Document
UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-Q
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þ | QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 |
For the quarterly period ended June 30, 2018
OR
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o | TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 |
Commission File No. 1-11083
BOSTON SCIENTIFIC CORPORATION
(Exact name of registrant as specified in its charter)
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DELAWARE | 04-2695240 |
(State or other jurisdiction of incorporation or organization) | (I.R.S. Employer Identification No.) |
300 BOSTON SCIENTIFIC WAY, MARLBOROUGH, MASSACHUSETTS 01752-1234
(Address of principal executive offices) (zip code)
(508) 683-4000
(Registrant’s telephone number, including area code)
Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes þ No o
Indicate by check mark whether the registrant has submitted electronically and posted on its corporate website, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files). Yes þ No o
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, smaller reporting company, or an emerging growth company. See the definitions of “large accelerated filer,” “accelerated filer,” “smaller reporting company,” and "emerging growth company" in Rule 12b-2 of the Exchange Act.
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Large accelerated filer þ | Accelerated filer o |
Non-Accelerated filer o (Do not check if a smaller reporting company) | Smaller reporting company o |
| Emerging growth company o |
If an emerging growth company, indicate by check mark if the registrant has elected not to use the extended transition period for complying with any new or revised financial accounting standards provided pursuant to Section 13(a) of the Exchange Act. o
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act). Yes o No þ
Indicate the number of shares outstanding of each of the issuer’s classes of common stock, as of the latest practicable date.
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| | Shares outstanding |
Class | | as of July 25, 2018 |
Common Stock, $0.01 par value | | 1,382,924,777 |
TABLE OF CONTENTS
PART I
FINANCIAL INFORMATION
ITEM 1. CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
BOSTON SCIENTIFIC CORPORATION AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS (UNAUDITED)
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| | | | | | | | | | | | | | | |
| Three Months Ended June 30, | | Six Months Ended June 30, |
(in millions, except per share data) | 2018 | | 2017 | | 2018 | | 2017 |
| | | | | | | |
Net sales | $ | 2,490 |
| | $ | 2,257 |
| | $ | 4,870 |
| | $ | 4,418 |
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Cost of products sold | 739 |
| | 632 |
| | 1,411 |
| | 1,282 |
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Gross profit | 1,751 |
| | 1,625 |
| | 3,458 |
| | 3,136 |
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Operating expenses: | | | | | | | |
Selling, general and administrative expenses | 886 |
| | 815 |
| | 1,746 |
| | 1,609 |
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Research and development expenses | 275 |
| | 244 |
| | 536 |
| | 480 |
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Royalty expense | 17 |
| | 17 |
| | 35 |
| | 34 |
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Amortization expense | 147 |
| | 142 |
| | 288 |
| | 285 |
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Intangible asset impairment charges | 34 |
| | — |
| | 35 |
| | — |
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Contingent consideration expense (benefit) | (4 | ) | | (24 | ) | | 1 |
| | (74 | ) |
Restructuring charges (credits) | 5 |
| | 1 |
| | 18 |
| | 5 |
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Litigation-related net charges (credits) | — |
| | 205 |
| | — |
| | 208 |
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| 1,359 |
| | 1,400 |
| | 2,659 |
| | 2,547 |
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Operating income (loss) | 392 |
| | 225 |
| | 799 |
| | 589 |
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| | | | | | | |
Other income (expense): | | | | | | | |
Interest expense | (57 | ) | | (58 | ) | | (119 | ) | | (115 | ) |
Other, net | 12 |
| | (76 | ) | | (11 | ) | | (78 | ) |
Income (loss) before income taxes | 347 |
| | 91 |
| | 670 |
| | 396 |
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Income tax expense (benefit) | (209 | ) | | (55 | ) | | (183 | ) | | (40 | ) |
Net income (loss) | $ | 555 |
| | $ | 146 |
| | $ | 853 |
| | $ | 436 |
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Net income (loss) per common share — basic | $ | 0.40 |
| | $ | 0.11 |
| | $ | 0.62 |
| | $ | 0.32 |
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Net income (loss) per common share — assuming dilution | $ | 0.40 |
| | $ | 0.11 |
| | $ | 0.61 |
| | $ | 0.31 |
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Weighted-average shares outstanding | | | | | | | |
Basic | 1,380.5 |
| | 1,369.8 |
| | 1,378.5 |
| | 1,367.6 |
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Assuming dilution | 1,398.9 |
| | 1,391.1 |
| | 1,397.8 |
| | 1,390.6 |
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See notes to the unaudited condensed consolidated financial statements.
BOSTON SCIENTIFIC CORPORATION AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME (LOSS) (UNAUDITED)
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| Three Months Ended June 30, | | Six Months Ended June 30, |
(in millions) | 2018 | | 2017 | | 2018 | | 2017 |
Net income (loss) | $ | 555 |
| | $ | 146 |
| | $ | 853 |
| | $ | 436 |
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Other comprehensive income (loss), net of tax: | | | | | | | |
Foreign currency translation adjustment | (45 | ) | | 13 |
| | (36 | ) | | 21 |
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Net change in derivative financial instruments | 158 |
| | (21 | ) | | 78 |
| | (76 | ) |
Net change in available-for-sale securities | — |
| | 2 |
| | — |
| | 2 |
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Net change in unrealized costs associated with certain retirement plans | — |
| | (1 | ) | | — |
| | (1 | ) |
Total other comprehensive income (loss) | 112 |
| | (7 | ) | | 42 |
| | (54 | ) |
Total comprehensive income (loss) | $ | 668 |
| | $ | 139 |
| | $ | 895 |
| | $ | 382 |
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See notes to the unaudited condensed consolidated financial statements.
BOSTON SCIENTIFIC CORPORATION AND SUBSIDIARIES
CONDENSED CONSOLIDATED BALANCE SHEETS
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| As of |
(in millions, except share and per share data) | June 30, 2018 | | December 31, 2017 |
| (unaudited) | | |
ASSETS | | | |
Current assets: | | | |
Cash and cash equivalents | $ | 208 |
| | $ | 188 |
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Trade accounts receivable, net | 1,587 |
| | 1,548 |
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Inventories | 1,087 |
| | 1,078 |
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Prepaid income taxes | 46 |
| | 66 |
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Other current assets | 1,001 |
| | 942 |
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Total current assets | 3,929 |
| | 3,822 |
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Property, plant and equipment, net | 1,715 |
| | 1,697 |
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Goodwill | 7,242 |
| | 6,998 |
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Other intangible assets, net | 5,934 |
| | 5,837 |
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Other long-term assets | 796 |
| | 688 |
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TOTAL ASSETS | $ | 19,615 |
| | $ | 19,042 |
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LIABILITIES AND STOCKHOLDERS’ EQUITY | | | |
Current liabilities: | | | |
Current debt obligations | $ | 1,685 |
| | $ | 1,801 |
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Accounts payable | 403 |
| | 530 |
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Accrued expenses | 2,266 |
| | 2,456 |
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Other current liabilities | 399 |
| | 867 |
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Total current liabilities | 4,753 |
| | 5,654 |
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Long-term debt | 4,808 |
| | 3,815 |
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Deferred income taxes | 364 |
| | 191 |
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Other long-term liabilities | 1,945 |
| | 2,370 |
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Commitments and contingencies |
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Stockholders’ equity | | | |
Preferred stock, $0.01 par value - authorized 50,000,000 shares, none issued and outstanding |
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Common stock, $0.01 par value - authorized 2,000,000,000 shares - issued 1,628,876,252 shares as of June 30, 2018 and 1,621,062,898 shares as of December 31, 2017 | 16 |
| | 16 |
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Treasury stock, at cost - 247,566,270 shares as of June 30, 2018 and December 31, 2017 | (1,717 | ) | | (1,717 | ) |
Additional paid-in capital | 17,231 |
| | 17,161 |
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Accumulated deficit | (7,770 | ) | | (8,390 | ) |
Accumulated other comprehensive income (loss), net of tax | (16 | ) | | (59 | ) |
Total stockholders’ equity | 7,744 |
| | 7,012 |
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TOTAL LIABILITIES AND STOCKHOLDERS' EQUITY | $ | 19,615 |
| | $ | 19,042 |
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See notes to the unaudited condensed consolidated financial statements.
BOSTON SCIENTIFIC CORPORATION AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS (UNAUDITED)
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| Six Months Ended June 30, |
(in millions) | 2018 | | 2017 |
| | | (restated)† |
Cash provided by (used for) operating activities | $ | (210 | ) | | $ | 290 |
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Investing activities: | | | |
Purchases of property, plant and equipment | (134 | ) | | (180 | ) |
Payments for acquisitions of businesses, net of cash acquired | (418 | ) | | (392 | ) |
Payments for investments and acquisitions of certain technologies | (112 | ) | | (47 | ) |
Cash provided by (used for) investing activities | (664 | ) | | (619 | ) |
| | | |
Financing activities: | | | |
Payment of contingent consideration amounts previously established in purchase accounting | (5 | ) | | (18 | ) |
Payments on long-term borrowings | (602 | ) | | (600 | ) |
Proceeds from long-term borrowings, net of debt issuance and extinguishment costs | 989 |
| | — |
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Net increase (decrease) in commercial paper | 472 |
| | 1,013 |
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Proceeds from borrowings on credit facilities | 569 |
| | 2,156 |
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Payments on borrowings from credit facilities | (569 | ) | | (2,216 | ) |
Cash used to net share settle employee equity awards | (52 | ) | | (62 | ) |
Proceeds from issuances of shares of common stock | 53 |
| | 44 |
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Cash provided by (used for) financing activities | 856 |
| | 317 |
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Effect of foreign exchange rates on cash | (5 | ) | | 2 |
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Net increase (decrease) in cash, cash equivalents, restricted cash and restricted cash equivalents | (23 | ) | | (11 | ) |
Cash, cash equivalents, restricted cash and restricted cash equivalents at beginning of period | 1,017 |
| | 487 |
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Cash, cash equivalents, restricted cash and restricted cash equivalents at end of period | $ | 994 |
| | $ | 476 |
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Supplemental Information | | | |
Stock-based compensation expense | $ | 68 |
| | $ | 62 |
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Fair value of contingent consideration recorded in purchase accounting | 140 |
| | — |
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| As of |
Reconciliation to amounts within the unaudited condensed consolidated balance sheets: | June 30, 2018 | | June 30, 2017 |
Cash and cash equivalents | $ | 208 |
| | $ | 195 |
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Restricted cash and restricted cash equivalents included in Other current assets | 756 |
| | 255 |
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Restricted cash equivalents included in Other long-term assets | 31 |
| | 27 |
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Cash, cash equivalents, restricted cash and restricted cash equivalents at end of period | $ | 994 |
| | $ | 476 |
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†Certain prior year balances related to restricted cash have been reclassified to reflect our adoption of Financial Accounting Standards Board (FASB) Accounting Standards Codification (ASC) Update No. 2016-18, Statement of Cash Flows (Topic 230) - Restricted Cash in the fourth quarter of 2017. Please refer to our most recent annual report on Form 10-K for additional details.
See notes to the unaudited condensed consolidated financial statements.
NOTES TO THE CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)
NOTE A – BASIS OF PRESENTATION
The accompanying unaudited condensed consolidated financial statements of Boston Scientific Corporation have been prepared in accordance with accounting principles generally accepted in the United States (U.S. GAAP) and with the instructions to Form 10-Q and Article 10 of Regulation S-X. Accordingly, they do not include all of the information and footnotes required by U.S. GAAP for complete financial statements. When used in this report, the terms, "we," "us," "our," and "the Company" mean Boston Scientific Corporation and its divisions and subsidiaries. In the opinion of management, all adjustments (consisting only of normal recurring adjustments) considered necessary for fair presentation have been included. Operating results for the three and six months ended June 30, 2018 are not necessarily indicative of the results that may be expected for the year ending December 31, 2018. For further information, refer to the consolidated financial statements and footnotes thereto included in Item 8 of our most recent Annual Report on Form 10-K.
Amounts reported in millions within this report are computed based on the amounts in thousands. As a result, the sum of the components reported in millions may not equal the total amount reported in millions due to rounding. Certain columns and rows within tables may not add due to the use of rounded numbers. Percentages presented are calculated from the underlying numbers in dollars. Prior year balances were subject to rounding.
Revision of Reportable Segments
Effective January 1, 2018, following organizational changes to align the company's business and organization structure focused on active implantable devices, we revised our reportable segments, in accordance with FASB ASC Topic 280, Segment Reporting. The revision reflects a reclassification of our Neuromodulation business from our Medical Surgical (MedSurg) segment to our newly created Rhythm and Neuro segment. We have revised prior year amounts to conform to the current year’s presentation (as denoted with an asterisk throughout *). There was no revision to operating segments or reporting units as a result of the organizational change. See Note C – Goodwill and Other Intangible Assets and Note K – Segment Reporting for further details.
Subsequent Events
We evaluate events occurring after the date of our most recent accompanying unaudited condensed consolidated balance sheet for potential recognition or disclosure in our financial statements. We did not identify any material subsequent events requiring adjustment to our accompanying unaudited condensed consolidated financial statements (recognized subsequent events) for the three and six months ended June 30, 2018. Those items requiring disclosure (unrecognized subsequent events) in the financial statements have been disclosed accordingly. Refer to Note B – Acquisitions and Strategic Investments and Note I – Commitments and Contingencies for more information.
Accounting Standards Implemented Since December 31, 2017
ASC Update No. 2014-09
In May 2014, the FASB issued FASB ASC Topic 606, Revenue from Contracts with Customers (Topic 606), which was subsequently updated. We adopted the standard as of January 1, 2018, using the modified retrospective method. Under this method, we applied FASB ASC Topic 606 to contracts that were not complete as of January 1, 2018 and recognized the cumulative effect of initially applying the standard as an adjustment to the opening balance of retained earnings. Results for reporting periods beginning after January 1, 2018 are presented in accordance with FASB ASC Topic 606. Prior period amounts are not adjusted and are reported in accordance with legacy GAAP requirements in FASB ASC Topic 605, Revenue Recognition.
Due to the adoption of FASB ASC Topic 606, we recorded a net reduction to retained earnings of $177 million on January 1, 2018, primarily related to the cost of providing non-contractual post-implant support to certain customers, which we historically deemed immaterial in the context of the arrangement. Upon the adoption of FASB ASC Topic 606, when we sell a device with an implied non-contractual post-implant support obligation, we forward accrue the cost of the service within Selling, general and administrative expenses and recognize it at the point in time the associated revenue is earned. We release the accrual over the related service period. These costs were previously expensed as incurred due to such service obligation being non-contractual.
The impact of adopting FASB ASC Topic 606 on our unaudited condensed consolidated balance sheets resulted in an increase in Other current liabilities of $58 million and an increase in Other long-term liabilities of $205 million as of June 30, 2018, as a result of accruing for our post-implant support obligation. We also recorded deferred tax assets primarily related to post-implant
support, resulting in an increase in Other long-term assets of $12 million and a reduction in Deferred income taxes of $41 million. The remaining impact of adopting FASB ASC Topic 606 was not material to our financial position or results of operations.
Refer to Note L – Revenue for additional details.
ASC Update No. 2016-01
In January 2016, the FASB issued ASC Update No. 2016-01, Financial Instruments - Overall (Subtopic 825-10): Recognition and Measurement of Financial Assets and Financial Liabilities. The purpose of Update No. 2016-01 is to improve financial reporting for financial instruments by reducing the number of items recorded to other comprehensive income. We adopted Update No. 2016-01 in the first quarter of 2018, using both the modified retrospective and prospective methods. For publicly-held securities, we used the modified retrospective approach. Unrealized gains and losses previously recorded to Other comprehensive income (loss) were reclassified to retained earnings and all future fair value changes will be recorded to Net income (loss). For privately-held securities, we elected the measurement alternative approach for our existing investments, which is applied prospectively upon adoption. This approach requires entities to measure their investments at cost minus impairment, if any, plus or minus changes resulting from observable price changes in orderly transactions for the identical or a similar investment of the same issuer. The adoption of the standard did not have a material impact on our financial position or results of operations. The actual impact to future periods resulting from fair value changes of our equity investments is difficult to predict as it will depend on their future performance.
ASC Update No. 2016-16
In October 2016, the FASB issued ASC Update No. 2016-16, Income Taxes (Topic 740): Intra-Entity Transfers of Assets Other Than Inventory. The purpose of Update No. 2016-16 is to allow an entity to recognize the income tax consequences of an intra-entity transfer of an asset other than inventory when the transfer occurs, as opposed to waiting until the asset is sold to a third party, or impaired. Update No. 2016-16 was effective for annual periods beginning after December 15, 2017, including interim periods within those annual periods. We adopted Update No. 2016-16 prospectively in the first quarter of 2018 and recognized a net reduction to opening retained earnings of $55 million for income tax consequences not previously recognized for intra-entity transfers of assets other than inventories. All future income tax consequences of intra-entity transfers of assets other than inventories will be recognized through Income tax expense (benefit).
ASC Update No. 2017-12
In August 2017, the FASB issued ASC Update No. 2017-12, Derivatives and Hedging (Topic 815): Targeted Improvements to Accounting for Hedging Activities. The purpose of Update No. 2017-12 is to simplify the application of hedge accounting and better align financial reporting of hedging relationships with risk management objectives. Update No. 2017-12 was effective for annual periods beginning after December 15, 2018, including interim periods within those annual periods. We early adopted Update No. 2017-12 in the first quarter of 2018. The adoption of the standard had no impact on our financial position or results of operations.
NOTE B – ACQUISITIONS AND STRATEGIC INVESTMENTS
2018 Acquisitions
Claret Medical, Inc.
On July 20, 2018, we announced the signing of our agreement to acquire Claret Medical, Inc. (Claret Medical), a privately-held company that has developed and commercialized the Sentinel™ Cerebral Embolic Protection System. The device is used to protect the brain during certain interventional procedures, predominately in patients undergoing transcatheter aortic valve replacement (TAVR). The transaction price consists of an upfront cash payment of $220 million, as well as a potential reimbursement-based milestone payment of up to $50 million. The acquisition is projected to close during the third quarter of 2018, subject to customary closing conditions. Upon closing, Claret Medical will be integrated into our Interventional Cardiology business.
Cryterion Medical, Inc.
On July 5, 2018, we announced the closing of our acquisition of Cryterion Medical, Inc. (Cryterion), a privately-held company developing a single-shot cryoablation platform for the treatment of atrial fibrillation. We have been an investor in Cryterion since its inception in 2016 and the transaction price to acquire the approximately 65 percent we did not already own was an upfront cash payment of $202 million. We are in the process of integrating Cryterion into our Electrophysiology business.
NxThera, Inc.
On April 30, 2018, we announced the closing of our acquisition of NxThera, Inc. (NxThera), a privately-held company that developed the Rezûm™ System, a minimally invasive therapy in a growing category of treatment options for patients with benign prostatic hyperplasia (BPH). The transaction consists of an upfront cash payment of $306 million, and up to an additional $100 million in potential commercial milestone payments over the next four years. We had an existing minority investment in NxThera, which resulted in a net upfront cash payment of approximately $240 million upon closing and a potential additional milestone payment of up to approximately $85 million. We are in the process of integrating NxThera into our Urology and Pelvic Health business.
nVision Medical Corporation
On April 16, 2018, we announced the closing of our acquisition of nVision Medical Corporation (nVision), a privately-held company focused on women’s health. nVision developed the first and only device cleared by the U.S. Food and Drug Administration (FDA) to collect cells from the fallopian tubes, offering a potential platform for earlier diagnosis of ovarian cancer. The transaction consists of an upfront cash payment of $150 million, and up to an additional $125 million in potential clinical and commercial milestones over four years. We are in the process of integrating nVision into our Urology and Pelvic Health business.
In addition, we completed other individually immaterial acquisitions during the first six months of 2018 for total consideration of $50 million in cash at closing plus aggregate contingent consideration of up to $10 million.
Purchase Price Allocation
We accounted for these acquisitions as business combinations, and in accordance with FASB ASC Topic 805, Business Combinations, we recorded the assets acquired and liabilities assumed at their respective fair values as of the acquisition dates. The components of the aggregate preliminary purchase prices are as follows:
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(in millions) | |
Payments for acquisitions, net of cash acquired | $ | 419 |
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Fair value of contingent consideration | 140 |
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Fair value of prior interests | 81 |
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| $ | 639 |
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The following summarizes the preliminary purchase price allocations for the acquisitions as of June 30, 2018:
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(in millions) | |
Goodwill | $ | 273 |
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Amortizable intangible assets | 418 |
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Other assets acquired | 53 |
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Liabilities assumed | (5 | ) |
Deferred tax liabilities | (99 | ) |
| $ | 639 |
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We allocated a portion of the preliminary purchase prices to specific intangible asset categories as follows:
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| Amount Assigned (in millions) | | Amortization Period (in years) | | Risk-Adjusted Discount Rates used in Purchase Price Allocation |
Amortizable intangible assets: | | | | | |
Technology-related | $ | 410 |
| | 10 - 13 | | 17% - 23% |
Other intangible assets | 7 |
| | 6 - 13 | | 13% - 15% |
| $ | 418 |
| | | | |
2017 Acquisitions
Symetis SA
On May 16, 2017, we announced the closing of our acquisition of Symetis SA (Symetis), a privately-held Swiss structural heart company focused on minimally-invasive transcatheter aortic valve replacement devices, for approximately $430 million in cash. We are in the process of integrating Symetis into our Interventional Cardiology business.
Purchase Price Allocation
We accounted for the acquisition of Symetis as a business combination, and in accordance with FASB ASC Topic 805, we recorded the assets acquired and liabilities assumed at their respective fair values as of the acquisition date. The purchase price was comprised of the following component:
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(in millions) | |
Payment for acquisition, net of cash acquired | $ | 391 |
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The following summarizes the purchase price allocation for the Symetis acquisition as of June 30, 2018:
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(in millions) | |
Goodwill | $ | 183 |
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Amortizable intangible assets | 278 |
|
Other assets acquired | 25 |
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Liabilities assumed | (95 | ) |
| $ | 391 |
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We allocated a portion of the purchase price to specific intangible asset categories as follows:
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| Amount Assigned (in millions) | | Amortization Period (in years) | | Risk-Adjusted Discount Rates used in Purchase Price Allocation |
Amortizable intangible assets: | | | | | |
Technology-related | $ | 268 |
| | 13 | | 24% |
Other intangible assets | 10 |
| | 2-13 | | 24% |
| $ | 278 |
| | | | |
Our technology-related intangible assets consist of technical processes, intellectual property and institutional understanding with respect to products and processes that we will leverage in future products or processes and will carry forward from one product generation to the next. We used the multi-period excess earnings method, a form of the income approach, to derive the fair value of the technology-related intangible assets and are amortizing them on a straight-line basis over their assigned estimated useful lives.
Goodwill was primarily established due to synergies expected to be gained from leveraging our existing operations as well as revenue and cash flow projections associated with future technologies and has been allocated to our reportable segments based on the relative expected benefit. Based on preliminary estimates updated for applicable regulatory changes, the goodwill recorded relating to our 2018 and 2017 acquisitions is not deductible for tax purposes.
Contingent Consideration
Within the Contingent consideration expense (benefit) caption of our accompanying unaudited condensed consolidated statements of operations, we recorded a net benefit of $4 million during the second quarter of 2018, a net benefit of $24 million during the second quarter of 2017, a net expense of $1 million during the first six months of 2018 and a net benefit of $74 million during the first six months of 2017 related to the changes in fair value of our contingent consideration liability. We made contingent consideration payments of $9 million during the first six months of 2018 and $28 million during the first six months of 2017.
Changes in the fair value of our contingent consideration liability were as follows:
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(in millions) | |
Balance as of December 31, 2017 | $ | 169 |
|
Amounts recorded related to new acquisitions | 140 |
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Purchase price adjustments related to prior acquisitions | (22 | ) |
Contingent consideration expense (benefit) | 1 |
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Contingent consideration payments | (9 | ) |
Balance as of June 30, 2018 | $ | 279 |
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As of June 30, 2018, the maximum amount of future contingent consideration (undiscounted) that we could be required to pay was approximately $1.532 billion.
The recurring Level 3 fair value measurements of our contingent consideration liability include the following significant unobservable inputs:
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Contingent Consideration Liability | Fair Value as of June 30, 2018 | Valuation Technique | Unobservable Input | Range |
R&D and Commercialization-based Milestones | $159 million | Discounted Cash Flow | Discount Rate | 3 | % | - | 4% |
Projected Year of Payment | 2018 |
| - | 2022 |
Revenue-based Payments | $120 million | Discounted Cash Flow | Discount Rate | 11 | % | - | 15% |
Projected Year of Payment | 2018 |
| - | 2026 |
Projected contingent payment amounts related to some of our research and development (R&D), commercialization-based and revenue-based milestones are discounted back to the current period using a discounted cash flow model. Projected revenues are based on our most recent internal operational budgets and strategic plans. Increases or decreases in projected revenues, probabilities of payment, discount rates or the time until payment is made may result in significantly lower or higher fair value measurements.
Strategic Investments
On January 24, 2018, we closed an investment and entered into an acquisition option agreement with Millipede, Inc. (Millipede), a privately-held company that has developed the IRIS Transcatheter Annuloplasty Ring System for the treatment of severe mitral regurgitation. Under the terms of the agreements, we have purchased a portion of the outstanding shares of Millipede along with newly issued shares of the company for a total consideration of $90 million. We also have the option to acquire the remaining shares of the company at any time prior to the completion of a first-in-human clinical study that meets certain parameters. Upon the completion of the clinical study, Millipede has the option to compel us to acquire the remaining shares of the company. Each company’s option period expires by the end of 2019. Completion of this acquisition would result in an additional $325 million payment by us at closing with a further $125 million becoming payable upon achievement of a commercial milestone.
On November 1, 2017, we entered into a definitive agreement with an investee company where we could have been obligated to pay $145 million in cash up-front and a maximum of $130 million in contingent payments to acquire the investee. The agreement contained a provision, expiring October 31, 2019, allowing the investee company to sell the remaining equity interests of the investee company to us upon achievement of a regulatory milestone and an option allowing us to acquire the remaining equity interests. We sent a notice of termination to the investee company in the second quarter of 2018.
The aggregate carrying amount of our strategic investments were comprised of the following categories: |
| | | | | | | |
| As of |
(in millions) | June 30, 2018 | | December 31, 2017 |
Equity method investments | $ | 281 |
| | $ | 209 |
|
Measurement alternative investments | 82 |
| | 81 |
|
Publicly-held securities | 1 |
| | 15 |
|
Notes receivable | 18 |
| | 47 |
|
| $ | 382 |
| | $ | 353 |
|
These investments are classified as Other long-term assets within our accompanying unaudited condensed consolidated balance sheets, in accordance with U.S. GAAP and our accounting policies.
As of June 30, 2018, the book value of our equity method investments exceeded our share of the book value of the investees’ underlying net assets by approximately $328 million, which represents amortizable intangible assets, in-process research and development, deferred tax liabilities and goodwill.
NOTE C – GOODWILL AND OTHER INTANGIBLE ASSETS
The gross carrying amount of goodwill and other intangible assets and the related accumulated amortization for intangible assets subject to amortization and accumulated write-offs of goodwill are as follows:
|
| | | | | | | | | | | | | | | |
| As of June 30, 2018 | | As of December 31, 2017 |
(in millions) | Gross Carrying Amount | | Accumulated Amortization/ Write-offs | | Gross Carrying Amount | | Accumulated Amortization/ Write-offs |
Amortizable intangible assets | | | | | | | |
Technology-related | $ | 9,698 |
| | $ | (5,032 | ) | | $ | 9,386 |
| | $ | (4,880 | ) |
Patents | 517 |
| | (384 | ) | | 517 |
| | (379 | ) |
Other intangible assets | 1,640 |
| | (897 | ) | | 1,633 |
| | (838 | ) |
| $ | 11,855 |
| | $ | (6,314 | ) | | $ | 11,536 |
| | $ | (6,097 | ) |
Unamortizable intangible assets | | | | | | | |
Goodwill | $ | 17,142 |
| | $ | (9,900 | ) | | $ | 16,898 |
| | $ | (9,900 | ) |
In-process research and development (IPR&D) | 273 |
| | — |
| | 278 |
| | — |
|
Technology-related | 120 |
| | — |
| | 120 |
| | — |
|
| $ | 17,535 |
| | $ | (9,900 | ) | | $ | 17,295 |
| | $ | (9,900 | ) |
Effective January 1, 2018, we reclassified our Neuromodulation operating segment and associated goodwill balance from our Medsurg reportable segment to our Rhythm and Neuro reportable segment as discussed in Note A – Basis of Presentation. This change did not trigger a goodwill impairment assessment or impact our total goodwill carrying value. The following represents our goodwill balance by global reportable segment:
|
| | | | | | | | | | | | | | | |
(in millions) | MedSurg | | Rhythm and Neuro | | Cardiovascular | | Total |
Balance as of December 31, 2017 | $ | 2,877 |
| | $ | 417 |
| | $ | 3,704 |
| | $ | 6,998 |
|
Impact of reportable segment revisions | (1,379 | ) | | 1,379 |
| | — |
| | — |
|
Impact of foreign currency fluctuations and other changes in carrying amount | (2 | ) | | (22 | ) | | (5 | ) | | (29 | ) |
Goodwill acquired | 248 |
| | 25 |
| | — |
| | 273 |
|
Balance as of June 30, 2018 | $ | 1,744 |
| | $ | 1,799 |
| | $ | 3,699 |
| | $ | 7,242 |
|
Goodwill Impairment Testing
In the second quarter of 2018, we performed our annual goodwill impairment test for all of our reporting units and concluded the fair value of each reporting unit exceeded its carrying value. Based on the criteria prescribed in FASB ASC Topic 350, Intangibles - Goodwill and Other, we assess goodwill for impairment at the reporting unit level, which is defined as an operating segment or one level below an operating segment, referred to as a component. For our 2018 and 2017 annual impairment assessments, we identified seven reporting units: Interventional Cardiology, Peripheral Interventions, Cardiac Rhythm Management, Electrophysiology, Endoscopy, Urology and Pelvic Health and Neuromodulation. We aggregated the Cardiac Rhythm Management and Electrophysiology reporting units, components of the Rhythm Management operating segment, based on the criteria prescribed in FASB ASC Topic 350.
In performing the goodwill impairment assessment, we utilized both the optional qualitative assessment and the quantitative approach prescribed under FASB ASC Topic 350. In 2018, we performed a qualitative assessment for our Urology and Pelvic Health and Neuromodulation reporting units since their fair values have historically exceeded carrying value by greater than 100 percent. The remaining reporting units were quantitatively tested for impairment. For the reporting units subject to a qualitative assessment, if it is determined that it is more likely than not that the fair value of the reporting unit is less than its carrying value, the quantitative approach of the goodwill impairment test is necessary. In 2018, for all reporting units tested using the qualitative assessment, we concluded that it was unnecessary to perform the quantitative impairment test. For all reporting units tested using the quantitative approach, we concluded that the fair value of each reporting unit exceeded its carrying value. Refer to Critical Accounting Policies and Estimates within Part II, Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations contained in our most recent Annual Report on Form 10-K for further discussion of our annual goodwill impairment testing.
NOTE D – HEDGING ACTIVITIES AND FAIR VALUE MEASUREMENTS
Derivative Instruments and Hedging Activities
We address market risk from changes in foreign currency exchange rates and interest rates through risk management programs which include the use of derivative financial instruments. We operate these programs pursuant to documented corporate risk management policies and do not enter into derivative transactions for speculative purposes. Our derivative instruments do not subject our earnings to material risk, as the gains or losses on these derivatives generally offset losses or gains recognized on the hedged item.
We manage concentration of counterparty credit risk by limiting acceptable counterparties to major financial institutions with investment grade credit ratings, limiting the amount of credit exposure to individual counterparties and by actively monitoring counterparty credit ratings and the amount of individual credit exposure. We also employ master netting arrangements that limit the risk of counterparty non-payment on a particular settlement date to the net gain that would have otherwise been received from the counterparty. Although not completely eliminated, we do not consider the risk of counterparty default to be significant as a result of these protections. Further, none of our derivative instruments are subject to collateral or other security arrangements, nor do they contain provisions that are dependent on our credit ratings from any credit rating agency.
Our risk from changes in currency exchange rates consists primarily of monetary assets and liabilities, forecast intercompany and third-party transactions and net investments in certain subsidiaries. We manage currency exchange rate risk at a consolidated level to reduce the cost of hedging by taking advantage of offsetting transactions. We employ derivative instruments, primarily forward currency contracts, to reduce the risk to our earnings and cash flows associated with changes in currency exchange rates.
The success of our currency risk management program depends, in part, on forecast transactions denominated primarily in British pound sterling, Euro and Japanese yen. We may experience unanticipated currency exchange gains or losses to the extent the actual activity is different than forecast. In addition, changes in currency exchange rates related to any unhedged transactions may impact our earnings and cash flows.
Certain of our currency derivative instruments are designated as cash flow hedges under FASB ASC Topic 815, Derivatives and Hedging and are intended to protect the U.S. dollar value of forecasted transactions. The gain or loss on a derivative instrument designated as a cash flow hedge is recorded in Other comprehensive income (loss), net of tax (OCI) and is included in the Accumulated other comprehensive income (loss), net of tax (AOCI) caption of our unaudited condensed consolidated balance sheets until the underlying third-party transaction occurs. When the related third-party transaction occurs, we recognize the gain or loss in earnings within the Cost of products sold caption of our unaudited condensed consolidated statements of operations. In the event the hedging relationship is no longer effective, or if the hedged forecast transaction becomes no longer probable of occurring, we reclassify the amount of gains or losses on the derivative instrument designated as a cash flow hedge to earnings at that time.
We also use forward currency contracts that are not part of designated hedging relationships under FASB ASC Topic 815 as a part of our strategy to manage our exposure to currency exchange rate risk related to monetary assets and liabilities and related forecast transactions. These non-designated currency forward contracts have an original time to maturity consistent with the hedged currency transaction exposures, generally less than one year, and are marked-to-market with changes in fair value recorded to earnings and reflected within the Other, net caption of our unaudited condensed consolidated statements of operations.
Our interest rate risk relates primarily to U.S. dollar borrowings partially offset by U.S. dollar cash investments. We use interest rate derivative instruments to manage our earnings and cash flow exposure to changes in interest rates. Under these agreements we and the counterparty, at specified intervals, exchange the difference between fixed and floating interest amounts calculated by reference to an agreed-upon notional principal amount. We designate these derivative instruments either as fair value or cash flow hedges under FASB ASC Topic 815.
The changes in the fair value of interest rate derivatives designated as fair value hedges and the changes in the fair value of the underlying hedged debt instrument generally offset and are recorded within the Interest expense caption of our unaudited condensed consolidated statements of operations. We record the changes in the fair value of interest rate derivatives designated as cash flow hedges within OCI, which is included within the AOCI caption of our unaudited condensed consolidated balance sheets until the underlying hedged transaction occurs, at which time we recognize the gain or loss within Interest expense. In the event the hedging relationship is no longer effective, or if the hedged forecast transaction becomes no longer probable of occurring, we reclassify the amount of gains or losses on the interest rate derivative designated as a cash flow hedge to earnings at that time.
We are amortizing the realized gains or losses from interest rate derivative instruments previously designated as fair value or cash flow hedges into earnings as a component of Interest expense over the remaining term of the hedged item in accordance with FASB ASC Topic 815, so long as the hedge relationship remains effective. Prior to the adoption of ASC Update No. 2017-12, Derivatives and Hedging (Topic 815), the ineffective portion, if any, of our interest rate derivatives designated as either fair value or cash flow hedges was recognized in earnings in the period in which the hedging relationship exhibited ineffectiveness.
Certain of our currency forward contracts are designated as net investment hedges under FASB ASC Topic 815 and are intended to hedge a portion of our net investments in certain of our European, Swiss and Japanese operating entities. We have elected to use the spot method to assess effectiveness for our derivatives that are designated as net investment hedges. Under the spot method, the change in fair value attributable to changes in the spot rate is recorded in the Foreign currency translation adjustment (CTA), which is included within the AOCI caption of our unaudited condensed consolidated balance sheets. Therefore, the spot-forward difference is excluded from the assessment of effectiveness and accounted for separately.
Consistent with FASB ASC Topic 815, we have elected to amortize the excluded spot-forward difference associated with the currency forward contracts as calculated at the date of designation. Amortization will be recognized on a straight-line basis over the term of the currency forward contracts from the AOCI caption of our unaudited condensed consolidated balance sheets to reported earnings as a reduction of Interest expense.
The following table presents the contractual amounts of our derivative instruments outstanding:
|
| | | | | | | | | | |
(in millions) | | FASB ASC Topic 815 Designation | | As of |
| June 30, 2018 | | December 31, 2017 |
Forward currency contracts | | Cash flow hedge | | $ | 4,205 |
| | $ | 3,252 |
|
Forward currency contracts | | Net investment hedge | | 1,455 |
| | — |
|
Forward currency contracts | | Non-designated | | 2,635 |
| | 2,671 |
|
Total Notional Outstanding | | | | $ | 8,295 |
| | $ | 5,923 |
|
The remaining time to maturity as of June 30, 2018 is within 60 months for all designated forward currency contracts and generally less than one year for all non-designated forward currency contracts.
We had no interest rate derivative instruments outstanding as of June 30, 2018 and December 31, 2017.
The following presents the effect of our derivative instruments designated as cash flow hedges and net investment hedges under FASB ASC Topic 815 on our accompanying unaudited condensed consolidated statements of operations:
|
| | | | | | | | | | | | | | | | | | | | | | | | | |
(in millions) | Unaudited Condensed Consolidated Statements of Operations | | Effective Amount Recognized in OCI | | Effective Amount Reclassified from AOCI into Earnings |
Location | | Total | | Pre-Tax Gain (Loss) | Tax Benefit (Expense) | Gain (Loss) Net of Tax | | Pre-Tax (Gain) Loss | Tax (Benefit) Expense | (Gain) Loss Net of Tax |
Three Months Ended June 30, 2018 | | | | | | | | | | | |
Forward currency contracts | Cost of products sold | | $ | 739 |
| | $ | 194 |
| $ | (44 | ) | $ | 151 |
| | $ | 10 |
| $ | (2 | ) | $ | 7 |
|
Forward currency contracts | Interest expense | | (57 | ) | | 21 |
| (5 | ) | 16 |
| | (7 | ) | 2 |
| (5 | ) |
| | | | | $ | 215 |
| $ | (48 | ) | $ | 167 |
| | $ | 3 |
| $ | (1 | ) | $ | 2 |
|
| | | | | | | | | | | |
Three Months Ended June 30, 2017 | | | | | | | | | | | |
Forward currency contracts | Cost of products sold | | $ | 632 |
| | $ | (6 | ) | $ | 2 |
| $ | (4 | ) | | $ | (27 | ) | $ | 10 |
| $ | (17 | ) |
| | | | | $ | (6 | ) | $ | 2 |
| $ | (4 | ) | | $ | (27 | ) | $ | 10 |
| $ | (17 | ) |
| | | | | | | | | | | |
Six Months Ended June 30, 2018 | | | | | |
| | | | | |
Forward currency contracts | Cost of products sold | | $ | 1,411 |
| | $ | 77 |
| $ | (17 | ) | $ | 59 |
| | $ | 25 |
| $ | (6 | ) | $ | 19 |
|
Forward currency contracts | Interest expense | | (119 | ) | | 21 |
| (5 | ) | 16 |
| | (7 | ) | 2 |
| (5 | ) |
| | | | | $ | 97 |
| $ | (22 | ) | $ | 76 |
| | $ | 18 |
| $ | (4 | ) | $ | 14 |
|
| | | | | | | | | | | |
Six Months Ended June 30, 2017 | | | | | | | | | | | |
Forward currency contracts | Cost of products sold | | $ | 1,282 |
| | $ | (64 | ) | $ | 23 |
| $ | (41 | ) | | $ | (55 | ) | $ | 21 |
| $ | (34 | ) |
Interest rate derivative contracts | Interest expense | | (115 | ) | | — |
| — |
| — |
| | (1 | ) | — |
| (1 | ) |
| | | | | $ | (64 | ) | $ | 23 |
| $ | (41 | ) | | $ | (56 | ) | $ | 21 |
| $ | (35 | ) |
For our outstanding net investment hedges, the net gain or loss reclassified from AOCI to earnings as a reduction of Interest expense represents the straight-line amortization of the excluded component as calculated at the date of designation. This initial value has been excluded from the assessment of effectiveness in accordance with FASB ASC Topic 815.
As of June 30, 2018, pre-tax net gains or losses for our derivative instruments designated, or previously designated, as fair value and cash flow hedges under FASB ASC Topic 815 that may be reclassified to earnings within the next twelve months are presented below (in millions):
|
| | | | | | | | |
Designated Derivative Instrument | | FASB ASC Topic 815 Designation | | Location in Unaudited Condensed Consolidated Statements of Operations | | Amount of Pre-Tax Gain (Loss) that may be Reclassified to Earnings |
Interest rate derivative contracts | | Fair value hedge | | Interest expense | | $ | 12 |
|
Interest rate derivative contracts | | Cash flow hedge | | Interest expense | | 1 |
|
Forward currency contracts | | Cash flow hedge | | Cost of products sold | | 11 |
|
Forward currency contracts | | Net investment hedge | | Interest expense | | 41 |
|
Net gains and losses on currency hedge contracts not designated as hedging instruments offset by net gains and losses from currency transaction exposures are presented below:
|
| | | | | | | | | | | | | | | | | | |
| | Location in Unaudited Condensed Consolidated Statements of Operations | | Three Months Ended June 30, | | Six Months Ended June 30, |
(in millions) | | | 2018 | | 2017 | | 2018 | | 2017 |
Net gain (loss) on currency hedge contracts | | Other, net | | $ | 32 |
| | $ | 5 |
| | $ | 8 |
| | $ | (12 | ) |
Net gain (loss) on currency transaction exposures | | Other, net | | (33 | ) | | (13 | ) | | (17 | ) | | 4 |
|
Net currency exchange gain (loss) | | | | $ | (1 | ) | | $ | (8 | ) | | $ | (9 | ) | | $ | (8 | ) |
Fair Value Measurements
FASB ASC Topic 815 requires all derivative instruments to be recognized at their fair values as either assets or liabilities on the balance sheet. We determine the fair value of our derivative instruments using the framework prescribed by FASB ASC Topic 820, Fair Value Measurements and Disclosures and considering the estimated amount we would receive or pay to transfer these instruments at the reporting date when taking into account current currency exchange rates, interest rates, the creditworthiness of the counterparty for unrealized gain positions and our own creditworthiness for unrealized loss positions. In certain instances, we may utilize financial models to measure fair value of our derivative instruments. In doing so, we use inputs that include quoted prices for similar assets or liabilities in active markets, quoted prices for identical or similar assets or liabilities in markets that are not active, other observable inputs for the asset or liability and inputs derived principally from, or corroborated by, observable market data by correlation or other means. The following are the balances of our derivative assets and liabilities:
|
| | | | | | | | | | |
| | Location in Unaudited Condensed Consolidated Balance Sheets (1) | | As of |
(in millions) | | | June 30, 2018 | | December 31, 2017 |
Derivative Assets: | | | | | | |
Designated Derivative Instruments | | | | | | |
Forward currency contracts | | Other current assets | | $ | 24 |
| | $ | 7 |
|
Forward currency contracts | | Other long-term assets | | 94 |
| | 57 |
|
Net investment hedges | | Other long-term assets | | 21 |
| | — |
|
| | | | 139 |
| | 64 |
|
Non-Designated Derivative Instruments | | | | | | |
Forward currency contracts | | Other current assets | | 64 |
| | 18 |
|
Total Derivative Assets | | | | $ | 202 |
| | $ | 82 |
|
| | | | | | |
Derivative Liabilities: | | | | | | |
Designated Derivative Instruments | | | | | | |
Forward currency contracts | | Other current liabilities | | $ | 9 |
| | $ | 37 |
|
Forward currency contracts | | Other long-term liabilities | | 10 |
| | 33 |
|
| | | | 19 |
| | 69 |
|
Non-Designated Derivative Instruments | | | | | | |
Forward currency contracts | | Other current liabilities | | 26 |
| | 21 |
|
Total Derivative Liabilities | | | | $ | 45 |
| | $ | 90 |
|
| |
(1) | We classify derivative assets and liabilities as current when the settlement date of the derivative contract is one year or less. |
Recurring Fair Value Measurements
On a recurring basis, we measure certain financial assets and financial liabilities at fair value based upon quoted market prices. Where quoted market prices or other observable inputs are not available, we apply valuation techniques to estimate fair value. FASB ASC Topic 820 establishes a three-level valuation hierarchy for disclosure of fair value measurements. The category of a financial asset or a financial liability within the valuation hierarchy is based upon the lowest level of input that is significant to the measurement of fair value. The three levels of the hierarchy are defined as follows:
| |
• | Level 1 – Inputs to the valuation methodology are quoted market prices for identical assets or liabilities. |
| |
• | Level 2 – Inputs to the valuation methodology are other observable inputs, including quoted market prices for similar assets or liabilities and market-corroborated inputs. |
| |
• | Level 3 – Inputs to the valuation methodology are unobservable inputs based on management’s best estimate of inputs market participants would use in pricing the asset or liability at the measurement date, including assumptions about risk. |
Assets and liabilities measured at fair value on a recurring basis consist of the following:
|
| | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | |
| As of |
| June 30, 2018 | | December 31, 2017 |
(in millions) | Level 1 | | Level 2 | | Level 3 | | Total | | Level 1 | | Level 2 | | Level 3 | | Total |
Assets | | | |
| | | | | | | | |
| | | | |
Money market and government funds | $ | 49 |
| | $ | — |
| | $ | — |
| | $ | 49 |
| | $ | 21 |
| | $ | — |
| | $ | — |
| | $ | 21 |
|
Publicly-held securities | 1 |
| | — |
| | — |
| | 1 |
| | 15 |
| | — |
| | — |
| | 15 |
|
Forward currency contracts | — |
| | 202 |
| | — |
| | 202 |
| | — |
| | 82 |
| | — |
| | 82 |
|
| $ | 50 |
| | $ | 202 |
| | $ | — |
| | $ | 253 |
| | $ | 36 |
| | $ | 82 |
| | $ | — |
| | $ | 118 |
|
Liabilities | | | | | | | | | | | | | | | |
Forward currency contracts | $ | — |
| | $ | 45 |
| | $ | — |
| | $ | 45 |
| | $ | — |
| | $ | 90 |
| | $ | — |
| | $ | 90 |
|
Accrued contingent consideration | — |
| | — |
| | 279 |
| | 279 |
| | — |
| | — |
| | 169 |
| | 169 |
|
| $ | — |
| | $ | 45 |
| | $ | 279 |
| | $ | 324 |
| | $ | — |
| | $ | 90 |
| | $ | 169 |
| | $ | 259 |
|
Our investments in money market and government funds are classified within Level 1 of the fair value hierarchy because they are valued using quoted market prices. These investments are classified as Cash and cash equivalents within our accompanying unaudited condensed consolidated balance sheets, in accordance with U.S. GAAP and our accounting policies. In addition to $49 million invested in money market and government funds as of June 30, 2018, we had $159 million in interest bearing and non-interest bearing bank accounts. In addition to $21 million invested in money market and government funds as of December 31, 2017, we had $167 million in interest bearing and non-interest bearing bank accounts.
Our recurring fair value measurements using Level 3 inputs relate solely to our contingent consideration liability. Refer to Note B – Acquisitions and Strategic Investments for a discussion of the changes in the fair value of our contingent consideration liability.
Non-Recurring Fair Value Measurements
We hold certain assets and liabilities that are measured at fair value on a non-recurring basis in periods subsequent to initial recognition. The fair value of a measurement alternative investment is not estimated if there are no identified events or changes in circumstances that may have a significant adverse effect on the fair value of the investment. Refer to Note B – Acquisitions and Strategic Investments for a discussion of our strategic investments.
Refer to Note C – Goodwill and Other Intangible Assets for a discussion of the fair values.
The fair value of our outstanding debt obligations was $6.702 billion as of June 30, 2018 and $5.945 billion as of December 31, 2017. We determined fair value by using quoted market prices for our publicly registered senior notes, classified as Level 1 within the fair value hierarchy, amortized cost for commercial paper and face value for term loans and credit facility borrowings outstanding. Refer to Note E – Borrowings and Credit Arrangements for a discussion of our debt obligations.
NOTE E – BORROWINGS AND CREDIT ARRANGEMENTS
We had total debt of $6.493 billion as of June 30, 2018 and $5.616 billion as of December 31, 2017. The debt maturity schedule for the significant components of our long-term debt obligations is presented below:
|
| | | | | | | | | | | | | | |
(in millions, except interest rates) | | Issuance Date | | Maturity Date | | As of | | Semi-annual Coupon Rate |
| June 30, 2018 | | December 31, 2017 | |
October 2018 Notes | | August 2013 | | October 2018 | | — |
| | †† |
| | 2.650% |
January 2020 Notes | | December 2009 | | January 2020 | | 850 |
| | 850 |
| | 6.000% |
May 2020 Notes | | May 2015 | | May 2020 | | 600 |
| | 600 |
| | 2.850% |
May 2022 Notes | | May 2015 | | May 2022 | | 500 |
| | 500 |
| | 3.375% |
October 2023 Notes | | August 2013 | | October 2023 | | 450 |
| | 450 |
| | 4.125% |
May 2025 Notes | | May 2015 | | May 2025 | | 750 |
| | 750 |
| | 3.850% |
March 2028 Notes | | February 2018 | | March 2028 | | 1,000 |
| | — |
| | 4.000% |
November 2035 Notes | | November 2005 | | November 2035 | | 350 |
| | 350 |
| | 7.000% |
January 2040 Notes | | December 2009 | | January 2040 | | 300 |
| | 300 |
| | 7.375% |
Unamortized Debt Issuance Discount and Deferred Financing Costs | | | | 2020 - 2040 | | (32 | ) | | (24 | ) | | |
Unamortized Gain on Fair Value Hedges | | | | 2020 - 2023 | | 32 |
| | 38 |
| | |
Capital Lease Obligation | | | | Various | | 8 |
| | 1 |
| | |
Long-term debt | | | | | | $ | 4,808 |
| | $ | 3,815 |
| | |
††As of December 31, 2017, $600 million under the October 2018 Notes was outstanding and classified as short-term debt.
Note: The table above does not include unamortized amounts related to interest rate contracts designated as cash flow hedges.
Revolving Credit Facility
As of June 30, 2018 and December 31, 2017, we maintained a $2.250 billion revolving credit facility (the 2017 Facility) with a global syndicate of commercial banks that matures on August 4, 2022. This facility provides backing for the commercial paper program described below. There were no amounts borrowed under our revolving credit facility as of June 30, 2018 and December 31, 2017.
The 2017 Facility requires that we maintain certain financial covenants, as follows:
|
| | | | |
| | Covenant Requirement | | Actual |
| | as of June 30, 2018 | | as of June 30, 2018 |
Maximum leverage ratio (1) | | 3.5 times | | 2.4 times |
| |
(1) | Ratio of total debt to consolidated EBITDA, as defined by the credit agreement, for the preceding four consecutive fiscal quarters. |
The 2017 Facility provides for an exclusion from the calculation of consolidated EBITDA, as defined by the agreement, through maturity, of any non-cash charges and up to $500 million in restructuring charges and restructuring-related expenses related to our current or future restructuring plans. As of June 30, 2018, we had $400 million of the restructuring charge exclusion remaining. In addition, any cash litigation payments (net of any cash litigation receipts), as defined by the 2017 Facility, are excluded from the calculation of consolidated EBITDA, as defined in the 2017 Facility, provided that the sum of any excluded net cash litigation payments does not exceed $2.624 billion in the aggregate. As of June 30, 2018, we had $1.526 billion of the legal exclusion remaining.
Any inability to maintain compliance with these covenants could require us to seek to renegotiate the terms of our credit facility or seek waivers from compliance with these covenants, both of which could result in additional borrowing costs. Further, there can be no assurance that our lenders would agree to such new terms or grant such waivers on terms acceptable to us. In this case, all credit facility commitments would terminate and any amounts borrowed under the facility would become immediately due and payable. Furthermore, any termination of our credit facility may negatively impact the credit ratings assigned to our commercial paper program which may impact our ability to refinance any then outstanding commercial paper as it becomes due and payable.
Commercial Paper
As of June 30, 2018, we had $1.685 billion of commercial paper outstanding and $1.197 billion outstanding as of December 31, 2017. Our commercial paper program is backed by the 2017 Facility, which allows us to have a maximum of $2.250 billion in commercial paper outstanding. Outstanding commercial paper directly reduces borrowing capacity available under the 2017 Facility. As of June 30, 2018, the commercial paper issued and outstanding had a weighted average maturity of 46 days and a weighted average yield of 2.58 percent. As of December 31, 2017, the commercial paper issued and outstanding had a weighted average maturity of 38 days and a weighted average yield of 1.85 percent.
Senior Notes
We had senior notes outstanding of $4.800 billion as of June 30, 2018 and $4.400 billion as of December 31, 2017.
In February 2018, we completed an offering of $1.000 billion in aggregate principal amount of 4.000% senior notes, due March 2028. We used a portion of the net proceeds from the offering to repay the $600 million plus accrued interest of our 2.650% senior notes due in October 2018. The remaining proceeds were used to repay a portion of our outstanding commercial paper.
Our senior notes were issued in public offerings, are redeemable prior to maturity and are not subject to sinking fund requirements. Our senior notes are unsecured, unsubordinated obligations and rank on parity with each other. These notes are effectively junior to borrowings under our credit and security facility, and to the extent borrowed by our subsidiaries, to liabilities of our subsidiaries (see Other Arrangements below).
Other Arrangements
As of June 30, 2018 and December 31, 2017, we maintained a $400 million credit and security facility secured by our U.S. trade receivables maturing in February 2019. We had no outstanding borrowings as of June 30, 2018 and December 31, 2017 under our credit and security facility.
We have accounts receivable factoring programs in certain European countries and with commercial banks in Japan which include promissory notes discounting programs. We account for our factoring programs as sales under FASB ASC Topic 860, Transfers and Servicing. We have no retained interest in the transferred receivables, other than collection and administration, and once sold, the accounts receivable are no longer available to satisfy creditors in the event of bankruptcy. Amounts de-recognized for accounts and notes receivable, which are excluded from Trade accounts receivable, net in the accompanying unaudited condensed consolidated balance sheets, are aggregated by contract denominated currency below (in millions):
|
| | | | | | | | | | | | | | | | | | | | | |
| As of June 30, 2018 | | As of December 31, 2017 |
Factoring Arrangements | Capacity (1) | | Amount De-recognized | | Average Interest Rate | | Capacity (1) | | Amount De-recognized | | Average Interest Rate |
Euro denominated | $ | 442 |
| | $ | 161 |
| | 1.5 | % | | $ | 456 |
| | $ | 171 |
| | 1.8 | % |
Yen denominated (2) | $ | 470 |
| | $ | 216 |
| | 0.5 | % | | $ | 195 |
| | $ | 157 |
| | 1.3 | % |
| |
(1) | The capacities are translated from local currency to U.S. dollar using the spot rates on the last business day of each period. |
| |
(2) | The factoring arrangements denominated in Japanese yen consist of two arrangements, one with a maximum capacity of 22.000 billion yen, which has been discontinued as of June 30, 2018, and a new arrangement with a maximum capacity of 30.000 billion yen entered into during March 2018. |
Debt Covenants Compliance
As of and through June 30, 2018, we were in compliance with all the required covenants related to our debt obligations. For additional information regarding the terms of our debt agreements, refer to Note E - Borrowings and Credit Arrangements of the consolidated financial statements in our most recent Annual Report on Form 10-K.
NOTE F – RESTRUCTURING-RELATED ACTIVITIES
2016 Restructuring Plan
On June 6, 2016, our Board of Directors approved and we committed to a restructuring initiative (the 2016 Restructuring Plan). The 2016 Restructuring Plan is intended to develop global commercialization, technology and manufacturing capabilities in key growth markets and build on our Plant Network Optimization (PNO) strategy, which is intended to simplify our manufacturing plant structure by transferring certain production lines among facilities and expanding operational efficiencies in support of our
operating income margin goals. Key activities under the 2016 Restructuring Plan include strengthening global infrastructure through evolving global real estate assets and workplaces, developing global commercial and technical competencies, enhancing manufacturing and distribution expertise in certain regions and continuing implementation of our PNO strategy. These activities were initiated in the second quarter of 2016 and are expected to be substantially complete by the end of 2018. We revised the original estimate for the costs and savings associated with the program in the first quarter of 2018, as approved by the Board of Directors.
The following table provides a summary of our estimates of costs associated with the 2016 Restructuring Plan by major type of cost:
|
| |
Type of cost | Total Estimated Amount Expected to be Incurred |
Restructuring charges: | |
Termination benefits | $105 million to $115 million |
Other (1) | $35 million to $60 million |
Restructuring-related expenses: | |
Other (2) | $135 million to $150 million |
| $275 million to $325 million |
(1) Consists primarily of consulting fees and costs associated with contract cancellations.
| |
(2) | Comprised of other costs directly related to the 2016 Restructuring Plan, including program management, accelerated depreciation, fixed asset write-offs and costs to transfer product lines among facilities. |
Approximately $250 million to $300 million of these charges are estimated to result in cash outlays.
The following presents these costs (credits) by major type and line item within our accompanying unaudited condensed consolidated statements of operations (in millions):
|
| | | | | | | | | | | | | | | |
Three Months Ended June 30, 2018 | Termination Benefits | | Transfer Costs | | Other | | Total |
Restructuring charges (credits) | $ | 2 |
| | $ | — |
| | $ | 2 |
| | $ | 5 |
|
Restructuring-related expenses: | | | | | | | |
Cost of products sold | — |
| | 16 |
| | — |
| | 16 |
|
Selling, general and administrative expenses | — |
| | — |
| | (5 | ) | | (5 | ) |
| — |
| | 16 |
| | (5 | ) | | 11 |
|
| $ | 2 |
| | $ | 16 |
| | $ | (3 | ) | | $ | 15 |
|
|
| | | | | | | | | | | | | | | |
Three Months Ended June 30, 2017 | Termination Benefits | | Transfer Costs | | Other | | Total |
Restructuring charges (credits) | $ | — |
| | $ | — |
| | $ | 1 |
| | $ | 1 |
|
Restructuring-related expenses: | | | | | | | |
Cost of products sold | — |
| | 12 |
| | — |
| | 12 |
|
Selling, general and administrative expenses | — |
| | — |
| | 3 |
| | 3 |
|
| — |
| | 12 |
| | 3 |
| | 15 |
|
| $ | — |
| | $ | 12 |
| | $ | 4 |
| | $ | 16 |
|
|
| | | | | | | | | | | | | | | |
Six Months Ended June 30, 2018 | Termination Benefits | | Transfer Costs | | Other | | Total |
Restructuring charges (credits) | $ | 15 |
| | $ | — |
| | $ | 3 |
| | $ | 18 |
|
Restructuring-related expenses: | | | | | | | |
Cost of products sold | — |
| | 23 |
| | — |
| | 23 |
|
Selling, general and administrative expenses | — |
| | — |
| | 3 |
| | 3 |
|
| — |
| | 23 |
| | 3 |
| | 26 |
|
| $ | 15 |
| | $ | 23 |
| | $ | 6 |
| | $ | 43 |
|
|
| | | | | | | | | | | | | | | |
Six Months Ended June 30, 2017 | Termination Benefits | | Transfer Costs | | Other | | Total |
Restructuring charges (credits) | $ | 3 |
| | $ | — |
| | $ | 2 |
| | $ | 5 |
|
Restructuring-related expenses: | | | | | | | |
Cost of products sold | — |
| | 24 |
| | — |
| | 24 |
|
Selling, general and administrative expenses | — |
| | — |
| | 6 |
| | 6 |
|
| — |
| | 24 |
| | 6 |
| | 30 |
|
| $ | 3 |
| | $ | 24 |
| | $ | 8 |
| | $ | 35 |
|
The following table presents cumulative restructuring and restructuring-related charges as of June 30, 2018, by major type:
|
| | | |
(in millions) | 2016 Restructuring Plan |
Termination benefits | $ | 63 |
|
Other (1) | 18 |
|
Total restructuring charges | 82 |
|
Transfer costs | 83 |
|
Other (2) | 19 |
|
Restructuring-related expenses | 102 |
|
| $ | 184 |
|
(1) Consists primarily of consulting fees and costs associated with contract cancellations.
| |
(2) | Comprised of other costs directly related to our Restructuring Plan, including program management, accelerated depreciation, fixed asset write-offs and costs to transfer product lines among facilities. |
Cash payments were made using cash generated from operations and are comprised of the following:
|
| | | |
(in millions) | 2016 Restructuring Plan |
Six Months Ended June 30, 2018 | |
Termination benefits | $ | 20 |
|
Transfer costs | 23 |
|
Other | 8 |
|
| $ | 51 |
|
| |
Program to Date | |
Termination benefits | $ | 47 |
|
Transfer costs | 82 |
|
Other | 19 |
|
| $ | 148 |
|
Our restructuring liability is primarily comprised of accruals for termination benefits. The following is a rollforward of the termination benefit liability, which is reported as a component of Accrued expenses included in our accompanying unaudited condensed consolidated balance sheets:
|
| | | |
(in millions) | 2016 Restructuring Plan |
Accrued as of December 31, 2017 | $ | 22 |
|
Charges (credits) | 15 |
|
Cash payments | (20 | ) |
Accrued as of June 30, 2018 | $ | 18 |
|
NOTE G – SUPPLEMENTAL BALANCE SHEET INFORMATION
Components of selected captions in our accompanying unaudited condensed consolidated balance sheets are as follows:
Cash, cash equivalents, restricted cash and restricted cash equivalents
|
| | | | | | | |
| As of |
(in millions) | June 30, 2018 | | December 31, 2017 |
Cash and cash equivalents | $ | 208 |
| | $ | 188 |
|
Restricted cash and restricted cash equivalents included in Other current assets | 756 |
| | 803 |
|
Restricted cash equivalents included in Other long-term assets | 31 |
| | 26 |
|
| $ | 994 |
| | $ | 1,017 |
|
Trade accounts receivable, net
|
| | | | | | | |
| As of |
(in millions) | June 30, 2018 | | December 31, 2017 |
Accounts receivable | $ | 1,650 |
| | $ | 1,645 |
|
Allowance for doubtful accounts | (63 | ) | | (68 | ) |
Allowance for sales returns (1) | — |
| | (30 | ) |
| $ | 1,587 |
| | $ | 1,548 |
|
| |
(1) | Due to the adoption of FASB ASC Topic 606 effective January 1, 2018, the allowance for sales returns has been prospectively reclassified from Trade accounts receivable, net to Other current liabilities within the unaudited condensed consolidated balance sheets. Prior period balances remain unchanged. |
The following is a rollforward of our allowance for doubtful accounts:
|
| | | | | | | | | | | | | | | |
| Three Months Ended June 30, | | Six Months Ended June 30, |
(in millions) | 2018 | | 2017 | | 2018 | | 2017 |
Beginning balance | $ | 67 |
| | $ | 75 |
| | $ | 68 |
| | $ | 73 |
|
Net charges to expenses | 4 |
| | 2 |
| | 8 |
| | 5 |
|
Utilization of allowances | (8 | ) | | (3 | ) | | (14 | ) | | (4 | ) |
Ending balance | $ | 63 |
| | $ | 74 |
| | $ | 63 |
| | $ | 74 |
|
Inventories
|
| | | | | | | |
| As of |
(in millions) | June 30, 2018 | | December 31, 2017 |
Finished goods | $ | 689 |
| | $ | 685 |
|
Work-in-process | 102 |
| | 110 |
|
Raw materials | 296 |
| | 284 |
|
| $ | 1,087 |
| | $ | 1,078 |
|
Property, plant and equipment, net
|
| | | | | | | |
| As of |
(in millions) | June 30, 2018 | | December 31, 2017 |
Land | $ | 102 |
| | $ | 102 |
|
Buildings and improvements | 1,124 |
| | 1,120 |
|
Equipment, furniture and fixtures | 3,255 |
| | 3,183 |
|
Capital in progress | 229 |
| | 219 |
|
| 4,709 |
| | 4,625 |
|
Accumulated depreciation | (2,995 | ) | | (2,928 | ) |
| $ | 1,715 |
| | $ | 1,697 |
|
Depreciation expense was $70 million for the second quarter of 2018, $65 million for the second quarter of 2017, $137 million for the first six months of 2018 and $127 million for the first six months of 2017.
Accrued expenses
|
| | | | | | | |
| As of |
(in millions) | June 30, 2018 | | December 31, 2017 |
Legal reserves | $ | 1,043 |
| | $ | 1,176 |
|
Payroll and related liabilities | 528 |
| | 591 |
|
Accrued contingent consideration | 52 |
| | 36 |
|
Other | 644 |
| | 653 |
|
| $ | 2,266 |
| | $ | 2,456 |
|
Other long-term liabilities
|
| | | | | | | |
| As of |
(in millions) | June 30, 2018 | | December 31, 2017 |
Accrued income taxes | $ | 781 |
| | $ | 1,275 |
|
Legal reserves | 221 |
| | 436 |
|
Accrued contingent consideration | 227 |
| | 133 |
|
Other | 716 |
| | 525 |
|
| $ | 1,945 |
| | $ | 2,370 |
|
NOTE H – INCOME TAXES
Our effective tax rate from continuing operations is presented below:
|
| | | | | | | | | | | |
| Three Months Ended June 30, | | Six Months Ended June 30, |
2018 | | 2017 | | 2018 | | 2017 |
Effective tax rate from continuing operations | (60.3 | )% | | (60.3 | )% | | (27.3 | )% | | (10.1 | )% |
The change in our reported tax rates for the first six months of 2018, as compared to the same period in 2017, relates primarily to the impact of certain receipts and charges that are taxed at different rates than our effective tax rate, including intangible asset impairment charges, acquisition-related items, restructuring items, litigation-related items, as well as certain discrete tax items including the effective settlement of our transfer pricing dispute with the Internal Revenue Service (IRS) for the 2001 through 2010 tax years and the impacts of the Tax Cuts and Jobs Act (TCJA), enacted on December 22, 2017.
On June 6, 2018, a decision was entered by the United States Tax Court resolving all disputes related to the transfer pricing issues for Guidant Corporation's 2001 through 2006 tax years and our 2006 and 2007 tax years as well as the tax issues related to our 2006 transaction with Abbott Laboratories. Additionally, on May 24, 2018, we resolved all issues with the IRS Office of Appeals for our 2008 through 2010 tax years, including the transfer pricing issue and other unrelated issues. The final settlement calculation included certain elections made in these relevant years and resulted in a final net tax payment of $303 million plus $307 million
of estimated interest, which was remitted to the IRS on June 15, 2018. Due to the final settlement of these disputes, we recorded a net tax benefit of $250 million as of June 30, 2018.
We currently expect to resolve the IRS examination of our 2011 through 2013 tax years before the end of 2018. We expect that the exam will be concluded utilizing the same transfer pricing methodologies employed in the 2001 through 2010 tax years. We believe we have recorded sufficient reserves with respect to these periods and therefore do not expect to recognize any additional charges related to the resolution of the 2011 through 2013 tax years.
As of June 30, 2018, we had $506 million of gross unrecognized tax benefits, of which a net $432 million, if recognized, would affect our effective tax rate. As of December 31, 2017, we had $1.238 billion of gross unrecognized tax benefits, of which a net $1.150 billion, if recognized, would affect our effective tax rate. The change in our gross unrecognized tax benefit is primarily related to reaching settlements with tax authorities.
We recognize interest and penalties related to income taxes as a component of income tax expense. We had $78 million accrued for gross interest and penalties as of June 30, 2018 and $655 million as of December 31, 2017. The change in our accrued interest and penalties is primarily related to reaching settlements with tax authorities. We recognized net tax expense related to interest and penalties of $2 million in the second quarter of 2018, $13 million in the second quarter of 2017, $19 million during the first six months of 2018 and $26 million during the first six months of 2017.
It is reasonably possible that within the next 12 months we will resolve multiple issues with foreign, federal and state taxing authorities, in which case we could record a reduction in our balance of unrecognized tax benefits of up to approximately $221 million.
There are a number of key provisions under the TCJA that impact us and we continue to monitor and analyze the ramifications of the new law as the implementation is executed. The final impact of the TCJA may differ from the estimates reported due to, among other things, changes in interpretations and assumptions made by us, additional guidance that may be issued by the U.S. Department of the Treasury and actions that we may take as a result. The TCJA reduces the US Federal corporate income tax rate from 35 percent to 21 percent, requires companies to pay a one-time transition tax on earnings of certain foreign subsidiaries that were previously tax deferred, and creates new taxes on certain foreign sourced earnings. Due to insufficient guidance, as well as the availability of information to accurately analyze the impact of the TCJA, we have made a reasonable estimate of the effects, as described below, and in other cases we have not been able to make a reasonable estimate and continue to account for those items based on our existing accounting under FASB ASC Topic 740, Income Taxes and the provisions of the tax laws that were in effect immediately prior to enactment. In the second quarter of 2018, we recognized an additional tax benefit of $28 million related to settling our transfer pricing dispute with the IRS. In the first six months of 2018, we recognized an additional tax benefit of $37 million, resulting in a total provisional estimate of $824 million related to the TCJA.
We are required to record deferred tax assets and liabilities based on the enacted tax rates at which they are expected to reverse in the future. Therefore, any U.S. related deferred taxes were re-measured from 35 percent down to 21 percent based on the recorded balances as of December 31, 2017. The analysis included a preliminary assessment on the deductibility of certain amounts for which deferred tax assets may have been recorded. However, we are still analyzing certain aspects of the TCJA and refining our calculations based on the available information, which could potentially affect the measurement of these balances or give rise to new deferred tax amounts. As of June 30, 2018, we have not adjusted our provisional estimate related to re-measurement of our deferred tax balances. As of December 31, 2017, we recorded an estimated tax benefit of approximately $99 million.
We are required to calculate a one-time transition tax based on our total post-1986 foreign earnings and profits (E&P) that we previously deferred from U.S. income taxes. As a result of settling our various tax audits, the revised provisional amount of transition tax is approximately $866 million. We anticipate offsetting this liability against existing tax attributes reducing the required payment to approximately $506 million, which will be remitted over an eight-year period. We remitted the first estimated installment payment in the second quarter of 2018. We have not yet completed our calculation of the total post-1986 E&P for these foreign subsidiaries, and we continue to refine the analysis. We expect that our undistributed foreign earnings as of December 31, 2017 will remain indefinitely reinvested in our foreign operations. Accordingly, no income taxes beyond the federal and state impact of the transition tax have been provided for these undistributed foreign earnings or any additional outside basis difference inherent in these entities. Determining the amount of unrecognized deferred tax liability related to any remaining undistributed foreign earnings and additional outside basis difference in these entities is not practicable.
We are subject to a territorial tax system under the TCJA, in which we are required to provide for tax on Global Intangible Low Taxed Income (GILTI) earned by certain foreign subsidiaries. Additionally, we are required to make an accounting policy election to either recognize deferred taxes for temporary basis differences expected to reverse as GILTI in future years or provide for the tax expense related to GILTI in the year the tax is incurred as a period expense. As of June 30, 2018, we are still evaluating the
effects of the GILTI provisions as guidance and interpretations continue to emerge. Therefore, we have not determined our accounting policy on the GILTI provisions. However, Securities and Exchange Commission (SEC) Staff Accounting Bulletin (SAB) No. 118 requires that we reflect the impact of the GILTI provisions as a period expense until the accounting policy is finalized. Therefore, we have included the provisional estimate of GILTI related to current-year operations in our estimated annual effective tax rate only and will be updating the impact and accounting policy as the analysis related to the GILTI provisions is completed.
NOTE I – COMMITMENTS AND CONTINGENCIES
The medical device market in which we primarily participate is largely technology driven. As a result, intellectual property rights, particularly patents and trade secrets, play a significant role in product development and differentiation. Over the years, there has been litigation initiated against us by others, including our competitors, claiming that our current or former product offerings infringe patents owned or licensed by them. Intellectual property litigation is inherently complex and unpredictable. In addition, competing parties frequently file multiple suits to leverage patent portfolios across product lines, technologies and geographies and to balance risk and exposure between the parties. In some cases, several competitors are parties in the same proceeding, or in a series of related proceedings, or litigate multiple features of a single class of devices. These forces frequently drive settlement not only for individual cases, but also for a series of pending and potentially related and unrelated cases. Although monetary and injunctive relief is typically sought, remedies and restitution are generally not determined until the conclusion of the trial court proceedings and can be modified on appeal. Accordingly, the outcomes of individual cases are difficult to time, predict or quantify and are often dependent upon the outcomes of other cases in other geographies.
During recent years, we successfully negotiated closure of several long-standing legal matters and have received favorable rulings in several other matters; however, there continues to be outstanding intellectual property litigation. Adverse outcomes in one or more of these matters could have a material adverse effect on our ability to sell certain products and on our operating margins, financial position, results of operations and/or liquidity.
In the normal course of business, product liability, securities and commercial claims are asserted against us. Similar claims may be asserted against us in the future related to events not known to management at the present time. We maintain an insurance policy providing limited coverage against securities claims and we are substantially self-insured with respect to product liability claims and fully self-insured with respect to intellectual property infringement claims. The absence of significant third-party insurance coverage increases our potential exposure to unanticipated claims or adverse decisions. Product liability claims, securities and commercial litigation and other legal proceedings in the future, regardless of their outcome, could have a material adverse effect on our financial position, results of operations and/or liquidity.
In addition, like other companies in the medical device industry, we are subject to extensive regulation by national, state and local government agencies in the U.S. and other countries in which we operate. From time to time we are the subject of qui tam actions and governmental investigations often involving regulatory, marketing and other business practices. These qui tam actions and governmental investigations could result in the commencement of civil and criminal proceedings, substantial fines, penalties and administrative remedies and have a material adverse effect on our financial position, results of operations and/or liquidity.
In accordance with FASB ASC Topic 450, Contingencies, we accrue anticipated costs of settlement, damages, losses for 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 $1.264 billion as of June 30, 2018 and $1.612 billion as of December 31, 2017 and includes certain estimated costs of settlement, damages and defense. A portion of our legal accrual is funded and included in our restricted cash and restricted cash equivalent balances of $787 million as of June 30, 2018 and $829 million as of December 31, 2017, as disclosed in Note G – Supplemental Balance Sheet Information. Litigation-related net charges (credits) were immaterial in the second quarter and first six months of 2018. We recorded litigation-related net charges of $205 million in the second quarter of 2017 and $208 million in the first six months of 2017. We continue to assess certain litigation and claims to determine the amounts, if any, that management believes will be paid as a result of such claims and litigation and, therefore, additional losses may be accrued and paid in the future, which could materially adversely impact our operating results, cash flows and/or our ability to comply with our debt covenants.
In management's opinion, we are not currently involved in any legal proceedings other than those disclosed in our most recent Annual Report on Form 10-K, our Quarterly Report on Form 10-Q for the period ended March 31, 2018 and those specifically identified below, which, individually or in the aggregate, could have a material adverse effect on our financial condition, operations and/or cash flows. Unless included in our legal accrual or otherwise indicated below, a range of loss associated with any individual material legal proceeding cannot be estimated.
Patent Litigation
On November 20, 2017, The Board of Regents, University of Texas System (UT) and TissueGen. Inc., served a lawsuit against us in the Western District of Texas. The complaint against us alleges patent infringement of two U.S. patents owned by UT, relating to “Drug Releasing Biodegradable Fiber Implant” and “Drug Releasing Biodegradable Fiber for Delivery of Therapeutics,” and affects the manufacture, use and sale of our Synergy™ Stent System. On March 12, 2018, the court dismissed the action and transferred it to the United States District Court for the District of Delaware. UT has appealed the decision.
Product Liability Litigation
As of July 24, 2018, approximately 49,500 product liability cases or claims related to transvaginal surgical mesh products designed to treat stress urinary incontinence and pelvic organ prolapse have been asserted against us. The pending cases are in various federal and state courts in the U.S. and include eight putative class actions. There were also fewer than 25 cases in Canada, inclusive of one certified and three putative class actions and fewer than 25 claims in the United Kingdom. Generally, the plaintiffs allege personal injury associated with use of our transvaginal surgical mesh products. The plaintiffs assert design and manufacturing claims, failure to warn, breach of warranty, fraud, violations of state consumer protection laws and loss of consortium claims. Over 3,100 of the cases have been specially assigned to one judge in state court in Massachusetts. On February 7, 2012, the Judicial Panel on Multi-District Litigation (MDL) established MDL-2326 in the U.S. District Court for the Southern District of West Virginia and transferred the federal court transvaginal surgical mesh cases to MDL-2326 for coordinated pretrial proceedings. During the fourth quarter of 2013, we received written discovery requests from certain state attorneys general offices regarding our transvaginal surgical mesh products. We have responded to those requests. As of July 24, 2018, we have entered into master settlement agreements in principle or are in the final stages of entering one with certain plaintiffs' counsel to resolve an aggregate of approximately 48,000 cases and claims. These master settlement agreements provide that the settlement and distribution of settlement funds to participating claimants are conditional upon, among other things, achieving minimum required claimant participation thresholds. Of the approximately 48,000 cases and claims, approximately 27,000 have met the conditions of the settlement and are final. All settlement agreements were entered into solely by way of compromise and without any admission or concession by us of any liability or wrongdoing.
We have established a product liability accrual for known and estimated future cases and claims asserted against us as well as with respect to the actions that have resulted in verdicts against us and the costs of defense thereof associated with our transvaginal surgical mesh products. While we believe that our accrual associated with this matter is adequate, changes to this accrual may be required in the future as additional information becomes available. While we continue to engage in discussions with plaintiffs’ counsel regarding potential resolution of pending cases and claims and intend to vigorously contest the cases and claims asserted against us, that do not settle, the final resolution of the cases and claims is uncertain and could have a material impact on our results of operations, financial condition and/or liquidity. Initial trials involving our transvaginal surgical mesh products have resulted in both favorable and unfavorable judgments for us. We do not believe that the judgment in any one trial is representative of potential outcomes of all cases or claims related to our transvaginal surgical mesh products.
Governmental Investigations and Qui Tam Matters
On February 23, 2015, a judge for the Court of Modena (Italy) ordered a trial for Boston Scientific SpA and three of its employees, as well as numerous other defendants charged in criminal proceedings. The charges arise from allegations that the defendants made improper donations to certain health care providers and other employees of the Hospital of Modena in order to induce them to conduct unauthorized clinical trials, as well as related government fraud in relation to the financing of such clinical trials. A trial began on February 24, 2016 and is ongoing. On November 10, 2017, the Court issued a ruling that convicted one Boston Scientific employee but acquitted two others, and levied a fine of €245 thousand against us and imposed joint and several civil damages of €620 thousand on all defendants. We continue to deny these allegations, timely appealed the decision on May 10, 2018 and intend to continue to defend ourselves vigorously.
Other Proceedings
On May 16, 2018, Arthur Rosenthal et al., filed a plenary summons against Boston Scientific Corporation and Boston Scientific Limited the High Court of Ireland alleging that payments are due pursuant a transaction agreement regarding Labcoat Limited.
Refer to Note H – Income Taxes for information regarding our tax litigation.
Matters Concluded Since December 31, 2017
On October 28, 2016, the Regents of the University of California filed a patent infringement action against us in the U.S. District Court for the Northern District of California alleging that two U.S. patents (Lesh) owned by the Regents of the University of California are infringed by certain of our catheters and other devices used to treat atrial fibrillation. The Company and the Regents settled the matter, and the case was dismissed on June 20, 2018.
NOTE J – WEIGHTED AVERAGE SHARES OUTSTANDING
|
| | | | | | | | | | | |
| Three Months Ended June 30, | | Six Months Ended June 30, |
(in millions) | 2018 |
| 2017 | | 2018 | | 2017 |
Weighted average shares outstanding - basic | 1,380.5 |
| | 1,369.8 |
| | 1,378.5 |
| | 1,367.6 |
|
Net effect of common stock equivalents | 18.3 |
| | 21.3 |
| | 19.3 |
| | 23.0 |
|
Weighted average shares outstanding - assuming dilution | 1,398.9 |
| | 1,391.1 |
| | 1,397.8 |
| | 1,390.6 |
|
The impact of stock options outstanding with exercise prices greater than the average fair market value of our common stock was immaterial for all periods presented.
We issued approximately two million shares of our common stock in the second quarter of 2018, one million shares of our common stock in the second quarter of 2017 and eight million shares of our common stock in the first six months of 2018 and 2017, following the exercise of underlying stock options, vesting of deferred stock units or purchases under our employee stock purchase plan. We did not repurchase any shares of our common stock during the first six months of 2018 or 2017.
NOTE K – SEGMENT REPORTING
We have three reportable segments comprised of MedSurg, Rhythm and Neuro, and Cardiovascular, which represent an aggregation of our operating segments.
Each of our reportable segments generates revenues from the sale of medical devices. We measure and evaluate our reportable segments based on segment net sales and operating income, excluding intersegment profits. In 2017, we updated our presentation of segment net sales and operating income to include the impact of foreign currency fluctuations, since our chief operating decision maker (CODM) reviews operating results both including and excluding the impact of foreign currency fluctuations, and the following presentation more closely aligns to our unaudited condensed consolidated financial statements. We exclude from segment operating income certain corporate-related expenses and certain transactions or adjustments that our CODM considers to be non-operational, such as amounts related to amortization expense, intangible asset impairment charges, acquisition-related items, restructuring and restructuring-related items and litigation-related items. Although we exclude these amounts from segment operating income, they are included in reported Income (loss) before income taxes on the unaudited condensed consolidated statements of operations and are included in the reconciliation below.