NOTE A - BASIS OF PRESENTATION
The accompanying unaudited condensed consolidated financial statements of Boston Scientific Corporation (Boston Scientific or the Company) have been prepared in accordance with accounting principles generally accepted in the United States for interim financial information and with the instructions to Form 10-Q and Article 10 of Regulation S-X. Accordingly, they do not include all of the information and footnotes required by accounting principles generally accepted in the United States for complete financial statements. In the opinion of management, all adjustments (consisting only of normal recurring adjustments) considered necessary for fair presentation have been included. Operating results for the three and nine months ended September 30, 2006 are not necessarily indicative of the results that may be expected for the year ending December 31, 2006. For further information, refer to the consolidated financial statements and footnotes thereto incorporated by reference in Boston Scientific’s Annual Report on Form 10-K for the year ended December 31, 2005.
On April 21, 2006, the Company consummated the acquisition of Guidant Corporation. Prior to the Company’s acquisition of Guidant, Abbott Laboratories acquired Guidant’s vascular intervention and endovascular businesses and agreed to share the drug-eluting technology it acquired from Guidant with Boston Scientific. See Note B- Guidant Acquisition and Abbott Transaction for further details regarding the transaction.
Certain prior year amounts have been reclassified to conform to the current year presentation. See Note J - Segment Reporting for further details.
NOTE B - GUIDANT ACQUISITION AND ABBOTT TRANSACTION
Guidant Acquisition
On April 21, 2006, the Company acquired 100 percent of the fully-diluted equity of Guidant. Guidant is a world leader in the treatment of cardiac and vascular disease. This acquisition enables the Company to become a major provider in the more than $9 billion global Cardiac Rhythm Management (CRM) business, significantly diversifying its revenue stream across multiple businesses and enhancing its overall competitive position and growth potential.
The aggregate purchase price of $28.4 billion included: $14.5 billion in cash; 577 million shares of the Company’s common stock at an estimated fair value of $12.5 billion; approximately 40 million of the Company’s fully-vested stock options granted to Guidant employees at an estimated fair value of approximately $450 million; approximately $100 million associated with the buyout of options of certain former Guidant employees; and approximately $800 million of direct acquisition costs, including a $705 million payment made to Johnson & Johnson in connection with the termination of its merger agreement with Guidant. The purchase price net of cash acquired was approximately $21.7 billion. In conjunction with the acquisition, and partially offsetting the purchase price, the Company acquired approximately $6.7 billion of cash, including $4.1 billion in connection with Guidant’s prior sale of its vascular intervention and endovascular solutions businesses to Abbott. The remaining cash relates to cash on hand at the time of closing.
Upon the closing of the acquisition, each share of Guidant common stock (other than shares owned by Guidant, Galaxy Merger Sub and Boston Scientific) was converted into (i) $42.00 in cash and (ii) 1.6799 shares of Boston Scientific common stock. In addition, Guidant shareholders received payments of $0.0132 in cash per share for each day beginning on April 1 through the closing date of April 21,
representing an additional $0.28 per share.
The Company will continue to incur integration and restructuring costs as it integrates certain operations of Guidant. In addition, the Company will continue to examine all of its operations in order to identify cost improvement measures that will better align operating expenses with expected revenue levels and reallocate resources to support growth initiatives. No assurances can be made that the Company will realize efficiencies related to the integration of the businesses sufficient to offset incremental transaction, merger-related, integration and restructuring costs over time.
To finance the cash portion of the Guidant acquisition, the Company borrowed $6.6 billion consisting of a $5.0 billion five-year term loan and a $700 million 364-day interim credit facility loan from a syndicate of commercial and investment banks, as well as a $900 million loan from Abbott Laboratories. See Note H-Borrowings and Credit Arrangements for further details regarding the debt issued to finance the cash portion of the Guidant acquisition.
During the first quarter of 2006, Boston Scientific increased its authorized common stock from 1,200,000,000 shares to 2,000,000,000 shares in anticipation of its acquisition of Guidant.
Boston Scientific’s offer to acquire Guidant was made after the execution of a merger agreement among Guidant, Johnson & Johnson and Shelby Merger Sub, Inc. On January 25, 2006, Guidant terminated the Johnson & Johnson merger agreement and, in connection with the termination, Guidant paid Johnson & Johnson a termination fee of $705 million. Boston Scientific then reimbursed Guidant for the full amount of the termination fee paid to Johnson & Johnson.
Abbott Transaction
On April 21, 2006, before the closing of the Boston Scientific-Guidant transaction, Abbott acquired Guidant’s vascular intervention and endovascular solutions businesses for:
| · | an initial payment of $4.1 billion in cash at the Abbott transaction closing; |
| · | a milestone payment of $250 million upon receipt of an approval from the U.S. FDA within ten years after the Abbott transaction closing to market and sell an everolimus-eluting stent in the U.S.; and |
| · | a milestone payment of $250 million upon receipt of an approval from the Japanese Ministry of Health, Labour and Welfare within ten years after the Abbott transaction closing to market and sell an everolimus-eluting stent in Japan. |
In addition, Abbott loaned Boston Scientific $900 million on a subordinated basis. See Note H-Borrowings and Credit Arrangements for further details regarding the Abbott loan.
Further, Abbott purchased from Boston Scientific approximately 65 million shares of the Company’s common stock for $1.4 billion, or $21.66 per share. Abbott agreed not to sell any of these shares of Boston Scientific common stock for six months following the Abbott transaction closing unless the average price per share of Boston Scientific common stock over any consecutive 20 day trading period during that six month period exceeds $30.00. In addition, during the 18-month period following the Abbott transaction closing, Abbott will not, in any one-month period, sell more than 8.33 percent of these shares of Boston Scientific common stock. Abbott must sell all of these shares of Boston Scientific common stock no later than 30 months following April 21, 2006. Abbott must apply a portion of the net proceeds from its sale of these shares of Boston Scientific common stock in excess of specified amounts,
if any, to reduce the principal amount of the loan from Abbott to Boston Scientific (sharing of proceeds feature).
The Company determined the fair value of the sharing of proceeds feature of the Abbott stock purchase as of April 21, 2006 to be $102 million and recorded this amount as an asset received in connection with the sale of the Guidant vascular intervention and endovascular solutions business to Abbott. The Company re-values this instrument each reporting period, and recorded an expense of $13 million during the third quarter and $100 million for the first nine months of 2006 to reflect the change in fair value. The Company will record fair value adjustments on this feature until all of the underlying shares are sold by Abbott. As of September 30, 2006, the Company has an asset of $2 million remaining, which reflects the estimated fair value of this feature as of September 30, 2006.
Approximately 18 months following the Abbott transaction closing, Boston Scientific will issue to Abbott additional shares of Boston Scientific common stock having an aggregate value of up to $60 million (based on the average closing price of Boston Scientific common stock during the 20 consecutive trading day period ending five trading days prior to the date of issuance of those shares) to reimburse Abbott for the cost of borrowing $1.4 billion to purchase the shares of Boston Scientific common stock. The Company has recorded the $60 million of stock to be issued as a liability assumed in connection with the sale of Guidant’s vascular intervention and endovascular solutions businesses to Abbott.
Prior to the Abbott transaction closing, Boston Scientific and Abbott entered into transition services agreements under which (1) Boston Scientific will provide or make available to the Guidant vascular intervention and endovascular solutions businesses acquired by Abbott those services, rights, properties and assets of Guidant that were not included in the assets purchased by Abbott and that are reasonably required by Abbott to enable them to conduct the Guidant vascular intervention and endovascular solutions businesses substantially as conducted at the time of the Abbott transaction closing; and (2) Abbott will provide or make available to Boston Scientific those services, rights, properties and assets reasonably required by Boston Scientific to enable it to conduct the business conducted by Guidant, other than the Guidant vascular intervention and endovascular solutions businesses, in substantially the same manner as conducted as of the Abbott transaction closing, to the extent those services, rights, properties and assets were included in the assets purchased by Abbott. These transition services will be made available at prices based on costs incurred in performing the services.
Purchase Price
The Company has accounted for the acquisition of Guidant as a purchase under U.S. generally accepted accounting principles. Under the purchase method of accounting, the assets and liabilities of Guidant were recorded as of the acquisition date, at their respective fair values, and consolidated with those of Boston Scientific. The purchase price is based upon preliminary estimates of the fair value of assets acquired and liabilities assumed. The Company is in the process of gathering information to finalize its valuation of certain assets and liabilities, primarily the determination of any amounts that may be paid as a result of assumed product liability claims and potential restructuring activities. The purchase price allocation will be finalized once the Company has all the necessary information to complete its estimate, but generally no later than one year from the acquisition date. The preparation of the valuation required the use of significant assumptions and estimates. Critical estimates included, but were not limited to, future expected cash flows and the applicable discount rates as of the date of the acquisition. These estimates were based on assumptions that the Company believed to be reasonable as of the date of the acquisition. However, actual results may differ from these estimates.
The preliminary purchase price is as follows (amounts in millions):
Consideration to Guidant | | | |
| Cash portion of consideration | | $ | 14,527 | |
| Fair value of Boston Scientific common stock | | | 12,514 | |
| Fair value of Boston Scientific options exchanged for Guidant stock options | | | 450 | |
| Buyout of options for certain former employees | | | 97 | |
| | | | 27,588 | |
Other acquisition-related costs | | | | |
| Johnson & Johnson termination fee | | | 705 | |
| Other estimated acquisition-related costs | | | 65 | |
| | | $ | 28,358 | |
The fair value of the Boston Scientific stock options exchanged for Guidant options was included in the purchase price due to the fact that the options were fully vested. The fair value of these options was estimated using a Black-Scholes option pricing model. The fair value of the stock options was estimated assuming no expected dividends and the following weighted-average assumptions:
| Expected life | | 2.4 years |
| Expected volatility | | 30 percent |
| Risk free interest rate | | 4.92 percent |
| Stock price on date of grant | | $22.49 |
| Weighted-average exercise price | | $13.11 |
Preliminary Purchase Price Allocation
The following chart summarizes the Guidant preliminary purchase price allocation:
in millions | | | |
| Cash | | $ | 6,730 | |
| Intangible assets subject to amortization | | | 7,719 | |
| Goodwill | | | 12,214 | |
| Other assets | | | 2,550 | |
| Purchased research and development | | | 4,169 | |
| Current liabilities | | | (1,282 | |
| Deferred tax liabilities | | | (3,063 | ) |
| Other long-term liabilities | | | (679 | ) |
| | | $ | 28,358 | |
The deferred tax liabilities primarily relate to the tax impact of future amortization associated with the identified intangible assets acquired, which are not deductible for tax purposes.
The excess of the purchase price over the fair value of net tangible assets acquired was allocated to specific intangible asset categories as follows:
in millions | | Amount Assigned | | Weighted Average Amortization Period | | Risk-Adjusted Discount Rates used in Purchase Price Allocation | |
| Amortizable intangible assets | | | | | | | |
| Technology - core | | $ | 6,142 | | | 25 years | | | 10%-16% | |
| Technology - developed | | | 885 | | | 6 years | | | 10% | |
| Customer relationships | | | 688 | | | 15 years | | | 10%-13% | |
| Other | | | 4 | | | 10 years | | | 10% | |
| | | $ | 7,719 | | | 22 years | | | | |
| | | | | | | | | | | |
| Goodwill | | $ | 12,214 | | | | | | | |
| Purchased research and development | | | 4,169 | | | | | | 13%-17% | |
The Company believes that the estimated intangible assets and purchased research and development so determined represent the fair value at the date of acquisition and do not exceed the amount a third party would pay for the assets. The Company used the income approach to determine the fair value of the amortizable intangible assets and purchased research and development. The Company valued and accounted for the identified intangible assets and purchased research and development from its 2006 acquisition of Guidant in accordance with its policy described in the Critical Accounting Policies section of its 2005 Annual Report on Form 10-K.
Various factors contributed to the establishment of goodwill, including: the strategic benefit of entering the CRM market; the value of Guidant’s highly trained assembled work force as of the acquisition date; the expected revenue growth over time that is attributable to expanded indications and increased market penetration from future products and customers; the incremental value to the Company’s existing interventional cardiology franchise from having two drug-eluting stent platforms; and the synergies expected to result from combining infrastructures, reducing combined operational spend and program reprioritization. The goodwill acquired in the Guidant acquisition is not deductible for tax purposes.
The core technology consists of technical processes, intellectual property, and institutional understanding with respect to products or processes that have been developed by Guidant and that will be leveraged in future products or processes. Core technology represents know-how, patented and unpatented technology, testing methodologies and hardware that will be carried forward from one product generation to the next. Over 90 percent of the value assigned to core technology is associated with Guidant’s CRM products and includes battery and capacitor technology, lead technology, software algorithms, and interfacing for shocking and pacing.
The developed technology acquired from Guidant represents the value associated with currently marketed products that have received FDA approval as of the acquisition date. Guidant’s currently marketed products include:
| · | Implantable defibrillator systems used to detect and treat abnormally fast heart rhythms (tachycardia) that could result in sudden cardiac death, including implantable cardiac resynchronization therapy defibrillator systems used to treat heart failure; |
| · | Implantable pacemaker systems used to manage slow or irregular heart rhythms (bradycardia), including implantable cardiac resynchronization therapy pacemaker systems used to treat heart failure; and |
| · | Cardiac surgery systems used to perform cardiac surgical ablation, endoscopic vein harvesting and clampless beating-heart bypass surgery. |
The currently marketed products primarily include products within the Insignia, Prizm, Vitality, Contak TR and Contak Renewal CRM product families, the VASOVIEW® Endoscopic Vein Harvesting System, FLEX Microwave Systems and the ACROBAT™ System.
Customer relationships represent the estimated fair value of the non-contractual customer relationships Guidant had with physician customers as of the acquisition date. The primary physician users of Guidant’s largest selling products include electrophysiologists, implanting cardiologists, cardiovascular surgeons, and cardiac surgeons. These relationships were valued separately from goodwill as Guidant (i) has information about and has regular contact with its physician customers and (ii) the physician customers have the ability to make direct contact with Guidant. The Company used the income approach to estimate the fair value of customer relationships as of the acquisition date.
Purchased Research and Development
The $4,169 million of purchased research and development associated with the Guidant acquisition primarily consists of approximately $3,260 million for acquired CRM-related products and approximately $540 million for drug-eluting stent technology shared with Abbott. The purchased research and development value associated with the Guidant acquisition also includes approximately $369 million that represents the estimated fair value of the two potential milestone payments of up to $500 million that may be received from Abbott upon receipt of certain regulatory approvals by the vascular intervention and endovascular solutions businesses it acquired from Guidant. The Company recorded the amounts as purchased research and development at the acquisition date because the receipt of the payments is dependent on future research and development activity and regulatory approvals, and the asset has no alternative future use as of the acquisition date. The milestone payments, if received, will be recognized as a gain in the Company’s financial statements at the time of receipt.
The most significant purchased research and development projects acquired from Guidant include the Frontier® platform for next generation CRM products and rights to the everolimus-eluting stent technology that the Company shares with Abbott. Frontier represents Guidant’s next generation CRM pulse generator platform that will incorporate new components and software while leveraging certain existing intellectual property, technology, manufacturing know-how and institutional knowledge of Guidant. This platform will be leveraged across all CRM product lines to treat electrical dysfunction in the heart. For purposes of valuing the acquired purchased research development, the Company estimated total costs to complete the Frontier platform of approximately $250 million. The $540 million attributable to the everolimus-eluting stent technology represents the estimated fair value of the rights to Guidant’s everolimus-based drug eluting stent technology the Company shares with Abbott as part of the Abbott Transaction. The Company estimated approximately $150 million of costs to complete the everolimus-eluting stent technology projects.
For the in-process projects the Company acquired in connection with the acquisition of Guidant, it used risk-adjusted discount rates that ranged from 13 percent to 17 percent to discount the projected cash flows. The Company believes that the estimated purchased research and development amounts so determined represent the fair value at the date of acquisition and do not exceed the amount a third party would pay for the projects. The Company valued and accounted for the purchased research and development from its 2006 acquisition of Guidant in accordance with its policy described in the Critical Accounting Policies section of the Company's 2005 Annual Report filed on Form 10-K.
Pro Forma Results of Operations
The Company’s condensed consolidated financial statements include Guidant’s operating results from the date of acquisition, April 21, 2006. The following unaudited pro forma information presents a summary of consolidated results of operations of the Company and Guidant as if the acquisition, the Abbott transaction and the financing for the acquisition, had occurred at the beginning of each of the periods presented. The historical consolidated financial information has been adjusted to give effect to pro forma events that are (i) directly attributable to the merger and (ii) factually supportable. The unaudited pro
forma condensed consolidated financial information is presented for informational purposes only. The pro forma information is not necessarily indicative of what the financial position or results of operations actually would have been had the merger, the sale of the Guidant vascular intervention and endovascular solutions businesses to Abbott and the financing transactions with Abbott and other lenders been completed at the dates indicated. In addition, the unaudited pro forma condensed consolidated financial information does not purport to project the future financial position or operating results of the combined Company after completion of the acquisition. Pro forma adjustments are tax-effected at the Company’s effective tax rate.
| | | Three Months Ended | | Nine Months Ended | |
| | | September 30, | | September 30, | |
in millions, except per share data | | 2006 | | 2005 | | 2006 | | 2005 | |
| | | | | | | | | | |
| Net sales | | | N/A* | | $ | 2,039 | | $ | 6,468 | | $ | 6,646 | |
| Net loss | | | N/A* | | | (4,939 | ) | | (4,189 | ) | | (4,522 | ) |
| | | | | | | | | | | | | | |
| Net loss per share - basic | | | N/A* | | $ | (3.38 | ) | $ | (2.85 | ) | $ | (3.08 | ) |
| Net loss per share - assuming dilution | | | N/A* | | $ | (3.38 | ) | $ | (2.85 | ) | $ | (3.08 | ) |
* Not applicable due to the fact that Guidant operations and the impact of financing transactions are included in the Company’s results for the full period.
The pro forma net loss for the third quarter of 2005 includes $120 million for the amortization of intangible assets obtained in conjunction with the Guidant acquisition. The pro forma net loss for the first nine months of 2006 and 2005 includes $360 million for the amortization of intangible assets obtained in conjunction with the Guidant acquisition. The unaudited pro forma financial information for each period presented also includes the following non-recurring charges: purchased research and development of $4,169 million obtained as part of the Guidant acquisition; expense associated with the step-up value of acquired inventory sold; a tax charge for the drug-eluting stent license right obtained from Abbott; and the fair value adjustment related to the sharing of proceeds feature of the Abbott stock purchase. In connection with the accounting for the acquisition of Guidant, the Company wrote-up inventory acquired from manufacturing cost to fair value. The Company recorded expense of $94 million during the third quarter of 2006 and $279 million for the first nine months of 2006 for the step-up value of acquired Guidant inventory sold during the period. As of September 30, 2006, the Company had no inventory step-up value remaining in inventory.
NOTE C - STOCK-BASED COMPENSATION
The Company’s Long-Term Incentive Plans provide for the issuance of up to 90 million shares of common stock. Together, the Plans cover officers, directors and employees of and consultants to the Company and provide for the grant of various incentives, including qualified and nonqualified options, deferred stock units, stock grants, share appreciation rights and performance awards. The Company’s Executive Compensation and Human Resources Committee may authorize the issuance of shares of common stock and authorize cash awards under the Plans in recognition of the achievement of long-term performance objectives established by the Committee. Nonqualified options issued to employees generally are granted with an exercise price equal to the market price of the Company’s stock at the date of grant, generally vest over a four year service period, and have a 10-year contractual term. Non-vested stock awards (awards other than options) issued to employees generally are granted with an exercise price of zero and generally vest over a five year service period. The Company generally issues shares for option exercises and non-vested stock from its treasury shares, if available.
During 2004, the FASB issued Statement No. 123(R), Share-Based Payment, which is a revision of
Statement No. 123, Accounting for Stock-Based Compensation. Statement No. 123(R) supersedes APB Opinion No. 25, Accounting for Stock Issued to Employees, and amends Statement No. 95, Statement of Cash Flows. In general, Statement No. 123(R) contains similar accounting concepts as those described in Statement No. 123. However, Statement No. 123(R) requires all share-based payments to employees, including grants of employee stock options, to be recognized in the income statement based on their fair values. Pro forma disclosure is no longer an alternative.
The Company adopted Statement No. 123(R) on January 1, 2006 using the “modified-prospective method,” which is a method in which compensation cost is recognized beginning with the effective date (i) based on the requirements of Statement No. 123(R) for all share-based payments granted after the effective date and (ii) based on the requirements of Statement No. 123 for all awards granted to employees prior to the effective date of Statement No. 123(R) that remain unvested on the effective date. In accordance with this method of adoption, prior period results of operations and financial position have not been restated to reflect the impact of stock-based compensation. Prior to the adoption of Statement No. 123(R), the Company accounted for options using the intrinsic value method under the guidance of APB Opinion No. 25, and provided pro forma disclosure as allowed by Statement No. 123.
The following presents the statement of operations impact of stock-based compensation expense recognized for the three months and nine months ended September 30, 2006 for options and restricted stock awards:
| | | Three months ended | | Nine months ended | |
in millions | | September 30, 2006 | | September 30, 2006 | |
| Cost of products sold | | $ | 4 | | $ | 12 | |
| Selling, general and administrative expenses | | | 16 | | | 59 | |
| Research and development expenses | | | 6 | | | 18 | |
| Income/(loss) before income taxes | | | 26 | | | 89 | |
| Income tax (benefit)/expense | | | 6 | | | 24 | |
| Net income/(loss) | | $ | 20 | | $ | 65 | |
| | | | | | | | |
| Net income/(loss) per common share - basic | | $ | 0.01 | | $ | 0.05 | |
| Net income/(loss) per common share - assuming dilution | | $ | 0.01 | | $ | 0.05 | |
In the third quarter of 2006, as a result of adopting Statement No. 123(R), the Company’s income before income taxes was $18 million lower and its net income was $14 million lower than if it had continued to account for share-based compensation under APB Opinion No. 25. Basic and diluted income per share was $0.01 lower than if the Company had continued to account for share-based compensation under APB Opinion No. 25.
In the first nine months of 2006, as a result of adopting Statement No. 123(R), the Company’s loss before income taxes was $54 million higher and its net loss was $38 million higher than if it had continued to account for share-based compensation under APB Opinion No. 25. Basic and diluted loss per share was $0.03 higher than if the Company had continued to account for share-based compensation under APB Opinion No. 25.
In 2005, if the Company had elected to recognize compensation expense for the granting of options under stock option plans based on the fair values at the grant date consistent with the methodology prescribed by Statement No. 123, net (loss)/income and net (loss)/income per share would have been reported as the following pro forma amounts:
| | | Three Months Ended | | Nine Months Ended | |
in millions, except per share data | | September 30, 2005 | | September 30, 2005 | |
| Net (loss)/income, as reported | | $ | (269 | ) | $ | 294 | |
| Add: Stock-based employee compensation expense included in net (loss)/income, net of related tax effects | | | 4 | | | 9 | |
| Less: Total stock-based employee compensation expense determined under fair value based method for all awards, net of related tax effects | | | (19 | ) | | (53 | ) |
Pro forma net (loss)/income | | $ | (284 | ) | $ | 250 | |
| Net (loss)/income per common share | | | | | | | |
| Basic | | | | | | | |
| Reported | | $ | (0.33 | ) | $ | 0.36 | |
| Pro forma | | $ | (0.35 | ) | $ | 0.30 | |
| Assuming dilution | | | | | | | |
| Reported | | $ | (0.33 | ) | $ | 0.35 | |
| Pro forma | | $ | (0.35 | ) | $ | 0.30 | |
Stock Options
Option Valuation
The Company uses the Black-Scholes option pricing model to calculate the grant-date fair value of its stock options. In conjunction with the Guidant acquisition, the Company converted certain outstanding Guidant options into approximately 40 million fully-vested Boston Scientific options. See Note B- Guidant Acquisition and Abbott Transaction for further details regarding the fair value and valuation assumptions related to those awards. The fair value for all other options granted during the three and nine month periods ended September 30, 2006 and 2005 was calculated using the following estimated weighted average assumptions:
| | | Three Months Ended | | Nine Months Ended | |
| | | September 30, | | September 30, | |
| | | 2006 | | 2005 | | 2006 | | 2005 | |
| Options granted (in thousands) | | | 383 | | | 4,032 | | | 4,470 | | | 7,737 | |
| Weighted-average exercise price | | $ | 16.34 | | $ | 26.93 | | $ | 22.68 | | $ | 30.28 | |
| Weighted-average grant-date fair value | | $ | 5.81 | | $ | 11.59 | | $ | 7.88 | | $ | 12.29 | |
| | | | | | | | | | | | | | |
Black-Scholes Assumptions | | | | | | | | | | | | | |
| Expected volatility | | | 30% | | | 36% | | | 30% | | | 37% | |
| Expected term (in years) | | | 5 | | | 5 | | | 5 | | | 5 | |
| Risk-free interest rate | | | 4.69%-5.09% | | | 4.02%-4.11% | | | 4.26%-5.18% | | | 3.37%-4.11% | |
Expected Volatility
The Company has considered a number of factors in estimating volatility. For options granted prior to 2006, the Company used its historical volatility as a basis to estimate expected volatility in its valuation of stock options. The Company changed its method of estimating volatility upon the adoption of Statement No. 123(R). The Company now considers historical volatility, trends in volatility within the
Company’s industry/peer group, and implied volatility.
Expected Term
The Company estimates the expected term of its options using historical exercise and forfeiture data. The Company believes that this historical data is currently the best estimate of the expected term of its new option grants.
Risk-Free Interest Rate
The Company uses yield rates on U.S. Treasury securities for a period approximating the expected term of the award to estimate the risk-free interest rate in its grant-date fair value assessment.
Expected Dividend Yield
The Company has not historically paid cash dividends to its shareholders. The Company currently does not intend to pay dividends, and intends to retain all of its earnings to repay indebtedness and invest in the continued growth of its business. Therefore, the Company has assumed an expected dividend yield of zero in its grant-date fair value assessment.
Information related to stock options at September 30, 2006 under stock incentive plans is as follows:
| | | Options (in thousands) | | Weighted Average Exercise Price | | Weighted Average Remaining Contractual Life (in years) | | Aggregate Intrinsic Value (in millions) | |
| Outstanding at January 1, 2006 | | | 50,285 | | $ | 20 | | | | | | | |
| Granted | | | 4,470 | | | 23 | | | | | | | |
| Exercised | | | (9,212 | ) | | 11 | | | | | | | |
| Cancelled / forfeited | | | (1,151 | ) | | 24 | | | | | | | |
| Guidant converted options | | | 39,649 | | | 13 | | | | | | | |
| Outstanding at September 30, 2006 | | | 84,041 | | $ | 17 | | | 5 | | $ | 137 | |
| Exercisable at September 30, 2006 | | | 67,110 | | $ | 15 | | | 4 | | $ | 136 | |
| Expected to vest as of September 30, 2006 | | | 81,650 | | $ | 18 | | | 5 | | $ | 136 | |
The total intrinsic value of options exercised was $7 million for the third quarter of 2006 and $13 million for the same period in prior year. The total intrinsic value of options exercised was $94 million for the first nine months of 2006 and $77 million for the same period in the prior year.
Non-Vested Stock
Award Valuation
The Company values restricted stock awards and deferred stock units based on the closing trading value of the Company’s shares on the date of grant.
Award Activity
Information related to non-vested stock awards at September 30, 2006 is as follows:
| | | Non-Vested Stock Award Units (in thousands) | | Weighted Average Grant-Date Fair Value | |
| Balance at January 1, 2006 | | | 3,834 | | $ | 30 | |
| Granted | | | 6,145 | | | 24 | |
| Vested | | | (40 | ) | | 32 | |
| Forfeited | | | (355 | ) | | 29 | |
| Balance at September 30, 2006 | | | 9,584 | | $ | 26 | |
CEO Award
During the first quarter of 2006, the Company granted a special market-based award of 2,000,000 deferred stock units to its chief executive officer. The attainment of this award is based on the individual’s continued employment and the Company’s stock reaching certain specified prices as of December 31, 2008 and December 31, 2009. Based on the estimated fair value determined as of the grant date, the Company estimates that the award will result in approximately $30 million of expense, which will be recognized in the Company’s statement of operations using an accelerated attribution method through 2009.
Expense Attribution
The Company generally recognizes compensation expense for its stock awards issued subsequent to the adoption of Statement No. 123(R) using a straight-line method over the substantive vesting period. Prior to the adoption of Statement No. 123(R), the Company allocated the pro forma compensation expense for stock option awards over the vesting period using an accelerated attribution method. The Company will continue to amortize compensation expense related to stock option awards granted prior to the adoption of Statement No. 123(R) using an accelerated attribution method. Prior to the adoption of Statement No. 123(R), the Company recognized compensation expense for non-vested stock awards over the vesting period using a straight-line method. The Company will continue to amortize compensation expense related to non-vested stock awards granted prior to the adoption of Statement No. 123(R) using a straight-line method.
The amount of stock-based compensation recognized is based on the value of the portion of awards that are ultimately expected to vest. Statement No. 123(R) requires forfeitures to be estimated at the time of grant and revised, if necessary, in subsequent periods if actual forfeitures differ from those estimates. The term “forfeitures” is distinct from “cancellations” or “expirations” and represents only the unvested portion of the surrendered option. The Company has applied, based on an analysis of its historical forfeitures, an annual forfeiture rate of 8 percent to all unvested stock awards as of September 30, 2006, which represents the portion that is expected to be forfeited each year over the vesting period. This analysis will be re-evaluated periodically and the forfeiture rate will be adjusted as necessary. Ultimately, the actual expense recognized over the vesting period will only be for those shares that vest.
Most of the Company’s stock awards provide for immediate vesting upon retirement, death or disability of the participant. The Company has traditionally accounted for the pro forma compensation expense related to stock-based awards made to retirement eligible individuals using the stated vesting period of the award.
This approach results in compensation expense being recognized over the vesting period except in the instance of the participant’s actual retirement. Statement No. 123(R) clarified the accounting for stock-based awards made to retirement eligible individuals, which explicitly provides that the vesting period for a grant made to a retirement eligible employee is considered non-substantive and should be ignored when determining the period over which the award should be expensed. Upon adoption of Statement No. 123(R), the Company is required to expense stock-based awards over the period between grant date and retirement eligibility or immediately if the employee is retirement eligible at the date of grant. If the Company had historically accounted for stock-based awards made to retirement eligible individuals under these requirements, the pro forma expense disclosed in the table below for the three and nine month periods ended September 30, 2005 would not have been materially impacted.
Unrecognized Compensation Cost
Under the provisions of Statement No. 123(R), the Company expects to recognize the following future expense for awards granted as of September 30, 2006:
| | | Unrecognized Compensation Cost (in millions)* | | Weighted Average Remaining Vesting Period (in years) | |
| Stock options | | $ | 71 | | | | |
| Non-vested stock awards | | | 150 | | | | |
| | | $ | 221 | | | 3.4 | |
*Amounts presented represent compensation cost, net of estimated forfeitures.
Tax Impact of Stock-Based Compensation
Prior to the adoption of Statement No. 123(R), the benefit of tax deductions in excess of recognized share-based compensation expense were reported on the consolidated statement of cash flows as operating cash flows. Under Statement No. 123(R), such excess tax benefits are reported as financing cash flows. Although total cash flows under Statement No. 123(R) remain unchanged from what would have been reported under prior accounting standards, net operating cash flows are reduced and net financing cash flows are increased due to the adoption of Statement No. 123(R). There were excess tax benefits of $1 million for the third quarter of 2006 and $6 million for the first nine months of 2006, which are classified as financing cash flows. There were excess tax benefits of $4 million for the third quarter of 2005 and $26 million for the first nine months of 2005, which are classified as operating cash flows.
Global Employee Stock Ownership Plan (GESOP)
Under the GESOP, each eligible employee is granted, at the beginning of each period designated by the Company’s Executive Compensation and Human Resources Committee as an offering period, an option to purchase shares of the Company’s common stock equal to not more than 10 percent of the employee’s eligible compensation or the statutory limit under the U.S. Internal Revenue Code. These awards have a six month offering period. Such options may be exercised generally only to the extent of accumulated payroll deductions at the end of the offering period, at a purchase price equal to 85 percent of the fair market value of the Company’s common stock at the beginning or end of each offering period, whichever is less.
In 2006, the Company’s stockholders approved and adopted a new global employee stock purchase plan that provides for the granting of options to purchase up to 20 million shares of the Company’s common stock to all eligible employees. The terms and conditions of the 2006 GESOP are substantially similar to the previous GESOP, which expires by its terms in 2007.
The Company uses the Black-Scholes option pricing model to calculate the grant-date fair value of shares issued under the GESOP. The Company recognizes expense related to shares purchased through the GESOP ratably over the offering period. During the first nine months of 2006, the Company recognized $8 million in expense associated with its GESOP.
NOTE D - COMPREHENSIVE INCOME/(LOSS)
The following table provides a summary of the Company’s comprehensive income/(loss):
| | | Three Months Ended | | Nine Months ended | |
| | | September 30, | | September 30, | |
in millions | | 2006 | | 2005 | | 2006 | | 2005 | |
| Net income/(loss) | | $ | 76 | | $ | (269 | ) | $ | (3,854 | ) | $ | 294 | |
| Foreign currency translation adjustment | | | 5 | | | 3 | | | 51 | | | (36 | ) |
| Net change in derivative financial instruments | | | (4 | ) | | 10 | | | (24 | ) | | 97 | |
| Net change in equity investments | | | (3 | ) | | (30 | ) | | (23 | ) | | 16 | |
Comprehensive income/(loss) | | $ | 74 | | $ | (286 | ) | $ | (3,850 | ) | $ | 371 | |
NOTE E - EARNINGS PER SHARE
The following table sets forth the computations of basic and diluted earnings per share:
| | | Three Months Ended | | Nine Months Ended | |
| | | September 30, | | September 30, | |
in millions, except per share data | | 2006 | | 2005 | | 2006 | | 2005 | |
Basic | | | | | | | | | |
| Net income/(loss) | | $ | 76 | | $ | (269 | ) | $ | (3,854 | ) | $ | 294 | |
| Weighted average shares outstanding | | | 1,472.8 | | | 819.9 | | | 1,207.0 | | | 827.8 | |
Net income/(loss) per common share | | $ | 0.05 | | $ | (0.33 | ) | $ | (3.19 | ) | $ | 0.36 | |
| | | | | | | | | | | | | | |
Assuming dilution | | | | | | | | | | | | | |
| Net income/(loss) | | $ | 76 | | $ | (269 | ) | $ | (3,854 | ) | $ | 294 | |
| Weighted average shares outstanding | | | 1,472.8 | | | 819.9 | | | 1,207.0 | | | 827.8 | |
| Net effect of common stock equivalents | | | 13.9 | | | | | | | | | 12.5 | |
| Total | | | 1,486.7 | | | 819.9 | | | 1,207.0 | | | 840.3 | |
Net income/(loss) per common share | | $ | 0.05 | | $ | (0.33 | ) | $ | (3.19 | ) | $ | 0.35 | |
The calculation of net income/(loss) per common share, assuming dilution, above excludes the net effect of common stock equivalents of 10.9 million for the third quarter of 2005 and 14.2 million for the first nine months of 2006 due to the Company being in a net loss position.
The net effect of common stock equivalents excludes the impact of 39.0 million stock options for the third quarter of 2006, 11.4 million for the third quarter of 2005, 27.1 million for the first nine months of 2006 and 11.2 million for the first nine months of 2005 due to the exercise prices of these stock options being greater than the average fair market value of the Company’s common stock during the period.
NOTE F - CONTINGENT CONSIDERATION
Certain of the Company’s business combinations involve the payment of contingent consideration. Certain of these payments are determined based on multiples of the acquired company’s revenue during the earn-out period and, consequently, the Company cannot currently determine the total payments that will have to be made. However, the Company has developed an estimate of the maximum potential contingent consideration for each of its acquisitions with an outstanding earn-out obligation. At September 30, 2006, the estimated maximum potential amount of future contingent consideration (undiscounted) that it could be required to make associated with its business combinations is approximately $4 billion, some of which may be payable in the Company’s common stock. The milestones associated with the contingent consideration must be reached in certain future periods through 2014. The estimated cumulative specified revenue level associated with these maximum future contingent payments is approximately $9 billion. There is no potential contingent consideration payable to the former Guidant shareholders.
As of September 30, 2006, the Company had accrued $205 million for acquisition-related payments, primarily associated with Advanced Bionics Corporation and Smart Therapeutics, Inc.
NOTE G - OTHER BALANCE SHEET INFORMATION
Components of selected captions in the condensed consolidated interim balance sheets are as follows:
| | | September 30, | | December 31, | |
in millions | | 2006 | | 2005 | |
Trade Accounts Receivable | | | | | |
| Accounts receivable | | $ | 1,557 | | $ | 1,015 | |
| Less: allowances | | | 97 | | | 83 | |
| | | $ | 1,460 | | $ | 932 | |
Inventories | | | | | | | |
| Finished goods | | $ | 439 | | $ | 286 | |
| Work-in-process | | | 176 | | | 64 | |
| Raw materials | | | 144 | | | 68 | |
| | | $ | 759 | | $ | 418 | |
Property, Plant and Equipment | | | | | | | |
| Property, plant and equipment | | $ | 2,622 | | $ | 1,853 | |
| Less: accumulated depreciation | | | 950 | | | 842 | |
| | | $ | 1,672 | | $ | 1,011 | |
Intangible Assets | | | | | | | |
| Intangible assets | | $ | 24,526 | | $ | 4,404 | |
| Less: accumulated amortization | | | 983 | | | 669 | |
| | | $ | 23,543 | | $ | 3,735 | |
Other Long-Term Liabilities | | | | | | | |
| Other accrued taxes | | $ | 910 | | $ | 267 | |
| Other long-term liabilities | | | 463 | | | 42 | |
| | | $ | 1,373 | | $ | 309 | |
Over time, the Company intends to reprioritize its internal research and development project portfolio and its external investment portfolio. This reprioritization may result in the Company’s decision to sell, discontinue, writedown, or otherwise reduce the funding of certain projects, operations, investments or assets. Any proceeds from sales, or any increases in operating cash flows, resulting from subsequent reviews may be used to reduce debt incurred to fund the Guidant merger, or may be re-invested in other research and development projects or other operational initiatives.
During the first nine months of 2006, the Company incurred impairment charges of $105 million attributable to investment writedowns to reflect an other-than-temporary decline in fair value of certain strategic alliances. During the first quarter of 2006, the Company incurred impairment charges of $38 million associated with investment writedowns due primarily to the termination of a gene therapy trial being conducted by one of the Company’s portfolio companies. This trial was suspended in March 2006 and then patient enrollment was terminated in April 2006. During the second quarter of 2006, the Company recorded $67 million of charges attributable to investment writedowns to reflect an other-than-temporary decline in fair value of certain strategic alliances. The most significant writedown related to one of the Company’s vascular sealing portfolio companies due to continued delays in its technology development and the resulting deterioration in its financial condition.
During the second quarter of 2006, management cancelled the abdominal aortic aneurysm (AAA) stent-graft program obtained in conjunction with the acquisition of TriVascular, Inc. The program cancellation was principally due to forecasted increases in time and costs to complete the development of the stent-graft and to receive regulatory approval. The cancellation of the AAA program resulted in the shut down of the Company’s facility in Santa Rosa, California and the displacement of approximately 300 employees. The shut down activities were substantially completed during the third quarter of 2006. During the second quarter of 2006, the Company recorded a charge to research and development expenses of approximately $20 million primarily associated with writedowns of fixed assets and a charge to research and development expenses of approximately $10 million associated with severance and related costs incurred in connection with the cancellation of the AAA program. In addition, the Company recorded an impairment charge related to the remaining TriVascular intangible assets and reversed its accrual for contingent payments recorded in the initial purchase accounting. The effect of the writeoff of these assets and liabilities was a $23 million charge to amortization expense and a $67 million credit to purchased research and development during the second quarter of 2006.
During the third quarter of 2006, the Company recorded a $31 million CRM technology offering charge. In October 2006, the FDA approved the Company’s LATITUDE® Patient Management System to be used for remote moninoring with its implantable cardioverter defibrillator systems and cardiac resynchronization defibrillators. The Company is in the process of making this technology available to most of its existing CRM patients without additional charge.
NOTE H - BORROWINGS AND CREDIT ARRANGEMENTS
At September 30, 2006, the Company had outstanding borrowings of $8,898 million at a weighted average interest rate of 6.13 percent as compared to outstanding borrowings of $2,020 million at a weighted average interest rate of 4.80 percent at December 31, 2005. During the first nine months of 2006, the Company received net proceeds from borrowings of $6,888 million, which it primarily used to finance the cash portion of the Guidant acquisition.
The debt maturity schedule for the Company’s term loan, Abbott loan and senior notes, as of September 30, 2006, is as follows:
in millions | | 2008 | | 2009 | | 2010 | | Thereafter | | Total* | |
| Term Loan | | $ | 650 | | $ | 650 | | $ | 1,700 | | $ | 2,000 | | $ | 5,000 | |
| Abbott Loan | | | | | | | | | | | | 900 | | | 900 | |
| Senior Notes | | | | | | | | | | | | 3,050 | | | 3,050 | |
Total | | $ | 650 | | $ | 650 | | $ | 1,700 | | $ | 5,950 | | $ | 8,950 | |
| | | | | | | | | | | | | | | | | |
* Debt balances as reported in the consolidated balance sheets include the mark-to-market effect of the Company’s interest rate swaps and is net of the unamortized investor discount associated with the issuance of senior notes in conjunction with the Company’s various public debt offerings.
The Company expects to use a significant portion of its operating cash flow to reduce its outstanding debt obligations over the next several years. In addition, the Company has the flexibility to sell certain non-strategic assets in order to reduce its outstanding debt.
During 2006, the Company made the following changes in its financing arrangements:
| · | In March 2006, the Company increased its credit and security facility that is secured by its U.S. trade receivables from $100 million to $350 million. During the third quarter of 2006, the Company extended the maturity of this credit and security facility to August 2007. |
| · | In March 2006, the Company repaid its commercial paper borrowings that approximated $149 million as of December 31, 2005. |
| · | In April 2006, to finance the cash portion of the Guidant acquisition, the Company borrowed $6.6 billion consisting of a $5.0 billion five-year term loan and a $700 million 364-day interim credit facility loan from a syndicate of commercial and investment banks, as well as a $900 million subordinated loan from Abbott. |
| · | In April 2006, the Company terminated its existing revolving credit facilities and established a new $2.0 billion five-year revolving credit facility. The Company repaid all $450 million in borrowings outstanding under its prior revolving credit facilities. |
| · | The Company’s term loan, interim credit facility and revolving credit facility bear interest at LIBOR plus an interest margin of 0.725 percent. The interest margin is based on the highest two out of three of the Company’s long-term, senior unsecured, corporate credit ratings from Fitch Ratings, Moody’s Investor Service, Inc. and Standard & Poor’s Rating Services (S&P). Since December 31, 2005, the Company’s credit ratings were downgraded by Fitch (from A to BBB), Moody’s (from A3 to Baa3) and S&P (from A to BBB+). The Company’s credit ratings are investment grade. The term loan is permitted to be prepaid prior to maturity with no penalty or premium. |
| · | The $900 million loan from Abbott bears interest at a fixed 4.00 percent, payable semi-annually. The loan is due on April 21, 2011. The Company has determined that an appropriate fair market interest rate on the loan from Abbott is 5.25 percent per annum. The Company has recorded the loan at a discount of approximately $50 million and will record interest at an imputed rate of 5.25 percent over the term of the loan. The Abbott loan is permitted to be prepaid prior to maturity with no penalty or premium. |
| · | In April 2006, the Company increased the interest rate payable on each of its $400 million 5.50 percent November 2015 Notes and its $350 million 6.25 percent November 2035 Notes by 0.75 percent in connection with its credit ratings being downgraded as a result of the Guidant acquisition. Subsequent upgrades to the Company’s long-term senior, unsecured corporate credit ratings may result in a decrease in the interest rates. The interest rates will be permanently |
| | restored to their original levels if the lowest credit ratings assigned to these senior notes is either A- or A3 or higher. |
| · | In May 2006, the Company repaid and terminated its $700 million 364-day interim credit facility loan. |
| · | In June 2006, under its shelf registration previously filed with the SEC, the Company issued $1.2 billion of publicly registered senior notes to fund general corporate purposes, including taxes payable related to Guidant’s asset sale to Abbott and to repay approximately $350 million in borrowings outstanding under the Company’s credit and security facility. The Company issued $600 million of senior notes due in 2011 (June 2011 Notes) and $600 million of senior notes due in 2016 (June 2016 Notes). The June 2011 Notes bear a semi-annual coupon of 6.00 percent and are redeemable prior to maturity. The June 2016 Notes bear a semi-annual coupon of 6.40 percent and are redeemable prior to maturity. These Notes represent the final portion of the Company’s permanent financing of the Guidant acquisition. |
| · | During the second quarter of 2006, the Company incurred approximately $57 million in fees associated with the financing of the Guidant acquisition. The Company has capitalized these fees as debt issuance costs and will amortize these fees to interest expense over the respective contractual term of the debt instruments. |
The Company’s credit facility and term loan agreements require it to maintain a ratio of debt to pro forma EBITDA, as defined by the respective agreement, of less than or equal to 4.5 to 1.0 through December 31, 2007 and 3.5 to 1.0 thereafter. These agreements also require the Company to maintain a ratio of pro forma EBITDA, as defined by the respective agreement, to interest expense of more than or equal to 3.0 to 1.0. As of September 30, 2006, the Company was in compliance with these debt covenants. The ratio of debt to pro forma EBITDA was 3.5 to 1.0 and the ratio of pro forma EBITDA to interest expense was 7.6 to 1.0. If the Company were to fail to satisfy the covenants in its debt agreements, there is no assurance that the Company’s lender would grant waivers. Failure to obtain any necessary waivers, or to obtain them on reasonable terms, could have a material adverse impact.
NOTE I - COMMITMENTS AND CONTINGENCIES
The medical device market in which the Company primarily participates is largely technology driven. Physician customers, particularly in interventional cardiology, move quickly to new products and new technologies. As a result, intellectual property rights, particularly patents and trade secrets, play a significant role in product development and differentiation. However, intellectual property litigation to defend or create market advantage is inherently complex and unpredictable. Furthermore, appellate courts frequently overturn lower court patent decisions.
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 of individual cases, but also of a series of pending and potentially related and unrelated cases. In addition, although monetary and injunctive relief is typically sought, remedies and restitution are generally not determined until the conclusion of the proceedings and are frequently 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.
Several third parties have asserted that the Company’s current and former stent systems infringe patents
owned or licensed by them. Adverse outcomes in one or more of these proceedings could limit the Company’s ability to sell certain stent products in certain jurisdictions, or reduce its operating margin on the sale of these products. In addition, damage awards related to historical sales could be material. The Company has similarly asserted that stent systems or other products sold by these third parties infringe patents owned or licensed by the Company.
The Company is substantially self-insured with respect to general, product liability and securities litigation claims. In the normal course of business, product liability and securities litigation claims are asserted against the Company. In connection with the acquisition of Guidant, the number of product liability claims and other legal proceedings filed against us, including private securities litigation and shareholder derivative suits, significantly increased. Product liability and securities litigation claims against the Company may be asserted in the future related to events not known to management at the present time. The absence of significant third-party insurance coverage increases the Company’s potential exposure to unanticipated claims or adverse decisions. Product liability claims, product recalls, securities litigation and other litigation in the future, regardless of their outcome, could have a material adverse effect on the Company’s financial position, results of operations or liquidity.
In accordance with FASB Statement No. 5, Accounting for Contingencies, the Company accrues anticipated costs of litigation and loss for product liability claims based on historical experience or to the extent specific losses are probable and estimable. The Company records losses for claims in excess of the limits of purchased insurance in earnings at the time and to the extent they are probable and estimable. If the estimate of a probable loss is a range and no amount within the range is more likely, the Company accrues the minimum amount of the range. The Company’s accrual for legal matters that are probable and estimable was $384 million at September 30, 2006 and $35 million at December 31, 2005. The amounts accrued at September 30, 2006 primarily represent accrued legal defense costs related to assumed Guidant litigation and product liability claims recorded as part of the purchase price. In connection with the acquisition of Guidant, the Company is still assessing certain assumed litigation and product liability claims to determine the amounts, if any, that management believes may be paid as a result of such claims and litigation and, therefore, no material amounts for such related losses have been accrued. Unless otherwise indicated below, a range of loss associated with any individual material legal proceeding cannot be estimated.
In connection with the acquisition by Abbott of Guidant’s vascular intervention and endovascular solutions businesses (the “Businesses”), Abbott assumed all liabilities of Guidant and its affiliates to the extent relating to these Businesses and agreed to indemnify Guidant and its affiliates from any losses arising out of or relating to the Businesses and the assumed liabilities. As a result, certain legal proceedings related to the Businesses to which Guidant and/or its affiliates are a party have been assumed by and are the responsibility of Abbott. These proceedings are not expected to have a material impact on the Company and are not described herein.
Except as disclosed below including litigation and other proceedings assumed by the Company in connection with its acquisition of Guidant, there have been no material developments with regard to any matters of litigation or other proceedings disclosed in the Company’s Form 10-K for the year-end December 31, 2005.
Developments with regard to matters disclosed in the Company’s Form 10-K for the year-end December 31, 2005
Litigation with Johnson & Johnson
On October 22, 1997, Cordis Corporation, a subsidiary of Johnson & Johnson, filed a suit for patent
infringement against the Company and SCIMED Life Systems, Inc., a subsidiary of the Company, alleging that the importation and use of the NIR® stent infringes two patents owned by Cordis. On April 13, 1998, Cordis filed a suit for patent infringement against the Company and SCIMED alleging that the Company’s NIR® stent infringes two additional patents owned by Cordis. The suits were filed in the U.S. District Court for the District of Delaware seeking monetary damages, injunctive relief and that the patents be adjudged valid, enforceable and infringed. A trial on both actions was held in late 2000. A jury found that the NIR® stent does not infringe three Cordis patents, but does infringe one claim of one Cordis patent and awarded damages of approximately $324 million to Cordis. On March 28, 2002, the Court set aside the damage award, but upheld the remainder of the verdict, and held that two of the four patents had been obtained through inequitable conduct in the U.S. Patent and Trademark Office. On May 27, 2005, Cordis filed an appeal on those two patents and an appeal hearing was held on May 3, 2006. The Court of Appeals remanded the case back to the trial court for further briefing and fact-finding by the Court. On May 16, 2002, the Court also set aside the verdict of infringement, requiring a new trial. On March 24, 2005, in a second trial, a jury found that a single claim of the Cordis patent was valid and infringed. The jury determined liability only; any monetary damages will be determined at a later trial. On March 27, 2006, the judge entered judgment in favor of Cordis, and on April 26, 2006, the Company filed an appeal. A hearing on the appeal has not yet been scheduled. Even though it is reasonably possible that the Company may incur a liability associated with this case, the Company does not believe that a loss is probable or estimable. Therefore, the Company has not accrued for any losses associated with this case.
On August 22, 1997, Johnson & Johnson filed a suit for patent infringement against the Company alleging that the sale of the NIR® stent infringes certain Canadian patents owned by Johnson & Johnson. Suit was filed in the federal court of Canada seeking a declaration of infringement, monetary damages and injunctive relief. On December 2, 2004, the Court dismissed the case, finding all patents to be invalid. On December 6, 2004, Johnson & Johnson appealed the Court’s decision, and in May 2006, the Court reinstated the patent. In August 2006, the Company appealed the Court’s decision.
On February 14, 2002, the Company and certain of its subsidiaries filed suit for patent infringement against Johnson & Johnson and Cordis alleging that certain balloon catheters and stent delivery systems sold by Johnson & Johnson and Cordis infringe five U.S. patents owned by the Company. The complaint was filed in the U.S. District Court for the Northern District of California seeking monetary and injunctive relief. On October 15, 2002, Cordis filed a counterclaim alleging that certain balloon catheters and stent delivery systems sold by the Company infringe three U.S. patents owned by Cordis and seeking monetary and injunctive relief. On December 6, 2002, the Company filed an amended complaint alleging that two additional patents owned by the Company are infringed by the Cordis products. A bench trial on interfering patent issues was held December 5, 2005 and on September 19, 2006, the Court found there to be no interference. A trial on infringement has not yet been scheduled.
On March 26, 2002, the Company and Target Therapeutics, Inc., a wholly owned subsidiary of the Company, filed suit for patent infringement against Cordis alleging that certain detachable coil delivery systems and /or pushable coil vascular occlusion systems (coil delivery systems) infringe three U.S. patents, owned by or exclusively licensed to Target. The complaint was filed in the U.S. District Court for the Northern District of California seeking monetary and injunctive relief. A summary judgment hearing was held on April 19, 2004, and on June 25, 2004, the Court granted summary judgment in favor of the Company finding infringement of one of the patents. On February 3, 2005, the Court granted a stay in the proceedings pending reexamination of two of the patents by the U.S. Patent and Trademark Office. On November 14, 2005, the Court denied Cordis’ summary judgment motions with respect to the validity of the patent. Cordis filed a motion for reconsideration and a hearing was held on October 26, 2006. A trial has not yet been scheduled.
On January 13, 2003, Cordis filed suit for patent infringement against the Company and SCIMED alleging the Company’s Express2™ coronary stent infringes a U.S. patent owned by Cordis. The suit was
filed in the U.S. District Court for the District of Delaware seeking monetary and injunctive relief. The Company answered the complaint, denying the allegations and filed a counterclaim alleging that certain Cordis products infringe a patent owned by the Company. On August 4, 2004, the Court granted a Cordis motion to add the Company’s Liberté™ coronary stent and two additional patents to the complaint. On June 21, 2005, a jury found that the Company’s TAXUS® Express2™, Express2, Express™ Biliary, and Liberté stents infringe a Johnson & Johnson patent and that the Liberté stent infringes a second Johnson & Johnson patent. The juries only determined liability; monetary damages will be determined at a later trial. The Company filed a motion to set aside the verdict and enter judgment in its favor as a matter of law. On May 11, 2006, the Company’s motion was denied. With respect to the Company’s counterclaim a jury found on July 1, 2005, that Johnson & Johnson’s Cypher®, Bx Velocity®, Bx Sonic™ and Genesis™ stents infringe the Company’s patent. Johnson & Johnson filed a motion to set aside the verdict and enter judgment in its favor as a matter of law. On May 11, 2006, the Court denied Johnson & Johnson’s motion. Johnson & Johnson has moved for reconsideration of the Court’s decision. Even though it is reasonably possible that the Company may incur a liability associated with this case, the Company does not believe that a loss is probable or estimable. Therefore, the Company has not accrued for any losses associated with this case.
On March 13, 2003, the Company and Boston Scientific Scimed, Inc. filed suit for patent infringement against Johnson & Johnson and Cordis, alleging that its Cypher drug-eluting stent infringes a patent owned by the Company. The suit was filed in the U.S. District Court for the District of Delaware seeking monetary and injunctive relief. Cordis answered the complaint, denying the allegations, and filed a counterclaim against the Company alleging that the patent is not valid and is unenforceable. The Company subsequently filed amended and new complaints in the U.S. District Court for the District of Delaware alleging that the Cypher drug-eluting stent infringes four additional patents owned by the Company. Following the announcement on February 23, 2004 by Guidant Corporation of an agreement with Johnson & Johnson and Cordis to sell the Cypher drug-eluting stent, the Company amended its complaint to include Guidant and certain of its subsidiaries as co-defendants as to certain patents in suit. The Company may replace Abbott for Guidant as a party in the suit as a result of Abbott's purchase of the Businesses from Guidant. In March 2005, the Company filed a stipulated dismissal as to three of the patents. On July 1, 2005, a jury found that Johnson & Johnson’s Cypher drug-eluting stent infringes one of the Company’s patents and upheld the validity of the patent. The jury determined liability only; any monetary damages will be determined at a later trial. Johnson & Johnson filed a motion to set aside the verdict and enter judgment in its favor as a matter of law. On June 15, 2006, the Court denied Johnson & Johnson’s motion. Johnson & Johnson has moved for reconsideration of the Court’s decision. A summary judgment hearing was held on June 14, 2006. A trial has not yet been scheduled.
On December 24, 2003, the Company (through its subsidiary Schneider Europe GmbH) filed suit against the Belgian subsidiaries of Johnson & Johnson, Cordis and Janssen Pharmaceutica alleging that Cordis’ Bx Velocity stent, Bx Sonic® stent, Cypher stent, Cypher Select stent, Aqua T3™ balloon and U-Pass balloon infringe one of the Company’s European patents. The suit was filed in the District Court of Brussels, Belgium seeking preliminary cross-border, injunctive and monetary relief and sought an expedited review of the claims by the Court. A separate suit was filed in the District Court of Brussels, Belgium against nine additional Johnson & Johnson subsidiaries. On February 9, 2004, the Belgium Court linked all Johnson & Johnson entities into a single action. A hearing was held on June 7, 2004, and on June 21, 2004, the Court dismissed the case for failure to satisfy the requirements for expedited review without commenting on the merits of the claims. On August 5, 2004, the Company refiled the suit on the merits against the same Johnson & Johnson subsidiaries in the District Court of Brussels, Belgium seeking cross-border, injunctive and monetary relief for infringement of the same European patent. A hearing is expected to be scheduled during the first quarter of 2007. In December 2005, the Johnson & Johnson subsidiaries filed a nullity action in France and, in January 2006, the same Johnson & Johnson subsidiaries filed nullity actions in Italy and Germany.
On May 12, 2004, the Company filed suit against two of Johnson & Johnson’s Dutch subsidiaries, alleging that Cordis’ Bx Velocity stent, Bx Sonic stent, Cypher stent, Cypher Select stent, and Aqua T3 balloon delivery systems for those stents, and U-Pass angioplasty balloon catheters infringe one of the Company’s European patents. The suit was filed in the District Court of The Hague in The Netherlands seeking injunctive and monetary relief. On June 8, 2005, the Court found the Johnson & Johnson products infringe the Company’s patent and granted injunctive relief. On June 23, 2005, the District Court in Assen, The Netherlands stayed enforcement of the injunction. On October 12, 2005, a Dutch Court of Appeals overturned the Assen court’s ruling and reinstated the injunction against the manufacture, use and sale of the Cordis products in The Netherlands. Damages for Cordis’ infringing acts in The Netherlands will be determined at a later date. Cordis’ appeal of the validity and infringement ruling by The Hague court remains pending. A hearing on this appeal was held on November 2, 2006 and a decision is expected on January 18, 2007.
On September 25, 2006, Johnson & Johnson filed a lawsuit against the Company, Guidant and Abbott in the United States District Court for the Southern District of New York. The complaint alleges that Guidant breached certain provisions of the amended merger agreement between Johnson & Johnson and Guidant (Merger Agreement) as well as the implied duty of good faith and fair dealing. The complaint further alleges that the Company and Abbott tortiously interfered with the Merger Agreement by inducing Guidant’s breach. The complaint seeks damages in an amount no less than $5.5 billion and attorneys’ fees and costs. The Company and Guidant have not yet answered the complaint, but plan to vigorously defend against Johnson & Johnson’s allegations.
Litigation with Guidant Corporation
On December 18, 2004, the Company and SCIMED filed suit for patent infringement against Guidant and certain of its subsidiaries alleging that Guidant’s ACCULINK™ stent and ACCUNET™ embolic protection system infringes three U.S. patents owned by the Company. The complaint was filed in the U.S. District Court for the District of Minnesota seeking monetary and injunctive relief. In connection with the acquisition of Guidant by the Company, this case was dismissed on April 21, 2006.
Litigation with Medtronic, Inc.
On August 13, 1998, Medtronic AVE, Inc., a subsidiary of Medtronic, Inc., filed a suit for patent infringement against the Company and SCIMED alleging that the Company’s NIR® stent infringes two patents owned by Medtronic AVE. The suit was filed in the U.S. District Court for the District of Delaware seeking injunctive and monetary relief. On May 25, 2000, Medtronic AVE amended the complaint to include a third patent. Cross-motions for summary judgment were filed and hearings were held on October 21 and 22, 2004. On January 5, 2005, the Court found the NIR® stent not to infringe the patents and on February 2, 2005, issued final judgment in favor of the Company. Medtronic appealed the judgment on March 16, 2005. On May 26, 2006, the Court confirmed judgment in favor of the Company.
On January 15, 2004, Medtronic Vascular, Inc., a subsidiary of Medtronic, filed suit against the Company and SCIMED alleging the Company’s Express® coronary stent and Express2™ coronary stent infringe four U.S. patents owned by Medtronic Vascular. The suit was filed in the District Court of Delaware seeking monetary and injunctive relief. Cross-motions for summary judgment were filed and hearings were held on October 21 and 22, 2004. On January 5, 2005, the Court found the Express coronary stent and Express2 coronary stent not to infringe the patents and on February 2, 2005, issued final judgment in favor of the Company. Medtronic appealed the judgment on March 16, 2005. On May 26, 2006, the Court confirmed judgment in favor of the Company.
On March 1, 2006, Medtronic Vascular filed suit against the Company and SCIMED alleging the Company’s cardiovascular balloon products infringe four U.S. patents owned by Medtronic Vascular. The suit was filed in the U.S. District Court for the Eastern District of Texas seeking monetary and injunctive relief. On April 25, 2006, the Company answered and filed a counterclaim seeking a declaratory judgment of invalidity and non-infringement.
On August 29, 2003, Medtronic filed a declaratory judgment action against Guidant, Guidant Sales Corp. (GSC), Eli Lilly and Company and Mirowski Family Ventures, L.L.C. in the District Court for Delaware, challenging its obligation to pay royalties to Mirowski on certain devices by alleging the
invalidity of certain claims of a patent relating to cardiac resynchronization therapy and bi-ventricular pacing therapy. The patent is exclusively licensed to Guidant as part of a broader license covering Mirowski patents and is sublicensed to Medtronic. The parties agreed to an expedited proceeding with limited scope, and a bench trial was held in November 2004. On July 19, 2005, the judge issued an order upholding the validity of the patent. Medtronic appealed this decision, and on October 12, 2006, the Court of Appeals for the Federal Circuit affirmed the validity of the patent.
Litigation Relating to St. Jude Medical, Inc.
On April 21, 2004, Advanced Neuromodulation Systems, Inc. (ANSI), now a subsidiary of St. Jude Medical, Inc., filed suit against Advanced Bionics, a subsidiary of the Company, alleging that its Precision® spinal cord stimulation system infringes a U.S. patent owned by ANSI. The suit also included allegations of misappropriation of trade secrets and tortious interference with a contract. The suit was filed in the U.S. District Court for the Eastern District of Texas seeking monetary and injunctive relief. On August 6, 2004, Advanced Bionics moved to send the trade secret claims and tortious interference proceedings to arbitration. On August 12, 2004, ANSI amended its complaint to include two additional patents. On January 25, 2005, the Court granted, in part, the motion to move the misappropriation of trade secrets and tortious interference claims to arbitration. On March 11, 2005, Advanced Bionics answered the amended complaint, denying the allegations and filed a counterclaim against ANSI alleging that certain products sold by ANSI infringe two patents owned by Advanced Bionics. The counterclaim sought monetary and injunctive relief. Pursuant to a Settlement Agreement dated July 29, 2006 between the Company and St. Jude Medical, this case and the related arbitration proceeding have been dismissed.
On March 6, 2002, Pacesetter, Inc., a subsidiary of St. Jude Medical, filed suit against Guidant’s subsidiaries, Cardiac Pacemakers, Inc. (CPI) and GSC, in the Central District of California alleging that CPI and GSC have infringed a number of Pacesetter patents covering various features of pacemakers and implantable defibrillators. The case was transferred to the District Court for Minnesota. Pacesetter was seeking injunctive relief, monetary damages and attorney fees. Pursuant to a Settlement Agreement dated July 29, 2006 between the Company and St. Jude Medical, this case has been dismissed.
On February 2, 2004, Guidant, GSC, CPI and Mirowski filed a declaratory judgment action in the District Court for Delaware against St. Jude Medical and Pacesetter alleging that their Epic HF, Atlas HF and Frontier 3x2 devices infringe a patent exclusively licensed to Guidant. Pursuant to a Settlement Agreement dated July 29, 2006 between the Company and St. Jude Medical, the parties have agreed to limit the scope and available remedies of this case. Trial is scheduled to begin on August 20, 2007.
On February 24, 2004, CPI filed suit against St. Jude Medical and Pacesetter in the District Court of Minnesota alleging patent infringement. An amended complaint was filed adding GSC and further alleging that St. Jude Medical’s Quicksite over-the-wire pacing lead infringes patents owned by CPI. Pursuant to the Settlement Agreement dated July 29, 2006 between the Company and St. Jude Medical, this case has been dismissed.
GSC, CPI and Mirowski are plaintiffs in a patent infringement suit originally filed against St. Jude Medical and its affiliates in November 1996 in the District Court in Indianapolis. In July 2001, a jury found that a patent licensed to CPI and expired in December 2003, was valid but not infringed by certain of St. Jude Medical’s defibrillator products. In February 2002, the District Court reversed the jury’s finding of validity. In August 2004, the Federal Circuit Court of Appeals, among other things, reinstated the jury verdict of validity and remanded the matter for a new trial on infringement and damages. The case was sent back to the District Court for further proceedings. Pursuant to a Settlement Agreement dated July 29, 2006 between the Company and St. Jude Medical, the parties agreed to limit the scope and available remedies of this case. Trial is scheduled to begin on April 30, 2007.
On April 26, 2006, Pacesetter, St. Jude Medical and St. Jude Medical S.C. Inc. filed a complaint against Guidant’s subsidiaries, Intermedics, Inc., CPI and GSC alleging that the Guidant subsidiaries breached a contract relating to certain rights covering endocardial lead assembly technology. The suit was filed in the Superior Court of the State of California for the County of Los Angeles and sought compensatory damages. Pursuant to a Settlement Agreement dated July 29, 2006 between the Company and St. Jude Medical, this case has been dismissed.
Litigation with Medinol Ltd.
On September 10, 2002, the Company filed suit against Medinol alleging Medinol’s NIRFlex™ stent and NIRFlex™ Royal stent products infringe two patents owned by the Company. The suit was filed in Dusseldorf, Germany seeking monetary and injunctive relief. On October 28, 2003, the German Court found that Medinol infringed one of the two patents owned by the Company. On December 8, 2003, the Company filed an appeal relative to the other patent. Subsequently, Medinol filed an appeal relative to the one patent found to be infringed. A hearing was held on both appeals on April 14, 2005. The Court had requested an expert to provide more evidence. On April 4, 2006, the Company reached a settlement with Medinol and the case was dismissed.
On February 20, 2006, Medinol submitted a request for arbitration against the Company, Boston Scientific Ltd. and Boston Scientific Scimed, Inc. under the Arbitration Rules of the World Intellectual Property Organization pursuant to the settlement agreement between Medinol and the Company dated September 21, 2005. The request for arbitration alleges that the Company’s Liberté coronary stent system infringes two U.S. patents and one European patent owned by Medinol. Medinol is seeking to have the patents declared valid and enforceable and a reasonable royalty. The September 2005 settlement agreement provides, among other things, that Medinol may only seek reasonable royalties and is specifically precluded from seeking injunctive relief. As a result, the Company does not expect the outcome of this proceeding to have a material impact on the continued sale of the Liberté™ stent system internationally or in the United States, the continued sale of the TAXUS® Liberté™ stent system internationally or the launch of the TAXUS® Liberté™ stent system in the United States. The Company plans to defend against Medinol’s claims vigorously.
On September 25, 2002, the Company filed suit against Medinol alleging Medinol’s NIRFlex™ and NIRFlex™ Royal products infringe a patent owned by the Company. The suit was filed in the District Court of The Hague, The Netherlands seeking cross-border, monetary and injunctive relief. On September 10, 2003, the Dutch Court ruled that the patent was invalid. The Company appealed the Court’s decision in December 2003. A hearing on the appeal was held on August 17, 2006 and a decision is expected in November 2006.
Other Patent Litigation
On July 28, 2000, Dr. Tassilo Bonzel filed a complaint naming certain of the Company’s Schneider Worldwide subsidiaries and Pfizer Inc. and certain of its affiliates as defendants, alleging that Pfizer failed to pay Dr. Bonzel amounts owed under a license agreement involving Dr. Bonzel’s patented Monorail® balloon catheter technology. The suit was filed in the U.S. District Court for the District of Minnesota seeking monetary relief. On September 26, 2001, Dr. Bonzel and the Company reached a contingent settlement involving all but one claim asserted in the complaint. The contingency has been satisfied and the settlement is now final. On December 17, 2001, the remaining claim was dismissed without prejudice with leave to refile the suit in Germany. Dr. Bonzel filed an appeal of the dismissal of the remaining claim. On July 29, 2003, the Appellate Court affirmed the lower court’s dismissal, and on
October 24, 2003, the Minnesota Supreme Court denied Dr. Bonzel’s petition for further review. On March 26, 2004, Dr. Bonzel filed a similar complaint against the Company, certain of its subsidiaries and Pfizer in the Federal District Court for the District of Minnesota. The Company and its subsidiaries answered, denying the allegations of the complaint. The Company filed a motion to dismiss the case and a hearing on the motion was held on August 27, 2004. On November 2, 2004, the Court granted the Company’s motion and the case was dismissed with prejudice. On February 7, 2005, Dr. Bonzel appealed the Court’s decision. A hearing on the appeal was held on October 25, 2005. On March 2, 2006, the Federal District Court dismissed the appeal and affirmed the lower court’s decision.
On September 12, 2002, EV3 Inc. filed suit against The Regents of the University of California and a subsidiary of the Company in the District Court of The Hague, The Netherlands, seeking a declaration that EV3’s EDC II and VDS embolic coil products do not infringe three patents licensed to the Company from The Regents. On October 22, 2003, the Court ruled that the EV3 products infringe three patents licensed to the Company. On December 18, 2003, EV3 appealed the Court’s ruling. A damages hearing is scheduled for June 15, 2007.
On March 29, 2005, the Company and Boston Scientific Scimed, Inc. filed suit against EV3 for patent infringement, alleging that EV3’s SpideRX™ embolic protection device infringes four U.S. patents owned by the Company. The complaint was filed in the U.S. District Court for the District of Minnesota seeking monetary and injunctive relief. On May 9, 2005, EV3 answered the complaint, denying the allegations, and filed a counterclaim seeking a declaratory judgment of invalidity and unenforceability, and noninfringement of the Company’s patents in the suit. On October 28, 2005, EV3 filed its first amended answer and counterclaim alleging that certain of the Company’s embolic protection devices infringe a patent owned by EV3. On June 20, 2006, the Company filed an amended complaint adding a claim of trade secret misappropriation and claiming infringement of two additional U.S. patents owned by the Company. On June 30, 2006, EV3 filed an amended answer and counterclaim alleging infringement of two additional U.S. patents owned by EV3. A trial has not yet been scheduled.
On December 16, 2003, The Regents of the University of California filed suit against Micro Therapeutics, Inc. and Dendron GmbH alleging that Micro Therapeutics’ Sapphire™ detachable coil delivery systems infringe twelve patents licensed to the Company and owned by The Regents. The complaint was filed in the U.S. District Court for the Northern District of California seeking monetary and injunctive relief. On January 8, 2004, Micro Therapeutics and Dendron filed a third-party complaint to include the Company and Target as third-party defendants seeking a declaratory judgment of invalidity and noninfringement with respect to the patents and antitrust violations. On February 17, 2004, the Company, as a third-party defendant, filed a motion to dismiss the Company from the case. On July 9, 2004, the Court granted the Company’s motion in part and dismissed the Company and Target from the claims relating only to patent infringement, while denying dismissal of an antitrust claim. Motions for summary judgment are pending. On April 7, 2006, the Court denied Micro Therapeutics’ motion seeking unenforceability of The Regents’ patent and denied The Regent’s cross-motion for summary judgment of unenforceability. A trial has been scheduled for June 5, 2007.
On September 27, 2004, the Company and a subsidiary filed suit for patent infringement against Micrus Corporation alleging that certain detachable embolic coil devices infringe two U.S. patents exclusively licensed to the subsidiary. The complaint was filed in the U.S. District Court for the Northern District of California seeking monetary and injunctive relief. On November 16, 2004, Micrus answered and filed counterclaims seeking a declaration of invalidity, unenforceability and noninfringement and included allegations of infringement against the Company relating to three U.S. patents owned by Micrus, and antitrust violations. On January 10, 2005, the Company filed a motion to dismiss certain of Micrus’ counterclaims, and on February 23, 2005, the Court granted a request to stay the proceedings pending a reexamination of the Company’s patents by the U.S. Patent and Trademark Office. On February 23, 2006,
the stay was lifted. A trial date has not yet been set.
On November 4, 2004, Applied Hydrogel Technology (AHT) and Dr. Lih-Bin Shih filed a complaint against Medluminal Systems, Inc., InterWest Partners, the Company and three individuals alleging that certain of Medluminal’s products infringe a patent owned by AHT. The complaint also includes claims of misappropriation of trade secrets and conversion against the Company and certain of the other defendants. The suit was filed in the U.S. District Court for the Southern District of California seeking monetary and injunctive relief. On February 15, 2005, the case was stayed pending arbitration proceedings. In January 2006, the parties agreed to dismiss the case, and on February 23, 2006, the case was dismissed with prejudice.
On February 1, 2005, the Company and Angiotech Pharmaceuticals, Inc. filed suit against Conor Medical System, Inc. in The Hague, The Netherlands seeking a declaration that Conor’s drug-eluting stent products infringe patents owned by Angiotech and licensed to the Company. A hearing was held on October 27, 2006 and a decision is expected on December 20, 2006.
On November 26, 2005, the Company and Angiotech filed suit against Occam International, BV in The Hague, The Netherlands seeking a preliminary injunction against Occam’s drug-eluting stent products based on infringement of patents owned by Angiotech and licensed to the Company. A hearing was held January 13, 2006, and on January 27, 2006, the Court denied the Company’s request for a preliminary injunction. The Company and Angiotech have appealed the Court’s decision, and the parties plan to pursue normal infringement proceedings against Occam in The Netherlands.
On April 4, 2005, the Company and Angiotech filed suit against Sahajanand Medical Technologies Pvt. Ltd. in The Hague, The Netherlands seeking a declaration that Sahajanand’s drug-eluting stent products infringe patents owned by Angiotech and licensed to the Company. On May 3, 2006, the Court found that the asserted claims were infringed and valid, and provided for injunctive and monetary relief. On July 13, 2006, Sahajanand appealed the Court’s decision. A hearing on the appeal has not been scheduled.
On May 4, 2006, the Company filed suit against Conor Medsystems Ireland Ltd. alleging that its Costar™ paclitaxel-eluting coronary stent system infringes a balloon catheter patent owned by the Company. The suit was filed in Ireland seeking monetary and injunctive relief. On May 24, 2006, Conor responded, denying the allegations and filed a counterclaim against the Company alleging that the patent is not valid and is unenforceable.
On May 19, 2005, G. David Jang, M.D. filed suit against the Company alleging breach of contract relating to certain patent rights assigned to the Company covering stent technology. The suit was filed in the U.S. District Court, Central District of California seeking monetary damages and rescission of the contract. On June 24, 2005, the Company answered, denying the allegations, and filed a counterclaim. After a Markman ruling relating to the Jang patent rights, Dr. Jang stipulated to the dismissal of certain claims alleged in the complaint. A trial has been scheduled for February 20, 2007.
On November 8, 2005, the Company and Scimed filed suit against Conor alleging that certain of Conor’s stent and drug-coated stent products infringe a patent owned by the Company. The complaint was filed in the U.S. District Court for the District of Delaware seeking monetary and injunctive relief. On December 30, 2005, Conor answered the complaint, denying the allegations. Trial is expected to begin in October 2007.
On December 16, 2005, Bruce N. Saffran, M.D., Ph.D. filed suit against the Company alleging the Company’s TAXUS® Express™coronary stent system infringes a patent owned by Dr. Saffran. The suit
was filed in the U.S. District Court for the Eastern District of Texas and seeks monetary and injunctive relief. On February 8, 2006, the Company filed an answer, denying the allegations of the complaint. Trial is expected to begin on January 3, 2008.
On September 7, 2005, Dr. Shaun L. W. Samuels filed suit against the Company alleging misappropriation of trade secrets, unfair competition and that one of the Company’s development-stage products infringes a patent owned by Dr. Samuels. The suit was filed in the U.S. District Court, Eastern District of Texas seeking monetary damages and injunctive relief. On November 2, 2005, the Company answered and filed counterclaims for declaratory judgment of non-infringement and invalidity. Pursuant to a settlement agreement between the parties, this case was dismissed in September 2006.
Other Proceedings
On January 10, 2002 and January 15, 2002, Alan Schuster and Antoinette Loeffler, respectively, putatively initiated shareholder derivative lawsuits for and on behalf of the Company in the U.S. District Court for the Southern District of New York against the Company’s then current directors and the Company as nominal defendant. Both complaints allege, among other things, that with regard to the Company’s relationship with Medinol, the defendants breached their fiduciary duties to the Company and its shareholders in the management and affairs of the Company, and in the use and preservation of the Company’s assets. The suits seek a declaration of the directors’ alleged breach, damages sustained by the Company as a result of the alleged breach and monetary and injunctive relief. On October 18, 2002, the plaintiffs filed a consolidated amended complaint naming two senior officials as defendants and the Company as nominal defendant. The action was stayed in February 2003 pending resolution of a separate lawsuit brought by Medinol against the Company. After the resolution of the Medinol lawsuit, plaintiffs, on May 1, 2006, were permitted to file an amended complaint to supplement the allegations in the prior consolidated amended complaint based mainly on events that occurred subsequent to the parties’ agreement to stay the action. The defendants filed a motion to dismiss the amended complaint on or about June 30, 2006. The motion was denied without prejudice at a hearing on October 20, 2006, and the Court ordered that the amended complaint be deemed a demand for the Board of Directors of the Company to consider taking action in connection with the allegations of the amended complaint. The Court stayed the litigation until January 5, 2007.
On September 8, 2005, the Laborers Local 100 and 397 Pension Fund initiated a putative shareholder derivative lawsuit for and on behalf of the Company in the Commonwealth of Massachusetts Superior Court Department for Middlesex County against the Company’s directors, certain of its current and former officers and the Company as nominal defendant. The complaint alleges, among other things, that with regard to certain matters of regulatory compliance, the defendants breached their fiduciary duties to the Company and its shareholders in the management and affairs of the Company and in the use and preservation of the Company’s assets. The complaint also alleges that as a result of the alleged misconduct and the purported failure to publicly disclose material information, certain directors and officers sold Company stock at inflated prices in violation of their fiduciary duties and were unjustly enriched. The suits seek a declaration of the directors’ and officers’ alleged breaches, unspecified damages sustained by the Company as a result of the alleged breaches and other unspecified equitable and injunctive relief. On September 15, 2005, Benjamin Roussey also initiated a putative shareholder derivative lawsuit in the same Court alleging similar misconduct and seeking similar relief. On April 10, 2006, the plaintiffs filed a consolidated derivative complaint. The defendants filed a motion to dismiss the consolidated derivative complaint on May 10, 2006, and a hearing on the motion was held on August 15, 2006. Defendant’s motion to dismiss was granted without leave to amend on September 11, 2006. On September 21, 2006, plaintiff Laborers Local 100 and 397 Pension Fund filed a motion to alter or amend judgment and for leave to file an amended complaint which was denied on October 19, 2006. The Board of Directors of the Company also received a letter dated January 17, 2006, on behalf of Benjamin
Roussey regarding the Company’s proposal to acquire Guidant Corporation. Mr. Roussey cited the pending litigation against Guidant and the potential liability it could face in the event of adverse outcomes to these matters and asked that the Board to Directors direct the Company to retract its offer to acquire Guidant before Guidant formally accepted it. The Board of Directors considered Mr. Roussey’s request and ultimately approved the execution of the merger agreement with Guidant.
On September 23, 2005, Srinivasan Shankar, on behalf of himself and all others similarly situated, filed a purported securities class action suit in the U.S. District Court for the District of Massachusetts on behalf of those who purchased or otherwise acquired the Company’s securities during the period March 31, 2003 through August 23, 2005, alleging that the Company and certain of its officers violated certain sections of the Securities Exchange Act of 1934. On September 28, 2005, October 27, 2005, November 2, 2005 and November 3, 2005, Jack Yopp, Robert L. Garber, Betty C. Meyer and John Ryan, respectively, on behalf of themselves and all others similarly situated, filed additional purported securities class action suits in the same Court on behalf of the same purported class. On February 15, 2006, the Court ordered that the five class actions be consolidated and appointed the Mississippi Public Employee Retirement System Group as lead plaintiff. A consolidated amended complaint was filed on April 17, 2006. The consolidated amended complaint alleges that the Company made material misstatements and omissions by failing to disclose the supposed merit of the Medinol litigation and DOJ investigation relating to the 1998 NIR ON® Ranger with Sox stent recall, problems with the TAXUS® drug-eluting coronary stent systems that led to product recalls, and the Company’s ability to satisfy FDA regulations concerning medical device quality. The consolidated amended complaint seeks unspecified damages, interest, and attorneys’ fees. The defendants filed a motion to dismiss the consolidated amended complaint on June 8, 2006.
On January 19, 2006, George Larson, on behalf of himself and all others similarly situated, filed a purported class action complaint in the U.S. District Court for the District of Massachusetts on behalf of participants and beneficiaries of the Company’s 401(k) Retirement Savings Plan (401(k) Plan) and GESOP (together the Plans) alleging that the Company and certain of its officers and employees violated certain provisions under the Employee Retirement Income Security Act of 1974, as amended (ERISA) and Department of Labor Regulations. On January 26, 2006, February 8, 2006, February 14, 2006, February 23, 2006 and March 3, 2006, Robert Hochstadt, Jeff Klunke, Kirk Harvey, Michael Lowe and Douglas Fletcher, respectively, on behalf of themselves and others similarly situated, filed purported class action complaints in the same Court on behalf of the participants and beneficiaries in the Company’s Plans alleging similar misconduct and seeking similar relief as in the Larson lawsuit. On April 3, 2006, the Court issued an order consolidating the actions and appointing Jeffrey Klunke and Michael Lowe as interim lead plaintiffs. On August 23, 2006, plaintiffs filed a consolidated complaint that purports to bring a class action on behalf of all participants and beneficiaries of the Company’s 401(k) Plan during the period May 7, 2004 through January 26, 2006 alleging that the Company, its 401(k) Administrative and Investment Committee (the Committee), members of the Committee, and certain directors violated certain provisions of ERISA. The complaint alleges, among other things, that the defendants breached their fiduciary duties to the 401(k) Plan’s participants. The complaint seeks equitable and monetary relief. Defendants filed a motion to dismiss on October 10, 2006.
On January 26, 2006, Donald Wright filed a purported class action complaint in the U.S. District Court for the District of Minnesota against the Company and Guidant on behalf of himself and all other senior citizens and handicapped persons similarly situated seeking a permanent injunction to prohibit the Company from completing its acquisition of Guidant, alleging violations of the Minnesota Fraudulent Transfers Act and Consumer Fraud Act. The complaint seeks restitution on behalf of those persons who suffered injury related to Guidant’s cardiac pacemakers and/or defibrillators. The complaint also seeks monetary damages and injunctive relief. Mr. Wright filed an amended complaint on February 21, 2006, dropping his claim for monetary damages. On February 14, 2006, Donald Wright filed a motion
for preliminary and permanent injunction, which he amended on March 9, 2006, directing the Company to interplead between $6.3 billion and $24.4 billion of the $27 billion purchase price to be paid to stockholders of Guidant. The motion was denied on March 24, 2006.
On March 3, 2005, the African Assistance Program filed a charge of discrimination with the Minnesota Department of Human Rights and the Minnesota office of the U.S. Equal Employment Opportunity Commission, purportedly on behalf of certain of the Company’s black employees of African national origin, alleging that the Company subjects black employees to a hostile work environment and discriminatory employment practices in violation of Title VII of the Civil Rights Act of 1964, as amended. The Company has denied liability in the action. On June 28, 2006 and July 31, 2006, the U.S. Equal Employment Opportunity Commission and Minnesota Department of Human Rights, respectively, dismissed the charge against the Company.
On June 12, 2003, Guidant announced that its subsidiary, EndoVascular Technologies, Inc. (EVT), had entered into a plea agreement with the U.S. Department of Justice relating to a previously disclosed investigation regarding the ANCURE ENDOGRAFT System for the treatment of abdominal aortic aneurysms. At the time of the EVT plea, Guidant had outstanding fourteen suits alleging product liability related causes of action relating to the ANCURE System. Subsequent to the EVT plea, Guidant has been notified of additional claims and served with additional complaints. From time to time, Guidant has settled certain of the individual claims and suits for amounts that were not material to Guidant. Currently, Guidant has over a dozen suits outstanding, and more suits may be filed. Additionally, Guidant has been notified of over 150 unfiled claims. The cases generally allege the plaintiffs suffered injuries, and in certain cases died, as a result of purported defects in the device or the accompanying warnings and labeling. The complaints seek damages, including punitive damages, and equitable relief. While insurance may reduce Guidant’s exposure with respect to ANCURE claims, one of Guidant’s carriers, Allianz Insurance Company (Allianz), filed suit in the Circuit Court, State of Illinois, County of DuPage, seeking to rescind or otherwise deny coverage, and additional carriers have intervened in the case. Guidant also has initiated suit against certain of its carriers, including Allianz, in the Superior Court, State of Indiana, County of Marion, in order to preserve Guidant’s rights to coverage.
Shareholder derivative suits relating to the ANCURE System are currently pending in the Southern District of Indiana and in the Superior Court of the State of Indiana, County of Marion. The suits, purportedly filed on behalf of Guidant, initially alleged that Guidant’s directors breached their fiduciary duties by taking improper steps or failing to take steps to prevent the ANCURE and EVT related matters described above. The complaints seek damages and other equitable relief. The state court derivative suits have been stayed in favor of the federal derivative action. Guidant moved to dismiss the federal derivative action. The plaintiff in the federal derivative case filed an amended complaint in December 2005, adding allegations regarding defibrillator and pacemaker products and Guidant’s proposed merger with Johnson & Johnson. On January 23, 2006, Guidant and its directors moved to dismiss the amended complaint. On March 1, 2006, a second amended complaint in the federal derivative case was filed. On May 1, 2006, the defendants moved to dismiss the second amended complaint.
In July 2005, a purported class action complaint was filed on behalf of participants in Guidant’s employee pension benefit plans. This action was filed in the U.S. District Court for the Southern District of Indiana against Guidant and its directors. The complaint alleges breaches of fiduciary duty under the Employee Retirement Income Security Act (ERISA), 29 U.S.C. § 1132. Specifically, the complaint alleges that Guidant fiduciaries concealed adverse information about Guidant’s defibrillators and imprudently made contributions to Guidant’s 401(k) plan and employee stock ownership plan in the form of Guidant stock. The complaint seeks class certification, declaratory and injunctive relief, monetary damages, the imposition of a constructive trust, and costs and attorneys’ fees. A second, similar complaint was filed and consolidated with the initial complaint. A consolidated, amended complaint was filed on February 8, 2006. The defendants moved to dismiss the consolidated complain, and on September 15, 2006, the Court dismissed the complaint for lack of jurisdiction. In October 2006, the Plaintiffs appealed the Court’s decision to the United States Court of Appeals for the Seventh Circuit.
Approximately 74 product liability class action lawsuits and approximately 768 individual lawsuits are pending in various state and federal jurisdictions against Guidant alleging personal injuries associated with defibrillators or pacemakers involved in the 2005 product communications. The majority of the cases in the United States are pending in federal court but approximately 85 cases are currently pending in state courts. On June 13, 2006, the Minnesota Supreme Court appointed a single judge to preside over all state court lawsuits involving cases arising from the product communications in 2005. On November 7, 2005, the Judicial Panel on Multi-District Litigation established MDL-1708 (MDL) in the United States District Court for the District of Minnesota and appointed a single judge to preside over all the cases in the MDL. On January 31, 2006, the MDL scheduled the first federal court trial for March 15, 2007. An additional nine lawsuits are pending in Canada. Of these nine suits in Canada, six are putative class actions and three are individual lawsuits.
In April 2006, the personal injury plaintiffs and certain third party payors served a Master Complaint in the MDL asserting claims for class action certification, alleging claims of strict liability, negligence, fraud, breach of warranty and other common law and/or statutory claims and seeking punitive damages. The majority of claimants allege no physical injury, but are suing for medical monitoring and anxiety. Pursuant to an agreement between the parties, the cases originally scheduled to be tried in Texas state court in September 2006 are no longer set for trial. Earlier this year, the FDA’s Office of Criminal Investigations has issued a subpoena to the plaintiffs’ attorneys involved in this trial asking plaintiffs’ counsel to turn over documents they have received from Guidant as part of the civil litigation discovery process. To date, Guidant has also been informed of over 3,500 claims of individuals that may or may not mature into filed suits.
Guidant has received requests for information in the form of Civil Investigative Demands (CID) from the attorneys general of Arizona, California, Oregon, Illinois, Vermont and Louisiana. These attorneys general advise that approximately thirty other states and the District of Columbia are cooperating in these CID demands. The CIDs pertain to whether Guidant violated any applicable state laws in connection with certain of its implantable defibrillators. Guidant is cooperating with these investigations.
On November 2, 2005, the Attorney General of the State of New York filed a civil complaint against Guidant pursuant to the New York’s Consumer Protection Law (N.Y. Executive Law § 63(12)). In the complaint, the Attorney General alleges that Guidant concealed from physicians and patients a design flaw in its PRIZM 1861 defibrillator from approximately February of 2002 until May 23, 2005. The complaint further alleges that due to Guidant’s concealment of this information, Guidant has engaged in repeated and persistent fraudulent conduct in violation of N.Y. Executive Law § 63(12). The Attorney General is seeking permanent injunctive relief, restitution for patients in whom a PRIZM 1861 defibrillator manufactured before April 2002 was implanted, disgorgement of profits, and all other proper relief. This case is currently pending in the MDL in the United States District Court for the District of Minnesota.
Approximately seventy former employees have filed charges against Guidant with the U.S. Equal Employment Opportunity Commission (EEOC). Most of the charges were filed in the Minneapolis Area Office. The charges allege that Guidant discriminated against the former employees on the basis of their age when Guidant terminated their employment in August 2004 in conjunction with Guidant’s reduction in force. In September 2006, the EEOC found probable cause to support the allegations in the charges pending before it. Separately, in April 2006, approximately sixty of these former employees also sued Guidant in federal district court for the District of Minnesota, alleging that Guidant discriminated against the former employees on the basis of their age when Guidant terminated their employment in August 2004 in conjunction with a reduction in force.
Guidant is a defendant in two separate complaints in which plaintiffs allege a right of recovery under the Medicare secondary payer (or MSP) private right of action, as well as related claims. Plaintiffs claim as damages double the amount paid by Medicare in connection with devices that were the subject of voluntary field actions during 2005. Both of these cases are now pending in the MDL in the United States District Court for the District of Minnesota. The Company has moved to dismiss one of the suits and the plaintiff filed an opposition to this motion. A hearing on the motion has not been scheduled. The Court has stayed the response time for the other action.
Guidant or its affiliates are defendants in four separate actions brought by private third-party providers of health benefits or health insurance (TPPs). In these cases, plaintiffs allege various theories of recovery, including derivative tort claims, subrogation, violation of consumer protection statutes and unjust enrichment, for the cost of health care benefits they allegedly paid for in connection with the devices that have been the subject of Guidant’s voluntary field actions.
Two of these actions are pending in the multi-district litigation in the federal district court in Minnesota (MDL) as part of a single ‘master complaint,’ filed on April 24, 2006, which also includes other types of claims by other plaintiffs. The two named TPP plaintiffs in the master complaint claim to represent a putative nationwide class of TPPs. These two TPP plaintiffs had previously filed separate complaints against Guidant. Guidant has moved to dismiss the MDL TPP claims in the master complaint for failure to state a claim. A hearing on the motion has not yet been scheduled.
The other two TPP actions are pending in state court in Minnesota, and are part of the coordinated state court proceeding ordered by the Minnesota Supreme Court. The plaintiffs in one of these cases are a number of Blue Cross & Blue Shield plans, while the plaintiffs in the other case are a national health insurer and its affiliates. The complaints in these cases were served on Guidant on May 18 and June 25, 2006, respectively. Guidant has moved to dismiss both cases. Hearings on the motions have not yet been scheduled.
In January 2006, Guidant was served with a civil False Claims Act qui tam lawsuit filed in the U.S. District Court for the Middle District of Tennessee in September 2003 by Robert Fry, a former employee alleged to have worked for Guidant from 1981 to 1997. The civil lawsuit claims that Guidant violated federal law and the laws of the States of Tennessee, Florida and California, by allegedly concealing limited warranties related to some upgraded or replaced medical devices, thereby allegedly causing hospitals to allegedly file reimbursement claims with federal and state health care programs for amounts that did not reflect available warranty credits. The state of California has not intervened and the states of Florida and Tennessee have formally declined to intervene in the False Claims case. On April 25, 2006, the Court denied Guidant’s motion to dismiss the complaint and ordered the plaintiff file a second amended complaint. As part of that Order, the Court denied the plaintiff’s motion to add a second plaintiff. On May 4, 2006, the plaintiff filed a second
amended complaint. On May 24, 2006, Guidant moved to dismiss that complaint, which was denied by the Court on September 13, 2006. On October 16, 2006, the United States filed a motion to intervene in this action, which was approved by the Court on November 2, 2006.
The Securities and Exchange Commission has begun a formal inquiry into issues related to certain of Guidant’s product disclosures and trading in Guidant stock. Guidant is cooperating with the inquiry.
On November 3, 2005, a securities class action complaint was filed on behalf of Guidant shareholders in the U.S. District Court for the Southern District of Indiana, against Guidant and several of its officers. The complaint alleges that the defendants concealed adverse information about Guidant’s defibrillators and pacemakers and sold stock in violation of federal securities laws. The complaint seeks a declaration that the lawsuit can be maintained as a class action, monetary damages, and injunctive relief. Several additional, related securities class actions were filed in November 2005 and January 2006, and were consolidated with the initial complaint filed on November 3, 2005. The Court issued an order consolidating the complaints and appointed the Iron Workers of Western Pennsylvania Pension Plan and David Fannon as lead plaintiffs. Lead plaintiffs filed a consolidated amended complaint. In August 2006, the defendants moved to dismiss the complaint. A hearing has not yet been scheduled.
In October 2005, Guidant received administrative subpoenas from the U.S. Department of Justice U.S. Attorney’s offices in Boston and Minneapolis, issued under the Health Insurance Portability & Accountability Act of 1996. The subpoena from the U.S. Attorney’s office in Boston requests documents concerning marketing practices for pacemakers, implantable cardioverter defibrillators, leads and related products. The subpoena from the U.S. Attorney’s office in Minneapolis requests documents relating to Guidant’s VENTAK PRIZM 2 and CONTAK RENEWAL and CONTAK RENEWAL 2 devices. Guidant is cooperating in these matters.
On May 3, 2006, Emergency Care Research Institute (ECRI) filed a complaint against Guidant in the U.S. District Court for the Eastern District of Pennsylvania generally seeking a declaration that ECRI may publish confidential pricing information about Guidant’s medical devices. The complaint seeks, on constitutional and other grounds, a declaration that confidentiality clauses contained in contracts between Guidant and its customers are not binding and that ECRI does not tortiously interfere with Guidant’s contractual relations by obtaining and publishing Guidant pricing information. Guidant sued ECRI in the U.S. District Court for the Eastern District of Pennsylvania alleging, among other things, ECRI was tortiously interfering with its contracts with its customers.
FDA Warning Letters
On December 23, 2005, Guidant received an FDA warning letter citing certain deficiencies with respect to Guidant’s manufacturing quality systems and record keeping procedures in its CRM facility in St. Paul, Minnesota. This FDA warning letter followed an inspection by the FDA that was completed on September 1, 2005 and cited a number of observations. Guidant received a follow-up letter from the FDA dated January 5, 2006. As stated in this follow-up letter, until the identified deficiencies have been corrected, the FDA may not grant requests for exportation certificates to foreign governments or approve pre-market approval (PMA) applications for class III devices to which the deficiencies described are reasonably related. A further FDA inspection of the CRM facility was conducted between December 15, 2005 and February 9, 2006 and resulted in one additional inspectional observation.
On January 26, 2006, legacy Boston Scientific received a corporate warning letter from the FDA, notifying the Company of serious regulatory problems at three facilities and advising the Company that its corrective action plan relating to three site-specific warning letters issued to the Company in 2005 was inadequate. As also stated in this FDA warning letter, the FDA may not grant the Company’s requests for
exportation certificates to foreign governments or approve PMA applications for class III devices to which the quality control or current good manufacturing practices deficiencies described in the letter are reasonably related until the deficiencies have been corrected.
NOTE J - SEGMENT REPORTING
The Company has four reportable operating segments based on geographic regions: the United States, Europe, Japan and Inter-Continental. Each of the Company’s reportable segments generates revenue from the sale of less-invasive medical devices. The reportable segments represent an aggregate of all operating divisions within each segment. Management continues to use the following segments in making decisions about operating matters following its recent acquisition of Guidant.
Sales and operating results of reportable segments are based on internally derived standard foreign exchange rates, which may differ from year to year and do not include intersegment profits. The segment information presented for 2005 has been restated based on the Company’s standard foreign exchange rates used for 2006. Because of the interdependence of the reportable segments, the operating profit as presented may not be representative of the geographic distribution that would occur if the segments were not interdependent.
in millions | | United States | | Europe | | Japan | | Inter-Continental | | Total | |
| Three months ended September 30, 2006 | | | | | | | | | | | |
| Net sales | | $ | 1,273 | | $ | 387 | | $ | 156 | | $ | 198 | | $ | 2,014 | |
| Operating income | | | 589 | | | 189 | | | 80 | | | 95 | | | 953 | |
| | | | | | | | | | | | | | | | | |
| Three months ended September 30, 2005 | | | | | | | | | | | | | | | | |
| Net sales | | $ | 926 | | $ | 278 | | $ | 142 | | $ | 166 | | $ | 1,512 | |
| Operating income | | | 420 | | | 158 | | | 74 | | | 82 | | | 734 | |
| | | | | | | | | | | | | | | | | |
| Nine months ended September 30, 2006 | | | | | | | | | | | | | | | | |
| Net sales | | $ | 3,579 | | $ | 1,125 | | $ | 455 | | $ | 579 | | $ | 5,738 | |
| Operating income | | | 1,683 | | | 573 | | | 242 | | | 284 | | | 2,782 | |
| | | | | | | | | | | | | | | | | |
| Nine months ended September 30, 2005 | | | | | | | | | | | | | | | | |
| Net sales | | $ | 2,924 | | $ | 851 | | $ | 431 | | $ | 497 | | $ | 4,703 | |
| Operating income | | | 1,416 | | | 480 | | | 230 | | | 242 | | | 2,368 | |
A reconciliation of the totals reported for the reportable segments to the applicable line items in the unaudited condensed consolidated financial statements is as follows:
| | | Three Months Ended | | Nine Months Ended | |
| | | September 30, | | September 30, | |
in millions | | 2006 | | 2005 | | 2006 | | 2005 | |
Net Sales | | | | | | | | | |
| Total net sales allocated to reportable segments | | $ | 2,014 | | $ | 1,512 | | $ | 5,738 | | $ | 4,703 | |
| Foreign exchange | | | 12 | | | (1 | ) | | 18 | | | 40 | |
| | | $ | 2,026 | | $ | 1,511 | | $ | 5,756 | | $ | 4,743 | |
Income before Income Taxes | | | | | | | | | | | | | |
| Total operating income allocated to reportable segments | | $ | 953 | | $ | 734 | | $ | 2,782 | | $ | 2,368 | |
| Manufacturing operations | | | (168 | ) | | (111 | ) | | (428 | ) | | (329 | ) |
| Corporate expenses and foreign exchange | | | (277 | ) | | (109 | ) | | (642 | ) | | (318 | ) |
| Purchase accounting adjustments | | | (94 | ) | | | | | (4,463 | ) | | (276 | ) |
Merger-related and other costs: | | | | | | | | | | | | | |
| Integration costs | | | (9 | ) | | | | | (42 | ) | | | |
| CRM technology offering charge | | | (31 | ) | | | | | (31 | ) | | | |
| Certain retirement benefits | | | | | | | | | | | | (17 | ) |
| Business optimization charges | | | | | | (28 | ) | | | | | (28 | ) |
| AAA program cancellation costs, including amortization expense | | | | | | | | | 13 | | | | |
| Litigation-related charges | | | | | | (780 | ) | | | | | (780 | ) |
| Amortization and stock compensation expense | | | (179 | ) | | (42 | ) | | (422 | ) | | (117 | ) |
| | | $ | 195 | | $ | (336 | ) | $ | (3,233 | ) | $ | 503 | |
| Other expense, net | | | (144 | ) | | (16 | ) | | (471 | ) | | (50 | ) |
| | | $ | 51 | | $ | (352 | ) | $ | (3,704 | ) | $ | 453 | |
In July 2006, the FASB issued Interpretation No. 48, Accounting for Uncertainty in Income Taxes, an interpretation of FASB Statement No. 109, Accounting for Income Taxes, to create a single model to address accounting for uncertainty in tax positions. Interpretation No. 48 requires the use of a two-step approach for recognizing and measuring tax benefits taken or expected to be taken in a tax return and disclosures regarding uncertainties in income tax positions, including a roll forward of tax benefits taken that do not qualify for financial statement recognition. The cumulative effect of initially adopting Interpretation No. 48 will be recorded as an adjustment to opening retained earnings for that year and will be presented separately. The Company is required to adopt Interpretation No. 48 effective January 1, 2007. Only tax positions that are more likely than not to be realized at the effective date may be recognized upon adoption of Interpretation No. 48. The Company is currently evaluating the impact this new standard will have on its future results of operations and financial position.
In September 2006, the FASB issued Statement No. 157, Fair Value Measurements. Statement No. 157 defines fair value, establishes a framework for measuring fair value in accordance with generally accepted accounting principles, and expands disclosures about fair value measurements. This Statement does not require any new fair value measurements; rather, it applies under other accounting pronouncements that require or permit fair value measurements. The provisions of this Statement are to be applied prospectively as of January 1, 2008, with any transition adjustment recognized as a cumulative-effect adjustment to the opening balance of retained earnings. The Company is in the process of determining the effect of adoption of Statement No. 157, but the Company does not believe such adoption will materially impact its future results of operations or financial position.
NOTE L - TAX RATE
The following table provides a summary of the Company’s reported tax rate:
| | | Three Months Ended | | | |
| | | September 30, | | Percentage Point | |
| | | 2006 | | 2005 | | Decrease | |
| Reported tax rate | | | (49%) | | | 24% | | | (73%) | |
| Impact of certain charges | | | (72%) | | | 0% | | | (72%) | |
| | | | | | | | | | | |
| | | Nine Months Ended | | | | |
| | | September 30, | | Percentage Point | |
| | | | 2006 | | | 2005 | | Decrease | |
| Reported tax rate | | | (4%) | | | 35% | | | (39%) | |
| Impact of certain charges | | | (27%) | | | 11% | | | (38%) | |
| | | | | | | | | | | |
The decrease in the Company’s reported tax rate for the third quarter of 2006 and the first nine months of 2006 primarily related to the net impact of certain charges that may be taxed at different rates than the Company’s effective tax rate. In 2006, these charges included purchased research and development primarily associated with the acquisition of Guidant; a charge relating to the step-up in value of acquired inventory sold during the period; a tax charge for the drug-eluting stent license right obtained from Abbott; the fair value adjustment related to the sharing of proceeds feature of the Abbott stock purchase; and changes in estimates for tax benefits claimed on prior year tax returns and for tax reserves pertaining to prior period tax exposures. In 2005, these charges primarily included a legal settlement with Medinol; purchased research and development; charges related to certain business optimization initiatives; costs related to certain retirement benefits; and a benefit for a tax adjustment associated with a technical correction made to the American Jobs Creation Act. In addition to the impact of these charges, the Company’s reported tax rate for the first nine months of 2006 also decreased by one percentage point as compared to the same period in the prior year primarily due to its anticipated geographic mix of earnings and the effect of foreign tax rates.
The Company provides for potential amounts due in various tax jurisdictions. In the ordinary course of conducting business in multiple countries and tax jurisdictions, there are many transactions and calculations where the ultimate tax outcome is uncertain. Judgment is required in determining the Company’s worldwide income tax provision. In management’s opinion, adequate provisions for income taxes have been made for all years subject to audit.
