryoCor, Inc. and $17 million, net of cash acquired to
acquire Labcoat, Ltd. Refer to Note G – Investments and Notes
Receivable and Note D –
Acquisitions to our consolidated financial statements contained in Item 8
of this Annual Report for more information.
During
2007, our investing activities included $248 million of payments related to
prior period acquisitions, associated primarily with Advanced Bionics; and $53
million of cash payments for investments in privately held companies, and
acquisitions of certain technology rights. Further, we paid approximately $70
million in cash, net of cash acquired, to acquire Remon Medical Technologies,
Inc. We also issued approximately five million shares of our common stock valued
at approximately $90 million and paid $10 million in cash, in addition to our
previous investments of $40 million, to acquire the remaining interests of
EndoTex Interventional Systems, Inc. These cash outflows were partially offset
by $243 million of gross proceeds from the sale of several of our investments
in, and collection of notes receivable from, certain privately held and publicly
traded companies. Refer to Note G – Investments and Notes
Receivable and Note D –
Acquisitions to our consolidated financial statements contained in Item 8
of this Annual Report for more information.
During
2006, we paid an aggregate purchase price of approximately $21.7 billion, net of
cash acquired, to acquire Guidant Corporation, which included: approximately
$7.8 billion of cash; 577 million shares of our common stock at an estimated
fair value of $12.5 billion; approximately 40 million of our fully vested stock
options granted to Guidant employees at an estimated fair value of $450 million;
$97 million associated with the buyout of options of certain former vascular
intervention and endovascular solutions Guidant employees; and $770 million of
direct acquisition costs, including a $705 million payment made to Johnson &
Johnson in connection with the termination of its merger agreement with Guidant.
In addition, our investing activities during 2006 included $397 million of
payments related to prior period acquisitions, associated primarily with
Advanced Bionics, CryoVascular Systems, Inc. and Smart Therapeutics, Inc.;
and $98 million of payments for acquisitions of certain technology rights.
Partially offsetting these cash outflows were proceeds of $159 million related
to the maturity of marketable securities and $33 million of proceeds from the
sale of investments in certain privately held companies.
Financing
Activities
Our cash
flows from financing activities reflect issuances and repayments of debt,
payments for share repurchases and proceeds from stock issuances related to our
equity incentive programs. We expect to continue to use
a significant portion of our future operating cash flow over the next several
years to reduce our debt obligations.
Debt
We had
total debt of $6.745 billion at December 31, 2008 at an average
interest rate of 5.65 percent as compared to total debt of
$8.189 billion at December 31, 2007 at an average interest rate of
6.36 percent. The debt maturity schedule for the significant
components of our debt obligations as of December 31, 2008, is as
follows:
|
(in
millions)
|
2009
|
2010
|
2011
|
2012
|
2013
|
Thereafter
|
Total
|
|||||||||||||||||||||
|
Term
loan
|
$ | 825 | $ | 2,000 | $ | 2,825 | ||||||||||||||||||||||
|
Abbott
Laboratories loan
|
900 | 900 | ||||||||||||||||||||||||||
|
Senior
notes
|
850 | $ | 2,200 | 3,050 | ||||||||||||||||||||||||
| $ | $ | 825 | $ | 3,750 | $ | $ | $ | 2,200 | $ | 6,775 | ||||||||||||||||||
|
|
Note:
|
The
table above does not include discounts associated with our Abbott loan and
senior notes, or amounts related to interest rate swaps used to hedge the
fair value of certain of our senior
notes.
|
During
2008, we made debt prepayments of $1.175 billion outstanding under our term loan
using cash generated by operations. In addition, we repaid $250 million
outstanding under our credit facility secured by our U.S. trade receivables.
There were no amounts outstanding under this facility at December 31, 2008. We
also maintain a separate $2.0 billion revolving credit facility. In 2008, we
issued a $717 million surety bond backed by a $702 million letter of credit and
$15 million of cash to secure a damage award related to the Johnson &
Johnson patent infringement case pending appeal, described in Note L – Commitments and
Contingencies, reducing the credit availability under the revolving
facility. There were no amounts outstanding under the facility at December 31,
2008. In February 2009, we amended our term loan and revolving credit facility
agreement to increase flexibility under our financial covenants. Refer to
Note I – Borrowings and Credit
Arrangements to our 2008 consolidated financial statements included in
Item 8 of this Annual Report for information regarding the terms of the
amendment. At the same time, we prepaid $500 million of our term loan
and reduced our revolving credit facility by $250 million. As a result,
our next debt maturity is $325 million due in April
2010.
During
2007, we prepaid $1.0 billion outstanding under the term loan, using $750
million of cash on hand and $250 million in borrowings against a $350 million
credit facility secured by our U.S. trade receivables. In addition, in
2007, cash flows from financing activities included a $60 million contractual
payment made to reimburse Abbott for a portion of its cost of borrowing $1.4
billion in 2006 to purchase shares of our common stock in connection with our
acquisition of Guidant. Refer to Note D – Acquisitions to our
2008 consolidated financial statements included in Item 8 of this Annual Report
for more information regarding the Abbott transaction.
During
2006, we received net proceeds from borrowings of $6.888 billion, which we used
primarily to finance the cash portion of the Guidant acquisition. In addition,
we received $1.4 billion from the sale of shares of our common stock to Abbott.
Refer to Note D – Acquisitions
and Note I – Borrowings
and Credit Arrangements to our consolidated financial statements
contained in Item 8 of this Annual Report for more information on the Abbott
transaction and our debt obligations.
Our term
loan and revolving credit facility agreement requires that we maintain certain
financial covenants. At December 31, 2008, we were in compliance with the
required covenants. Our inability to maintain these covenants could require us
to seek to further renegotiate the terms of our credit facilities or seek
waivers from compliance with these covenants, both of which could result in
additional borrowing costs. See Note I – Borrowings and Credit
Arrangements to our consolidated financial statements contained in Item 8
of this Annual Report for more information regarding these
covenants.
Equity
During
2008, we received $71 million in proceeds from stock issuances related to
our stock option and employee stock purchase plans, as compared to $132 million
in 2007 and $145 million in 2006. Proceeds from the exercise of employee stock
options and employee stock purchases vary from period to period based upon,
among other factors, fluctuations in the trading price of our common stock and
in the exercise and stock purchase patterns of employees.
We did
not repurchase any of our common stock during 2008, 2007 or 2006. Approximately
37 million shares remain under our previous share repurchase
authorizations.
Contractual
Obligations and Commitments
The
following table provides a summary of certain information concerning our
obligations and commitments to make future payments, which is in addition to our
outstanding principal debt obligations as presented in the previous table, and
is based on conditions in existence as of December 31, 2008. See Note D - Acquisitions and
Note I - Borrowings and Credit
Arrangements to our 2008 consolidated financial statements included
in Item 8 of this Annual Report for additional information regarding our
acquisition and debt obligations.
|
Payments
Due by Period
|
||||||||||||||||||||||||||||
|
(in
millions)
|
2009
|
2010
|
2011
|
2012
|
2013
|
Thereafter
|
Total
|
|||||||||||||||||||||
|
Lease
obligations (1)
|
$ | 64 | $ | 56 | $ | 45 | $ | 35 | $ | 26 | $ | 57 | $ | 283 | ||||||||||||||
|
Purchase
obligations (1)(2)
|
338 | 39 | 11 | 4 | 3 | 395 | ||||||||||||||||||||||
|
Minimum
royalty obligations (1)
|
29 | 27 | 14 | 2 | 1 | 6 | 79 | |||||||||||||||||||||
|
Unrecognized
tax benefits
|
124 | 124 | ||||||||||||||||||||||||||
|
Interest
payments (1)(3)
|
338 | 297 | 199 | 133 | 133 | 747 | 1,847 | |||||||||||||||||||||
| $ | 893 | $ | 419 | $ | 269 | $ | 174 | $ | 163 | $ | 810 | $ | 2,728 | |||||||||||||||
|
(1)
|
In
accordance with U.S. GAAP, these obligations relate to expenses associated
with future periods and are not reflected in our consolidated balance
sheets.
|
|
(2)
|
These
obligations relate primarily to inventory commitments and capital
expenditures entered in the normal course of
business.
|
|
(3)
|
Interest
payment amounts related to our term loan are projected using market
interest rates as of December 31, 2008. Future interest payments may
differ from these projections based on changes in the market interest
rates.
|
The table
above does not reflect unrecognized tax benefits of $1.251 billion, the timing
of which is uncertain. Refer to Note K– Income Taxes to our
2008 consolidated financial statements included in Item 8 of this Annual Report
for more information on these unrecognized tax benefits.
Certain
of our acquisitions involve the payment of contingent consideration. See Note D - Acquisitions to our
2008 consolidated financial statements included in Item 8 of this Annual
Report for the estimated maximum potential amount of future contingent
consideration we could be required to pay associated with our recent
acquisitions. Since it is not possible to estimate when, or even if, performance
milestones will be reached, or the amount of contingent consideration payable
based on future revenues, the maximum contingent consideration has not been
included in the table above. Additionally, we may consider satisfying these
commitments by issuing our stock or refinancing the commitments with cash,
including cash obtained through the sale of our stock. Payments due to the
former shareholders of Advanced Bionics in connection with our amended merger
agreement are accrued as of December 31, 2008, and therefore, do not appear in
the table above.
Certain
of our equity investments give us the option to acquire the company in the
future. Since it is not possible to estimate when, or even if, we will exercise
our option to acquire these companies, we have not included these future
potential payments in the table above.
At
December 31, 2008, we had outstanding letters of credit of approximately $819
million, as compared to approximately $110 million at December 31, 2007, which
consisted primarily of bank guarantees and collateral for workers’
compensation programs. The increase is due primarily to a $702 million
letter of credit entered into in 2008 in order to secure a damage award pending
appeal related to the Johnson & Johnson patent infringement case. As of
December 31, 2008, none of the beneficiaries had drawn upon the letters of
credit or guarantees. We believe we have sufficient cash on hand and intend to
fund these payments without drawing on the letters of credit.
Critical
Accounting Policies and Estimates
Our
financial results are affected by the selection and application of accounting
policies. We have adopted accounting policies to prepare our consolidated
financial statements in conformity with U.S. GAAP. We describe these accounting
polices in Note A—Significant Accounting
Policies to our 2008 consolidated financial
statements
included in Item 8 of this Annual Report.
To
prepare our consolidated financial statements in accordance with U.S. GAAP,
management makes estimates and assumptions that may affect the reported amounts
of our assets and liabilities, the disclosure of contingent assets and
liabilities at the date of our financial statements and the reported amounts of
our revenue and expenses during the reporting period. Our actual results may
differ from these estimates.
We
consider estimates to be critical if (i) we are required to make assumptions
about material matters that are uncertain at the time of estimation or if (ii)
materially different estimates could have been made or it is reasonably likely
that the accounting estimate will change from period to period. The following
are areas requiring management’s judgment that we consider
critical:
Revenue
Recognition
We
generate revenue primarily from the sale of single-use medical devices. We
consider revenue to be realized or realizable and earned when all of the
following criteria are met: persuasive evidence of a sales arrangement exists; delivery has occurred or
services have been rendered; the price is fixed or determinable; and
collectibility is reasonably assured. We generally meet these criteria at the
time of shipment, unless a consignment arrangement exists or we are required to
provide additional services. We recognize revenue from consignment arrangements
based on product usage, or implant, which indicates that the sale is complete.
For our other transactions, we recognize revenue when our products are delivered
and risk of loss transfers to the customer, provided there are no
substantive remaining performance obligations required of us or any matters
requiring customer acceptance, and provided we can form an estimate for sales
returns. For multiple-element arrangements where the sale of devices is combined
with future service obligations, as with our LATITUDE® Patient Management
System, we defer revenue on the undelivered element based on verifiable
objective evidence of fair value, and recognize the associated revenue over the
related service period. We present revenue net of sales taxes in our
consolidated statements of operations.
We
generally allow our customers to return defective, damaged and, in certain
cases, expired products for credit. We base our estimate for sales returns upon
historical trends and record the amount as a reduction to revenue when we
sell the initial product. In addition, we may allow customers to return
previously purchased products for next-generation product offerings; for these
transactions, we defer recognition of revenue based upon an estimate of the
amount of product to be returned when the next-generation products are shipped
to the customer.
We offer
sales rebates and discounts to certain customers. We treat sales rebates and
discounts as a reduction of revenue and classify the corresponding liability as
current. We estimate rebates for products where there is sufficient historical
information available to predict the volume of expected future rebates. If we
are unable to estimate the expected rebates reasonably, we record a liability
for the maximum rebate percentage offered. We have entered certain agreements
with group purchasing organizations to sell our products to participating
hospitals at negotiated prices. We recognize revenue from these agreements
following the same revenue recognition criteria discussed above.
Inventory
Provisions
We base
our provisions for excess and obsolete inventory primarily on our estimates of
forecasted net sales. A significant change in the timing or level of demand for
our products as compared to forecasted amounts may result in recording
additional provisions for excess and obsolete inventory in the future. The
industry in which we participate is characterized by rapid product development
and frequent new product introductions. Uncertain timing of next-generation
product approvals, variability in product launch strategies, product recalls and
variation in product utilization all affect our estimates related to excess and
obsolete inventory.
Valuation of Business
Combinations
We record
intangible assets acquired in business combinations under the purchase method of
accounting. We allocate the amounts we pay for each acquisition to the assets we
acquire and liabilities we assume based on their fair values at the dates of
acquisition in accordance with FASB Statement No. 141, Business Combinations,
including identifiable intangible assets and purchased research and development
which either arise from a contractual or legal right or are separable from
goodwill. We base the fair value of identifiable intangible assets and purchased
research and development on detailed valuations that use information and
assumptions provided by management. We allocate any excess purchase price over
the fair value of the net tangible and identifiable intangible assets acquired
to goodwill. The use of alternative valuation assumptions, including estimated
cash flows and discount rates, and alternative estimated useful life assumptions
could result in different purchase price allocations, purchased research and
development charges, and intangible asset amortization expense in current and
future periods.
Purchased Research and
Development
Our
purchased research and development represents the value of acquired in-process
projects that have not yet reached technological feasibility and have no
alternative future uses as of the date of acquisition. The primary basis for
determining the technological feasibility of these projects is obtaining
regulatory approval to market the underlying products in an applicable
geographic region. Through December 31, 2008, we have expensed the value
attributable to these in-process projects at the time of the acquisition in
accordance with accounting standards effective through that date. If the
projects are not successful or completed in a timely manner, we may not realize
the financial benefits expected for these projects or for the acquisition as a
whole. In addition, we record certain costs associated with our alliances as
purchased research and development.
We use
the income approach to determine the fair values of our purchased research and
development. This approach calculates fair value by estimating the after-tax
cash flows attributable to an in-process project over its useful life and then
discounting these after-tax cash flows back to a present value. We base our
revenue assumptions on estimates of relevant market sizes, expected market
growth rates, expected trends in technology and expected levels of market share.
In arriving at the value of the in-process projects, we consider, among other
factors: the in-process projects’ 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. We base the discount rate used to arrive at a present value
as of the date of acquisition on the time value of money and medical technology
investment risk factors. For the in-process projects acquired in connection with
our recent acquisitions, we used the following ranges of risk-adjusted discount
rates to discount our projected cash flows: 34 percent in 2008, 19 percent in
2007, and 13 percent to 17 percent in 2006. We believe that the estimated
in-process 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.
Impairment of Intangible
Assets
We review
intangible assets subject to amortization quarterly to determine if any adverse
conditions exist or a change in circumstances has occurred that would indicate
impairment or a change in the remaining useful life. Conditions that may
indicate impairment include, but are not limited to, a significant adverse
change in legal factors or business climate that could affect the value of an
asset, a product recall, or an adverse action or assessment by a regulator. If
an impairment indicator exists we test the intangible asset for
recoverability. For purposes of the recoverability test, we group our
intangible assets with other assets and liabilities at the lowest level of
identifiable cash flows if the intangible asset does not generate cash flows
independent of other assets and liabilities. If the carrying value of the
intangible asset (asset group) exceeds the undiscounted cash flows expected to
result from the use and eventual disposition of the intangible asset (asset
group), we will write the carrying value down to the fair
value in the period identified. In addition, we review our indefinite-lived
intangible
assets at
least annually for impairment and reassess their classification as
indefinite-lived assets. To test for impairment, we calculate the fair value of
our indefinite-lived intangible assets and compare the calculated fair values to
the respective carrying values. If the carrying value exceeds the
fair value of the indefinite-lived intangible asset, the carrying value is
written down to the fair value.
We
generally calculate fair value of our intangible assets as the present value of
estimated future cash flows we expect to generate from the asset using a
risk-adjusted discount rate. In determining our estimated
future cash flows associated with our intangible assets,
we use estimates and assumptions about future revenue
contributions, cost structures and remaining useful lives of the asset (asset
group). The use of alternative assumptions, including estimated cash
flows, discount rates, and alternative estimated remaining
useful lives could result in different calculations of impairment. See
Note A - Significant
Accounting Policies and Note E - Goodwill and
Other Intangible Assets to our 2008 consolidated financial statements
included in Item 8 of this Annual Report for more information related to
impairment of intangible assets during 2008, 2007 and 2006.
Goodwill
Impairment
We test
our goodwill balances as of April 1 during the second quarter of each year for
impairment. We test our goodwill balances more frequently if indicators are
present or changes in circumstances suggest that impairment may exist. In
performing the test, we utilize the two-step approach prescribed under FASB
Statement No. 142, Goodwill and Other Intangible
Assets. The first step requires a comparison of the carrying value of the
reporting units, as defined, to the fair value of these units. We have
identified our domestic divisions, which in aggregate make up the U.S.
reportable segment, and our two international operating segments as our
reporting units for purposes of the goodwill impairment test. To
derive the carrying value of our reporting units at the time of acquisition, we
assign goodwill to the reporting units that we expect to benefit from the
respective business combination. In addition, for purposes of performing our
annual goodwill impairment test, assets and liabilities, including corporate
assets, which relate to a reporting unit’s operations, and would be considered
in determining fair value, are allocated to the individual reporting units. We
allocate assets and liabilities not directly related to a specific reporting
unit, but from which the reporting unit benefits, based primarily on the
respective revenue contribution of each reporting unit. If the carrying value of
a reporting unit exceeds its fair value, we will perform the second step of the
goodwill impairment test to measure the amount of impairment loss, if
any.
The
second step of the goodwill impairment test compares the implied fair value of a
reporting unit’s goodwill to its carrying value. If we were unable to complete
the second step of the test prior to the issuance of our financial statements
and an impairment loss was probable and could be reasonably estimated, we would
recognize our best estimate of the loss in our current period financial
statements and disclose that the amount is an estimate. We would then
recognize any adjustment to that estimate in subsequent reporting periods, once
we have finalized the second step of the impairment test.
During
the fourth quarter of 2008, we recorded a $2.613 billion goodwill impairment
charge associated with our acquisition of Guidant. The decline in our stock
price and our market capitalization during the fourth quarter created an
indication of potential impairment of our goodwill balance; therefore, we
performed an interim impairment test. Key factors contributing to the impairment
charge included disruptions in the credit and equity market, and the resulting
impacts to weighted-average cost of capital, and changes in CRM market demand
relative to our original assumptions at the time of acquisition. Refer to Note E – Goodwill and Other
Intangible Assets to our consolidated financial statements contained in
Item 8 of this Annual Report for more information.
Investments in Publicly
Traded and Privately Held Entities
We
account for investments in entities over which we have the ability to exercise
significant influence under the equity method if we hold 50 percent or less
of the voting stock and the entity is not a variable interest
entity in
which we are the primary beneficiary. We account for investments in entities
over which we do not have the ability to exercise significant influence under
the cost method. Our determination of whether we have the ability to exercise
significant influence over an entity requires judgment. We consider the guidance
in Accounting Principles Board (APB) Opinion No. 18, The Equity Method of Accounting for
Investments in Common Stock, Emerging Issues Task Force (EITF) Issue No.
03-16, Accounting for
Investments in Limited Liability Companies, and EITF Topic D-46, Accounting for Limited Partnership
Investments, in determining whether we have the ability to exercise
significant influence over an entity.
We
regularly review our investments for impairment indicators. If we
determine that impairment exists and it is other-than-temporary, we recognize an
impairment loss equal to the difference between an investment’s carrying value
and its fair value. See Note A
- Significant Accounting Policies and Note G- Investments and Notes
Receivable to our 2008 consolidated financial statements included in Item
8 of this Annual Report for a detailed analysis of our investments and our
accounting treatment for our investment portfolio.
Income
Taxes
We
utilize the asset and liability method for accounting for income taxes. Under
this method, we determine deferred tax assets and liabilities based on
differences between the financial reporting and tax bases of our assets and
liabilities. We measure deferred tax assets and liabilities using the enacted
tax rates and laws that will be in effect when we expect the differences to
reverse.
We
recognized net deferred tax liabilities of $1.351 billion at December 31,
2008 and $1.605 billion at December 31, 2007. The liabilities relate
primarily to deferred taxes associated with our acquisitions. The assets relate
primarily to the establishment of inventory and product-related reserves,
litigation and product liability reserves, purchased research and development,
investment write-downs, net operating loss carryforwards and tax credit
carryforwards. In light of our historical financial performance, we believe we
will recover substantially all of these assets. We reduce our deferred tax
assets by a valuation allowance if, based upon the weight of available evidence,
it is more likely than not that we will not realize some portion or all of the
deferred tax assets. We consider relevant evidence, both positive and negative,
to determine the need for a valuation allowance. Information evaluated includes
our financial position and results of operations for the current and preceding
years, as well as an evaluation of currently available information about future
years.
We do not
provide income taxes on unremitted earnings of our foreign subsidiaries where we
have indefinitely reinvested such earnings in our foreign operations. It is not
practical to estimate the amount of income taxes payable on the earnings that
are indefinitely reinvested in foreign operations. Unremitted earnings of our
foreign subsidiaries that we have indefinitely reinvested offshore are
$9.327 billion at December 31, 2008 and $7.804 billion at
December 31, 2007.
We
provide for potential amounts due in various tax jurisdictions. In the ordinary
course of conducting business in multiple countries and tax jurisdictions, there
are many transactions and calculations where the ultimate tax outcome is
uncertain. Judgment is required in determining our worldwide income tax
provision. In our opinion, we have made adequate provisions for income taxes for
all years subject to audit. Although we believe our estimates are reasonable, we
can make no assurance that the final tax outcome of these matters will not be
different from that which we have reflected in our historical income tax
provisions and accruals. Such differences could have a material impact on our
income tax provision and operating results in the period in which we make such
determination.
See Note K — Income Taxes to
our 2008 consolidated financial statements included in Item 8 of this
Annual Report for a detailed analysis of our income tax accounting.
Legal, Product Liability
Costs and Securities Claims
We are
involved in various legal and regulatory proceedings, including intellectual
property, breach of contract, securities litigation and product liability suits.
In some cases, the claimants seek damages, as well as other relief, which, if
granted, could require significant expenditures or impact our ability to sell
our products. We are substantially self-insured with respect to product
liability claims. We maintain insurance policies providing limited coverage
against securities claims. We generally record losses for claims in excess of
purchased insurance in earnings at the time and to the extent they are probable
and estimable. In accordance with FASB Statement No. 5, Accounting for
Contingencies, we accrue anticipated costs of settlement, damages, losses
for general product liability claims and, under certain conditions, costs of
defense, based on historical experience or to the extent specific losses are
probable and estimable. Otherwise, we expense these costs as incurred. If the
estimate of a probable loss is a range and no amount within the range is more
likely, we accrue the minimum amount of the range.
Our
accrual for legal matters that are probable and estimable was
$1.089 billion at December 31, 2008 and $994 million at
December 31, 2007, and includes estimated costs of settlement, damages and
defense. The
increase in our accrual is due primarily to a pre-tax charge of $334 million
resulting from a ruling by a federal judge in a patent infringement case brought
against us by Johnson & Johnson, which we recorded during the third quarter
of 2008. Partially offsetting this increase was a reduction of $187 million as a
result of payments made in the fourth quarter of 2008 related to the Guidant
multi-district litigation (MDL) settlement described in Note L – Commitments and
Contingencies. In the first quarter of 2009, we made an additional MDL
payment of approximately $13 million, and anticipate making the remaining
payments of $20 million during the first half of 2009. These amounts were both
accrued as of December 31, 2008. We continue to assess certain litigation
and claims to determine the amounts that management believes will be
paid as a result of such claims and litigation and, therefore, additional losses
may be accrued in the future, which could adversely impact our operating
results, cash flows and our ability to comply with our debt covenants. See
further discussion of our material legal proceedings in Item 3. Legal Proceedings and
Note L — Commitments and
Contingencies to our 2008 consolidated financial statements included in
Item 8 of this Annual Report for further discussion of our individual
material legal proceedings.
New
Accounting Standards
Standards
Implemented
Interpretation
No. 48
In July
2006, the FASB issued Interpretation No. 48, Accounting for Uncertainty in
Income Taxes, to create a single model to address accounting for
uncertainty in tax positions. We adopted Interpretation No. 48 as of the first
quarter of 2007. Interpretation No. 48 requires the use of a two-step approach
for recognizing and measuring tax benefits taken or expected to be taken in a
tax return, as well as enhanced disclosures regarding uncertainties in income
tax positions, including a roll forward of tax benefits taken that do not
qualify for financial statement recognition. Refer to Note K – Income Taxes to our
2008 consolidated financial statements included in Item 8 of this Annual Report
for more information regarding our application of Interpretation No. 48 and its
impact on our consolidated financial statements.
Statement
No. 157
In
September 2006, the FASB issued Statement No. 157, Fair Value Measurements.
Statement No. 157 defines fair value, establishes a framework for measuring fair
value in accordance with U.S. GAAP, and expands disclosures about fair value
measurements. Statement No. 157 does not require any new fair value
measurements; rather, it applies to other accounting pronouncements that require
or permit fair value measurements. We adopted the provisions of Statement No.
157 for financial assets and financial liabilities as of January 1, 2008, and
will apply those provisions to nonfinancial assets and nonfinancial liabilities
as of January 1, 2009. Refer to Note C – Fair Value Measurements
to our consolidated financial statements contained in Item 8 of this
Annual Report for a discussion of our adoption of Statement No. 157 and its
impact on our financial statements.
Statement
No. 158
In
September 2006, the FASB issued Statement No. 158, Employers’ Accounting for Defined
Benefit Pension and Other Postretirement Plans, which amends Statements
Nos. 87, 88, 106 and 132(R). Statement No. 158 requires recognition of the
funded status of a benefit plan in the consolidated statements of financial
position, as well as the recognition of certain gains and losses that arise
during the period, but are deferred under pension accounting rules, in other
comprehensive income (loss). Additionally, Statement No. 158 requires that,
beginning with fiscal years ending after December 15, 2008, a business entity
measure plan assets and benefit obligations as of its fiscal year-end statement
of financial position. We adopted the measurement-date requirement in 2008 and
the other provisions of Statement No. 158 in 2006. Refer to Note A – Significant Accounting
Policies to our 2008 consolidated financial statements included in Item 8
of this Annual Report for more information on our pension and other
postretirement plans.
Statement
No. 159
In
February 2007, the FASB issued Statement No. 159, The Fair Value Option for Financial
Assets and Financial Liabilities, which allows an entity to elect to
record financial assets and financial liabilities at fair value upon their
initial recognition on a contract-by-contract basis. We adopted Statement No.
159 as of January 1, 2008 and did not elect the fair value option for our
eligible financial assets and financial liabilities.
New Standards to be
Implemented
Statement
No. 161
In March
2008, the FASB issued Statement No. 161, Disclosures about Derivative
Instruments and Hedging Activities, which amends Statement No. 133 by
requiring expanded disclosures about an entity’s derivative instruments and
hedging activities. Statement No. 161 requires increased qualitative,
quantitative, and credit-risk disclosures, including (a) how and why an entity
uses derivative instruments, (b) how derivative instruments and related hedged
items are accounted for under Statement No. 133 and its related interpretations,
and (c) how derivative instruments and related hedged items affect an entity’s
financial position, financial performance, and cash flows. We are
required to adopt Statement No. 161 for our first quarter ending March 31,
2009.
Staff
Position No. 157-2
In
February 2008, the FASB released Staff Position No. 157-2, Effective Date of FASB Statement
No. 157, which delays the effective date of Statement No. 157
for all nonfinancial assets and nonfinancial liabilities, except for those that
are recognized or disclosed at fair value in the financial statements on a
recurring basis. We are required to apply the provisions of Statement No. 157 to
nonfinancial assets and nonfinancial liabilities as of January 1, 2009. We do
not believe the adoption of Staff Position No. 157-2 will have a material impact
on our future results of operations or financial position.
Statement
No. 141(R)
In
December 2007, the FASB issued Statement No. 141(R), Business Combinations, a
replacement for Statement No. 141. Statement No. 141(R) retains the fundamental
requirements of Statement No. 141, but requires the recognition of all assets
acquired and liabilities assumed in a business combination at their fair values
as of the acquisition date. It also requires the recognition of assets acquired
and liabilities assumed arising from contractual contingencies at their
acquisition date fair values. Additionally, Statement No. 141(R) supersedes FASB
Interpretation No. 4, Applicability of FASB Statement No.
2 to Business Combinations Accounted for by the Purchase Method, which
required research and development assets acquired in a business combination that
had no alternative future use to be measured at their fair values and expensed
at the acquisition date.
Statement
No. 141(R) now requires that purchased research and development be recognized as
an intangible asset. We are required to adopt Statement No. 141(R) prospectively
for any acquisitions on or after January 1, 2009, except for changes in tax
assets and liabilities associated with prior acquisitions.
Management’s
Report on Internal Control over Financial Reporting
As the
management of Boston Scientific Corporation, we are responsible for establishing
and maintaining adequate internal control over financial reporting. We designed
our internal control system to provide reasonable assurance to management and
the Board of Directors regarding the preparation and fair presentation of our
financial statements.
We
assessed the effectiveness of our internal control over financial reporting as
of December 31, 2008. In making this assessment, we used the criteria set
forth by the Committee of Sponsoring Organizations of the Treadway Commission in
Internal Control—Integrated Framework. Based on our assessment, we believe that,
as of December 31, 2008, our internal control over financial reporting is
effective at a reasonable assurance level based on these criteria.
Ernst &
Young LLP, an independent registered public accounting firm, has issued an audit
report on the effectiveness of our internal control over financial reporting.
This report in which they expressed an unqualified opinion is included
below.
| /s/ James R. Tobin |
/s/
Sam R. Leno
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James
R. Tobin
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Sam
R. Leno
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President
and Chief Executive Officer
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Executive
Vice President – Finance & Information Systems and Chief Financial
Officer
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