.
.
.
Exhibit 13.1
2003
Consolidated Financial Statements
Boston Scientific and Subsidiaries
<Table>
Management's discussion and analysis of financial condition and results
of operations ........................................................... 2
Consolidated statements of operations ..................................... 32
Consolidated balance sheets ............................................... 33
Consolidated statements of stockholders' equity ........................... 35
Consolidated statements of cash flows ..................................... 36
Notes to the consolidated financial statements ............................ 37
Report of independent auditors ............................................ 76
Five-year selected financial data ......................................... 77
Quarterly results of operations ........................................... 78
Market for the Company's common stock and related matters ................. 79
</Table>
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF
OPERATIONS
OVERVIEW
Boston Scientific Corporation (Boston Scientific or the Company) is a worldwide
developer, manufacturer, and marketer of medical devices that are used in a
broad range of interventional medical specialties. The Company's mission is to
improve the quality of patient care and the productivity of health care delivery
through the development and advocacy of less-invasive medical devices and
procedures. This is accomplished through the continuing refinement of existing
products and procedures and the investigation and development of new
technologies that can reduce risk, trauma, cost, procedure time, and the need
for aftercare. The Company's approach to innovation combines internally
developed products and technologies with those obtained externally through
strategic acquisitions and alliances.
The Company's products are used in a broad range of interventional medical
specialties, including interventional cardiology, peripheral interventions,
vascular surgery, neurovascular intervention, electrophysiology, endoscopy,
oncology, urology, and gynecology.
Management's discussion and analysis (MD&A) begins with an executive summary
that outlines the financial highlights of the Company during 2003 and discusses
the drug-eluting stent opportunity that may impact future operations. Following
the executive summary is an examination of the material changes in operating
results for 2003 as compared to 2002, and the operating results for 2002 as
compared to 2001. The discussion then provides an examination of liquidity,
focusing primarily on material changes in operating, investing and financing
cash flows, as depicted in the consolidated statements of cash flows, and the
trends underlying these changes. Finally, MD&A provides information on market
risk exposures and certain legal matters.
All references in MD&A, the consolidated financial statements and the notes
thereto related to common shares, share prices, and per share amounts have been
retroactively restated for the two-for-one common stock split that was effected
in the form of a 100 percent stock dividend on November 5, 2003.
EXECUTIVE SUMMARY
Net sales for the year ended December 31, 2003 were $3,476 million as compared
to $2,919 million in 2002, an increase of 19 percent. Excluding the favorable
impact of $162 million of foreign currency fluctuations, net sales increased 14
percent.
The growth in net sales of the Company in 2003 was largely a result of sales of
its TAXUS(TM) paclitaxel-eluting coronary stent system that was launched in its
Europe and Inter-Continental markets during the first quarter of 2003. TAXUS
stent sales in these markets in 2003 were approximately $200 million and
represented leading market share
2
positions exiting 2003. On a worldwide basis, the Company's Cardiovascular and
Endosurgery groups experienced sales growth of 21 percent and 14 percent,
respectively.
The Company expects to achieve significant sales growth in 2004 following the
launch of the TAXUS(TM) stent system in the United States (U.S.) in the first
quarter of 2004. The Company believes drug-eluting stent technology represents
one of the largest market opportunities in the history of the medical device
industry. It is estimated that the annual worldwide market for coronary stents,
including drug-eluting stents, may grow to more than $5 billion in 2005. The
Company believes it is poised to take advantage of the drug-eluting stent
opportunity for a variety of reasons, including its more than six years of
scientifically rigorous research and development, the clinical results of its
TAXUS clinical program, the success of the TAXUS stent system in Europe and
Inter-Continental markets where the product has been launched, the combined
strength of the components of its technology, its overall market leadership, and
its sizeable interventional cardiology sales force. In addition, in order to
capitalize on this opportunity, the Company has made significant investments in
its sales, clinical and manufacturing capabilities.
Gross profit increased to $2,515 million, or 72.4 percent of net sales, in 2003
from $2,049 million, or 70.2 percent of net sales, in 2002. The increase in
gross profit was partially used to fund additional spending on research and
development platforms, particularly related to the drug-eluting stent program,
and additional costs incurred to strengthen the Company's sales and marketing
organization. The reported net income for 2003 was $472 million, or $0.56 per
diluted share, as compared to $373 million, or $0.45 per diluted share, in 2002.
The reported results for 2003 included net after-tax charges of $49 million, or
$0.06 per diluted share, compared to net after-tax charges of $40 million, or
$0.05 per diluted share, in 2002.(1)
The Company continued to generate strong cash flow during 2003. The Company's
cash provided by operating activities was $787 million in 2003 and $736 million
in 2002. Cash generated from operating activities was used in part to fund the
Company's TAXUS program and various research and development initiatives, to pay
for acquisition-related obligations and strategic alliances, and to repurchase
Company stock on the open market.
- -------------------
(1) The 2003 net after-tax charges consisted of purchased research and
development costs primarily attributable to acquisitions, and charges related to
litigation with the Federal Trade Commission and product liability settlements.
The 2002 net after-tax charges consisted of purchased research and development
associated with acquisitions, costs related to the Company's global operations
strategy that was substantially completed in 2002, a charitable donation to fund
the Bostom Scientific Foundation, special credits for net amounts received in
connection with settlements of litigation related to rapid exchange catheter
technology, and a tax refund of previously paid taxes.
3
RESULTS OF OPERATIONS
FINANCIAL SUMMARY
YEARS ENDED DECEMBER 31, 2003 AND 2002
NET SALES
U.S. revenues increased approximately 10 percent to $1,924 million during 2003.
A significant percentage of the increase was attributable to sales growth in the
U.S. Cardiovascular division. Coronary stent revenues in the U.S. increased by
approximately $35 million or 19 percent in 2003 compared to 2002 as a result of
sales of the Company's Express2(TM) coronary stent that was launched in
September 2002. Sales from other Cardiology products, including the Maverick(TM)
line of coronary angioplasty balloons and the FilterWire EX(TM) embolic
protection device that was launched in June of 2003, also increased by
approximately $50 million or 6 percent compared to 2002. The remainder of the
increase in U.S. revenues was related to sales growth in each of the other five
U.S. divisions. Significant drivers of this growth include approximately $15
million of increased sales of its Guglielmi Detachable Coils (GDC(R)), which
received FDA clearance for expanded treatment of brain aneurysms in August of
2003, and approximately $15 million in increased sales of certain women's health
devices, including the Hydro ThermAblator(R), which the Company acquired in
conjunction with a 2002 business combination.
International revenues increased approximately 33 percent on an as reported
currency basis to $1,552 million during 2003. On a constant currency basis,
international revenues increased 20 percent for 2003, compared to the same
period in the prior year. The Company's Europe and Inter-Continental regions had
combined sales growth of 51 percent on an as reported currency basis, and 33
percent on a constant currency basis compared to 2002. The increase was
primarily due to approximately $200 million in sales of the TAXUS stent system,
which the Company launched in its Europe and Inter-Continental markets during
the first quarter of 2003. The remainder of the increase in revenue in these
markets was due to incremental growth in various product franchises, none of
which were individually significant.
During 2003, Japan revenues increased by approximately 10 percent on an as
reported currency basis and 2 percent on a constant currency basis compared to
2002. The Company was able to achieve growth in Japan as a result of increased
sales of various product franchises, including the Company's ultrasound product
line, and peripheral vascular stents and balloons. The growth in Japan was
limited, however, due to a $20 million decrease in coronary stent sales, which
was largely attributable to competitive product offerings and the lack of
physician acceptance of the NIR(R) coronary stent platform. The Company launched
its Express(2) coronary stent system in Japan in the first quarter of 2004 and
expects to achieve revenue growth in Japan in 2004 relative to 2003 primarily as
a result of this launch.
Worldwide coronary stent sales increased 66 percent to $528 million in 2003
compared to $318 million in 2002. The increase was primarily due to
approximately $200 million in
4
sales of the TAXUS stent system in the Company's Europe and Inter-Continental
markets. The Company's U.S. bare metal stent revenue, which approximated $210
million for 2003, declined throughout 2003 following the introduction of a
competitor's drug-eluting stent system, as physicians converted interventional
procedures to this new technology. The Company estimates that, as of December
31, 2003, physicians have converted approximately 50 percent of the stents used
in interventional procedures in the U.S. from bare metal stents to drug-eluting
stents.
The following table provides sales by region and relative change on an as
reported and constant currency basis for the years ended December 31, 2003 and
2002, respectively:
Change
December 31, As reported At constant
(in millions) 2003 2002 currency basis currency basis
------ ------ -------------- --------------
United States $1,924 $1,756 10% 10%
Europe $ 672 $ 456 47% 26%
Japan 541 494 10% 2%
Inter-Continental 339 213 59% 48%
------ ------ ---- ----
International $1,552 $1,163 33% 20%
------ ------ ---- ----
Worldwide $3,476 $2,919 19% 14%
====== ====== ==== ====
The following table provides worldwide sales by division and relative change on
an as reported and constant currency basis for the years ended December 31, 2003
and 2002, respectively:
Change
December 31, As reported At constant
(in millions) 2003 2002 currency basis currency basis
------ ------ -------------- --------------
Cardiovascular $2,168 $1,797 21% 15%
Electrophysiology 113 101 12% 8%
Neurovascular 223 169 32% 23%
------ ------ -- --
CARDIOVASCULAR $2,504 $2,067 21% 15%
Oncology $ 166 $ 143 16% 12%
Endoscopy 580 513 13% 8%
Urology 226 196 15% 13%
------ ------ -- --
ENDOSURGERY $ 972 $ 852 14% 10%
------ ------ -- --
Worldwide $3,476 $2,919 19% 14%
====== ====== == ==
The Company's international operating regions and divisions are managed on a
constant currency basis, while market risk from changes in currency exchange
rates is managed at the corporate level.
5
GROSS PROFIT
Gross profit increased to $2,515 million in 2003 from $2,049 million in 2002. As
a percentage of net sales, gross profit increased by 220 basis points to 72.4
percent in 2003 from 70.2 percent in 2002. Approximately 200 basis points was
due to operational cost improvements primarily achieved through the Company's
2000 global operations strategy; approximately 130 basis points was the result
of shifts in the Company's product sales mix toward higher margin products,
primarily coronary stents; and approximately 100 basis points was the result of
the elimination of costs associated with the implementation of the Company's
global operations strategy incurred in 2002. These improvements in gross profit
were partially offset by approximately 100 basis points related to increased
period expenses, including start-up costs primarily associated with the
Company's TAXUS stent system production. The Company anticipates that its gross
profit percentage will continue to increase during 2004 following the U.S.
launch of the Company's TAXUS stent system.
OPERATING EXPENSES
The following is a summary of certain operating costs and expenses for 2003 and
2002:
2003 2002
---- ----
% of % of
(in millions) $ Net Sales $ Net Sales
-------------------- --------------------
Selling, general and administrative expenses 1,171 33.7 1,002 34.3
Amortization expense 89 2.6 72 2.5
Royalties 54 1.6 36 1.2
Research and development expenses 452 13.0 343 11.8
SELLING, GENERAL AND ADMINISTRATIVE (SG&A) EXPENSES
The increase in SG&A expenses in 2003 primarily related to approximately $95
million in additional marketing programs, increased headcount and higher
employee compensation, primarily attributable to the TAXUS stent program, and,
to a lesser degree, to support the Company's other product franchises; and
approximately $45 million in increased expense due to foreign currency
translation. The decrease in SG&A expenses as a percentage of net sales was
primarily attributable to the Company's efforts to control general and
administrative expenses. The Company anticipates that SG&A expenses will
continue to increase in terms of dollars in 2004, but decrease as a percentage
of net sales, excluding the impact of any future acquisitions, due to
significant expected revenue growth and management's intention to grow SG&A
spending at a slower rate than revenue.
AMORTIZATION EXPENSE
The increase in amortization expense was primarily the result of amortization of
intangible assets acquired during 2002 and 2003.
6
ROYALTIES
The increase in royalties was due to increased sales of royalty-bearing
products, including approximately $10 million of royalties payable on sales of
the Company's TAXUS stent system, and approximately $5 million of increased
royalties on certain nitinol products, including the FilterWire EX embolic
protection device. The Company expects that its royalties will significantly
increase as sales of its TAXUS stent system increase. In addition, the Company
continues to enter strategic technological alliances, some of which may include
royalty arrangements.
RESEARCH AND DEVELOPMENT EXPENSES
The investment in research and development dollars reflects spending on new
product development programs as well as regulatory compliance and clinical
research. The increase in research and development expenses was primarily
attributable to $55 million of increased investment in the development of, and
clinical trials relating to, the Company's drug-eluting stent franchise. In
addition, the Company had increased investment of approximately $15 million
related to certain other Cardiovascular projects and approximately $25 million
related to Endosurgery projects during 2003.
INTEREST EXPENSE AND OTHER, NET
Interest expense increased to $46 million in 2003 from $43 million in 2002.
Other, net, reflected expense of $8 million in 2003 as compared to expense of
$18 million in 2002. The change was primarily due to a charitable donation made
during the second quarter of 2002 to fund the Boston Scientific Foundation.
TAX RATE
The Company's reported tax rate was 27 percent and 32 percent in 2003 and 2002,
respectively. The decrease was due in part to the decrease in purchased research
and development charges, which are not deductible for tax purposes, from $85
million in 2002 to $37 million in 2003.
In addition, as more revenue is generated from products manufactured in lower
tax jurisdictions, the Company's overall effective tax rate is favorably
impacted. Management currently estimates that the 2004 effective tax rate,
excluding the impact of any special charges and credits, will be approximately
24 percent. However, the effective tax rate could be impacted positively or
negatively by geographic changes in the manufacturing of products sold by the
Company or by strategic acquisitions.
During 2003, the Company determined that it is likely to repatriate cash from
certain non-U.S. operations. The Company has established tax liabilities of
approximately $180 million that management believes are adequate to provide for
the related tax impact of these transactions.
The Company settled several tax audits during the year and has reduced its
previous estimate for accrued taxes by approximately $139 million to reflect the
resolution of these audits.
7
YEARS ENDED DECEMBER 31, 2002 AND 2001
Net sales for the year ended December 31, 2002 were $2,919 million as compared
to $2,673 million in 2001. For the year ended December 31, 2002, the impact of
foreign currency fluctuations was not material relative to 2001. The reported
net income for 2002 was $373 million, or $0.45 per diluted share, as compared to
a reported net loss of $54 million, or $(0.07) per share, in 2001. The reported
results for 2002 included net after-tax charges of $40 million, or $0.05 per
diluted share, compared to net after-tax charges of $377 million, or $0.47 per
share, in 2001.(2)
NET SALES
U.S. revenues increased approximately 10 percent to $1,756 million during 2002.
U.S. revenues increased primarily due to approximately $65 million in sales
growth in the Company's Endosurgery product lines and approximately $50 million
in increased sales of the Cutting Balloon(R) microsurgical dilatation device.
International revenues increased approximately 8 percent on an as reported and
constant currency basis to $1,163 million during 2002. The Company's Europe and
Inter-Continental regions had sales growth of approximately 21 percent on an as
reported currency basis, and 19 percent on a constant currency basis compared to
2001. The increase was primarily due to $30 million of increased sales of
coronary stents, $25 million in growth in the Company's Endosurgery product
lines, and revenue growth in the remaining product franchises.
During 2002, Japan revenue decreased by approximately 5 percent on an as
reported currency basis and 3 percent on a constant currency basis compared to
2001. The decrease in revenues was primarily due to a $55 million decrease in
coronary stent sales, which was largely attributable to competitive product
offerings and the lack of physician acceptance of the NIR(R) coronary stent
platform. The decrease in coronary stent sales was partially offset by growth in
various product franchises in Japan.
Worldwide coronary stent sales declined approximately 8 percent to $318 million
during 2002 due to the lack of physician acceptance of the NIR(R) coronary stent
platform and competitive product launches.
GROSS PROFIT
Gross profit increased to $2,049 million in 2002 from $1,754 million in 2001. As
a percentage of net sales, gross profit increased 460 basis points to 70.2
percent in 2002
- -------------------
(2) The 2002 net after-tax charges consisted of purchased research and
development associated with acquisitions, costs related to the Company's global
operations strategy that was substanitially completed in 2002, a charitable
donation to fund the Boston Scientific Foundation, special credits for net
amounts received in connection with settlements of litigation related to rapid
exchange catheter technology, and a tax refund of previously paid taxes. The
2001 net after-tax charges consisted of purchased research and development costs
attributable to acquisitions, costs associated with the Company's global
operations strategy, a provision for excess NIR(R) inventory due to declining
demand for the NIR(R) coronary stent technology, and a write-down of intangible
assets related to discontinued technology platforms.
8
from 65.6 percent in 2001. Approximately 120 basis points relate to a $33
million reduction in costs associated with the implementation of the Company's
global operations strategy. In addition, approximately 180 basis points relate
to a $49 million provision recorded in 2001 for excess NIR(R) coronary stent
inventories. The remainder of the increase was due to operational cost
improvements achieved through the global operations strategy and to shifts in
the Company's product sales mix toward higher margin products, primarily the
Express(2) coronary stent, partially offset by higher margin revenue declines in
Japan.
OPERATING EXPENSES
The following is a summary of certain operating costs and expenses for 2002 and
2001:
2002 2001
---- ----
(in millions) $ % of $ % of
Net Sales Net Sales
--------------------- --------------------
Selling, general and administrative expenses 1,002 34.3 926 34.6
Amortization expense 72 2.5 136 5.1
Royalties 36 1.2 35 1.3
Research and development expenses 343 11.8 275 10.3
SELLING, GENERAL AND ADMINISTRATIVE (SG&A) EXPENSES
The increase in SG&A expenses in 2002 was primarily attributable to additional
costs of approximately $45 million to expand the Company's Cardiovascular field
sales force in Europe and the Endosurgery field sales force in the U.S., and
increased employee compensation and higher sales commissions due to the increase
in net sales. The Company also experienced increases in marketing, legal and
administrative expenses in 2002 compared to 2001, which were individually
insignificant. The decrease in 2002 SG&A expenses as a percentage of net sales
was primarily due to the increase in net sales and the realization of synergies
as the Company integrated its 2001 acquisitions into its organization.
AMORTIZATION EXPENSE
The decrease in 2002 amortization expense was primarily a result of the adoption
of Financial Accounting Standards Board Statement No. 142, Goodwill and Other
Intangible Assets. As a result of adoption of Statement No. 142, the Company
realized a pre-tax benefit of approximately $46 million of amortization
reductions for goodwill and indefinite-lived intangible assets in 2002. This
benefit was partially offset by amortization of intangible assets related to
businesses acquired in 2002 and 2001. The decrease was also a result of a $24
million write-down of intangible assets in the second quarter of 2001 primarily
related to guidewire and brachytherapy technology that the Company had acquired
as part of the Schneider Worldwide business combination, which was consummated
in 1998. Company management determined during the second quarter of 2001, based
on available clinical and market data, that the future use of these platforms
would be significantly reduced or discontinued. The Company does not believe
that the write-downs of these assets will have a material impact on future
operations.
9
ROYALTIES
There were no material changes to royalties during 2002.
RESEARCH AND DEVELOPMENT EXPENSES
The increase in research and development expenses during 2002 was primarily
attributable to investment in the development of, and clinical trials relating
to, the Company's TAXUS drug-eluting stent program and to investment in
development programs acquired in connection with the Company's business
combinations consummated in 2001, primarily related to the Embolic Protection,
Inc. (EPI) FilterWire(TM) embolic protection device.
INTEREST EXPENSE AND OTHER, NET
Interest expense decreased to $43 million in 2002 from $59 million in 2001. The
decrease in interest expense was primarily attributable to lower average
interest rates during 2002 as compared to 2001. Other, net, was expense of $18
million in 2002 and income of $3 million in 2001. The change was primarily due
to a charitable donation made during the second quarter of 2002 to fund the
Boston Scientific Foundation.
TAX RATE
The Company's reported tax rate was 32 percent and 223 percent in 2002 and 2001,
respectively. The decrease was primarily due to special charges that were
incurred in 2001, mainly purchased research and development charges associated
with the 2001 acquisitions. These charges are not deductible for tax purposes
and therefore had a significant impact on the Company's reported tax rate in
2001. In addition, the Company's income tax expense was reduced by $15 million
in 2002 as a result of a refund of previously paid taxes. The reported tax rate
also decreased due to shifts in the mix between the Company's U.S. and
international operations.
GLOBAL OPERATIONS STRATEGY
During 2000, the Company approved and committed to a global operations strategy
consisting of three strategic initiatives designed to increase productivity and
enhance innovation. The global operations strategy included a plant network
optimization initiative, a manufacturing process control initiative, and a
supply chain optimization initiative.
The plant network optimization initiative has created a better allocation of the
Company's resources by forming a more effective network of manufacturing and
research and development facilities. The initiative resulted in the
consolidation of manufacturing operations along product lines and the shifting
of production to the Company's facilities in Miami and Ireland, and to contract
manufacturing. The plant network optimization initiative included the
discontinuation of manufacturing activities at three facilities in the U.S.
During 2000, the Company recorded a $58 million pre-tax charge to cost of sales
for severance and related costs associated with the plant network optimization
initiative. The approximately 1,700 affected employees included manufacturing,
manufacturing support and management employees. During 2001, the Company
recorded pre-tax expense of approximately $62 million as cost of sales,
10
primarily related to transition costs and accelerated depreciation on fixed
assets whose useful lives were reduced as a result of the plant network
optimization initiative. During 2002, the Company recorded pre-tax expense of
approximately $23 million as cost of sales for transition costs associated with
the plant network optimization initiative and abnormal production variances
related to underutilized plant capacity. The Company substantially completed the
plant network optimization initiative during the second quarter of 2002.
The manufacturing process control initiative involved the strengthening of the
Company's technical manufacturing resources to improve quality, reduce cost and
accelerate time to market. As a result, the Company has improved its
manufacturing efficiencies and yields. Due to the achievement of operational
efficiencies and its continued efforts to manage costs, during the second
quarter of 2002, the Company approved and committed to a workforce reduction
plan, impacting approximately 250 manufacturing, manufacturing support and
management employees. As a result, during the second quarter of 2002, the
Company recorded a $6 million pre-tax charge to cost of sales for severance and
related costs. The Company substantially completed the workforce reduction plan
during the fourth quarter of 2002.
The supply chain optimization initiative consisted of procurement and inventory
management programs, which have reduced inventory levels, lowered
inventory holding costs, and reduced inventory write-offs.
The Company did not record any significant expenses in 2003 related to its
global operations strategy.
As of December 31, 2003, the Company has made cash outlays of approximately $164
million since the inception of the global operations strategy. The cash outlays
included severance and outplacement costs, transition costs, and capital
expenditures. The Company has substantially completed its 2000 global operations
strategy and the anticipated cost savings have been achieved. During 2003, the
Company achieved pre-tax operating savings, relative to the strategy's base year
of 1999, of approximately $250 million as compared to savings of $220 million
and $130 million in 2002 and 2001, respectively, relative to the base year of
1999. These savings have been realized primarily as reduced cost of sales.
Savings to date have been impacted by the erosion of average selling prices on
certain products, changes in product mix, and foreign currency fluctuations.
The Company accrued the severance and related costs associated with the global
operations strategy in accordance with Staff Accounting Bulletin No. 100,
Restructuring and Impairment Charges, and Emerging Issues Task Force Issue No.
94-3, Liability Recognition for Certain Employee Termination Benefits and Other
Costs to Exit an Activity (Including Certain Costs Incurred in a Restructuring).
All other costs associated with the global operations strategy were expensed as
incurred. As of December 31, 2003, the Company does not have any significant
accruals remaining for its global operations strategy.
11
LITIGATION SETTLEMENTS
During the third quarter of 2003, the Company agreed to settle a number of
outstanding product liability cases. The cost of settlement in excess of the
Company's available insurance limits was approximately $8 million, which was
recorded as a charge to operating income.
On March 28, 2003, the U.S. District Court for the District of Massachusetts
entered a judgment against the Company for approximately $7 million. The
judgment related to a suit filed by the Federal Trade Commission (FTC) on
October 31, 2000 for alleged violations of a Consent Order dated May 5, 1995.
The Company recorded this amount as a charge to operating income in the first
quarter of 2003.
During the third quarter of 2002, the Company entered into an agreement to
settle a number of patent infringement lawsuits between the Company and
Medtronic, Inc. (Medtronic). The settlement resolved the Company's damage claims
against Medtronic arising out of a German court case and a U.S. arbitration
proceeding involving Medtronic rapid exchange stent delivery systems and
angioplasty dilatation balloon catheters. In accordance with the settlement
agreement, during the third quarter of 2002, Medtronic paid the Company
approximately $175 million to settle damage award claims for past infringement.
In addition, during the third quarter of 2002, the Company recorded a net charge
of approximately $76 million for settlement of litigation related to rapid
exchange catheter technology.
PURCHASED RESEARCH AND DEVELOPMENT
The Company's approach to innovation combines internally developed products and
technologies with those obtained externally through strategic acquisitions and
alliances. The Company's acquisitions are intended to further expand its ability
to offer its customers effective, quality medical devices that satisfy their
interventional needs.
The Company recorded purchased research and development of $37 million, $85
million and $282 million in 2003, 2002 and 2001, respectively. The 2003
purchased research and development primarily related to acquisitions consummated
in prior years and the 2003 acquisition of InFlow Dynamics, Inc. (InFlow). The
purchased research and development associated with the prior years' acquisitions
resulted from consideration that was contingent at the date of acquisition, but
was earned during 2003, primarily related to the acquisition of EPI. The 2002
and 2001 purchased research and development related primarily to acquisitions
consummated in each of these years.
During 2003, the Company paid approximately $13 million in cash and recorded
approximately $12 million of acquisition-related obligations to acquire InFlow.
During 2002, the Company paid approximately $187 million in cash to acquire
Smart Therapeutics, Inc. (Smart), BEI Medical Systems Company, Inc. and Enteric
Medical Technologies, Inc. (EMT). During 2001, the Company paid approximately
$620 million in cash and issued approximately 3.8 million shares valued at $40
million to acquire
12
RadioTherapeutics Corporation, Cardiac Pathways Corporation, Interventional
Technologies, Inc. (IVT), Quanam Medical Corporation, Catheter Innovations, Inc.
and EPI. These acquisitions were intended to strengthen the Company's leadership
position in interventional medicine. The acquisitions were accounted for using
the purchase method of accounting. The consolidated financial statements include
the operating results for each acquired entity from its respective date of
acquisition. Pro forma information is not presented, as the acquired companies'
results of operations prior to their date of acquisition are not material,
individually or in the aggregate, to the Company.
The amounts paid for each acquisition have been allocated to the assets acquired
and liabilities assumed based on their fair values at the date of acquisition.
The estimated excess of purchase price over the fair value of the net tangible
assets acquired was allocated to identifiable intangible assets based on
detailed valuations. The Company's purchased research and development charges
are based upon these valuations. The valuation of purchased research and
development represents the estimated fair value at the date of acquisition
related to in-process projects. As of the date of acquisition, the in-process
projects had not yet reached technological feasibility and had no alternative
future uses. The primary basis for determining the technological feasibility of
these projects is obtaining regulatory approval to market the product in an
applicable geographical region. Accordingly, the value attributable to these
projects, which had not yet obtained regulatory approval, was expensed in
conjunction with the acquisition. If the projects are not successful, or
completed in a timely manner, the Company may not realize the financial benefits
expected for these projects.
The income approach was used to establish the fair values of purchased research
and development. This approach establishes fair value by estimating the
after-tax cash flows attributable to the in-process project over its useful life
and then discounting these after-tax cash flows back to a present value. Revenue
estimates were based on estimates of relevant market sizes, expected market
growth rates, expected trends in technology and expected product introductions
by competitors. In arriving at the value of the in-process research and
development projects, the Company considered, among other factors, the
in-process project's stage of completion, the complexity of the work completed
as of the acquisition date, the costs already incurred, the projected costs to
complete, the contribution of core technologies and other acquired assets, the
expected introduction date and the estimated useful life of the technology. The
discount rate used to arrive at a present value as of the date of acquisition
was based on the time value of money and medical technology investment risk
factors. For the purchased research and development programs acquired in
connection with the 2003 acquisition, a risk-adjusted discount rate of 24
percent was utilized to discount the projected cash flows. For the purchased
research and development programs acquired in connection with the 2002
acquisitions, risk-adjusted discount rates ranging from 17 percent to 26 percent
were utilized to discount the projected cash flows. For the purchased research
and development programs acquired in connection with the 2001 acquisitions,
risk-adjusted discount rates ranging from 16 percent to 28 percent were utilized
to discount the projected cash flows. The Company believes that the estimated
purchased research and development amounts
13
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 in-process projects acquired in connection with the Company's 2003
acquisition were not significant to the Company. The most significant in-process
projects acquired in connection with the Company's 2002 acquisitions include
EMT's Enteryx(TM) technology for the treatment of gastroesophageal reflux
disease (GERD) and Smart's atherosclerosis stent, which collectively represent
approximately 82 percent of the 2002 in-process value. Enteryx is a patented
liquid polymer for the treatment of GERD. During the second quarter of 2003, the
Company completed the Enteryx in-process project and received FDA approval for
this technology. The total cost to complete the project was approximately $6
million. The atherosclerosis stent is a self-expanding nitinol stent designed to
treat narrowing of the arteries around the brain. The Company continues to
pursue the development of Smart's atherosclerosis stent and believes it has a
reasonable chance of completing the project. The Company has spent approximately
$3 million on this project as of December 31, 2003 and estimates costs of
approximately $2 million to complete the project. The Company expects that it
will receive FDA approval for this technology in 2005. These estimates are
consistent with the Company's estimates at the time of acquisition.
The most significant in-process projects acquired in connection with the
Company's 2001 acquisitions include IVT's next-generation Cutting Balloon, IVT's
next-generation Infiltrator(R) transluminal drug-delivery catheter and EPI's
next-generation embolic protection devices, which collectively represent
approximately 63 percent of the 2001 in-process value. The Cutting Balloon is a
novel balloon angioplasty device with mounted scalpels that relieve stress in
the artery, reducing the force necessary to expand the vessel. This contributes
to less inadvertent arterial trauma and injury as compared to standard balloon
angioplasty. The Company continues to pursue the development of IVT's
next-generation Cutting Balloon and believes it has a reasonable chance of
completing the project. The Company has spent approximately $3 million on this
project as of December 31, 2003 and estimates costs of approximately $4 million
to complete the project. The Company expects that it will receive FDA approval
for this technology in 2005, which is later than anticipated at the time of
acquisition, primarily as a result of the Company's continuing focus on its
drug-eluting stent program. The Company does not expect that this delay will
have a material impact on its operations. The Infiltrator transluminal
drug-delivery catheter is designed to deliver therapeutic agents directly into
the wall of the artery with high levels of efficiency. During the second quarter
of 2002, due to alternative drug-delivery products available to the Company, the
Company substantially canceled the future development of the Infiltrator
project. The Company does not believe that the cancellation of this project will
have a material impact on its future operations. The embolic protection devices
are filters that are mounted on a guidewire and are used to capture embolic
material that is dislodged during cardiovascular interventions. During the
second quarter of 2003, the Company completed EPI's FilterWire EX embolic
protection device in-process project and received FDA approval for this
technology. The total cost to complete the project was approximately $20
million.
14
OUTLOOK
The Company expects to significantly increase revenue, earnings and cash flow in
2004, primarily driven by its TAXUS stent system that was approved for sale in
the U.S. during the first quarter of 2004. The introduction of drug-eluting
stents is increasingly having a significant impact on the market size for
coronary stents and on the distribution of market share across the industry. The
worldwide coronary stent market is dynamic and highly competitive with
significant market share volatility. Although the Company's drug-eluting stent
system is currently one of only two products in the U.S. market, uncertainties
exist about the rate of development and potential size of the drug-eluting stent
market, and the Company's share of the market. The most significant variables
that contribute to this uncertainty include the adoption rate of drug-eluting
stent technology, the average number of stents used per procedure and the
average selling prices of drug-eluting stent systems. In February of 2004,
Cordis Corporation (Cordis), a subsidiary of Johnson & Johnson, and Guidant
Corporation entered an alliance to co-promote Cordis' drug-eluting stent system,
which may result in further uncertainty.
The Company's success with drug-eluting stents, and its ability to improve
operating margins, could be adversely affected by more gradual physician
adoption rates, changes in reimbursement policies, delayed or limited regulatory
approvals, unexpected variations in clinical results, third-party intellectual
property, the outcome of litigation and the availability of inventory to meet
customer demand. Inconsistent clinical data from ongoing or future trials
conducted by the Company, or additional clinical data presented by the Company's
competitors, may impact the Company's position in and share of the drug-eluting
stent market.
Recognizing the promise of drug-eluting stents and the benefits of the TAXUS
stent system, physicians are expected to continue to adopt rapidly this new
technology in the U.S. The Company believes that the more gradual adoption rates
in Europe relative to the U.S. is primarily due to the timing of local
reimbursement and funding levels. However, adoption rates in these markets are
slowly but steadily increasing and the Company expects this trend to continue in
2004. A more gradual physician adoption rate may limit the number of procedures
in which the technology may be used and the price at which institutions may be
willing to purchase the technology. In addition, the Company expects to be
impacted as additional competitors enter the drug-eluting stent market, which
the Company anticipates during 2004 and 2005 internationally and during 2006 in
the U.S. It is expected that one of the Company's competitors will launch a
drug-eluting stent into the Japan market during 2004, while the Company's TAXUS
stent system is expected to be launched in Japan in late 2005 or early 2006.
The manufacture of the TAXUS stent system involves the integration of multiple
technologies and complex processes. During 2004, the Company anticipates
significantly increasing the amount of TAXUS inventory on hand to meet the
forecasted demand for the product. However, expected inventory levels may be
impacted by significant favorable or unfavorable changes in forecasted demand
and disruptions associated with the TAXUS manufacturing process. In addition,
variability in expected demand, product mix and shelf life may result in excess
inventory positions.
Further, there continues to be significant intellectual property litigation in
the coronary stent market. The Company is currently involved in a number of
legal proceedings with its competitors, including Johnson & Johnson, Medtronic
and Medinol Ltd. There can be no assurance that an adverse outcome in one or
more of these proceedings would not impact the Company's ability to meet its
objectives in the market. See the notes to the
15
consolidated financial statements contained in this Annual Report for a
description of these legal proceedings.
Since early 2001, the Company has consummated ten business acquisitions.
Management believes it has developed a sound plan to integrate these businesses.
The failure to successfully integrate these businesses could impair the
Company's ability to realize the strategic and financial objectives of these
transactions. In addition, the Company has entered a significant number of
strategic alliances with privately held and publicly traded companies. Many of
these alliances involve equity investments by the Company. The Company enters
these strategic alliances to broaden its product technology portfolio and to
strengthen and expand the Company's reach into existing and new markets.
However, the full benefit of these alliances is often dependent on the strength
of the counterparty's underlying technology. As such, the inability to achieve
regulatory approvals, competitive product offerings, or litigation related to
this technology may, among other factors, prevent the Company from realizing the
benefit of these alliances. In connection with these acquisitions and strategic
alliances, the Company has acquired numerous in-process research and development
platforms. As the Company continues to undertake strategic initiatives, it is
reasonable to assume that it will acquire additional in-process research and
development platforms.
The Company expects to continue to invest heavily in its drug-eluting stent
program to achieve sustained worldwide market leadership positions. In addition,
the Company anticipates increasing its focus and spending on internal research
and development and other programs not associated with its TAXUS drug-eluting
stent technology. Further, the Company will continue to seek market
opportunities and growth through investments in strategic alliances and
acquisitions. Potential future acquisitions may be dilutive to the Company's
earnings and may require additional financing, depending on their size and
nature.
Uncertainty continues to exist concerning future changes within the health care
industry. The trend toward managed care, economically motivated and more
sophisticated buyers in the U.S. may result in continued pressure on selling
prices of certain products and compression of gross margins. Further, the U.S.
marketplace is increasingly characterized by consolidation among health care
providers and purchasers of medical devices who prefer to limit the number of
suppliers from which they purchase medical products. There can be no assurance
that these entities will continue to purchase products from the Company.
International markets are also being affected by economic pressure to contain
reimbursement levels and health care costs. The Company's profitability from its
international operations may be limited by risks and uncertainties related to
economic conditions in these regions, regulatory and reimbursement approvals,
competitive offerings, infrastructure development, rights to intellectual
property and the ability of the Company to implement its overall business
strategy. Any significant changes in the competitive, political, legal,
regulatory, reimbursement or economic environment where the Company conducts
international operations may have a material impact on revenues and profits,
especially in Japan, given its high profitability relative to its contribution
to
16
revenues. Further, the trend in countries around the world, including Japan,
toward more stringent regulatory requirements for product clearance, changing
reimbursement models, and more vigorous enforcement activities has generally
caused or may cause medical device manufacturers to experience more uncertainty,
greater risk and higher expenses. In addition, the Company is required to renew
regulatory approvals in certain international jurisdictions, which may require
additional testing and documentation. A decision not to dedicate sufficient
resources, or the failure to timely renew these approvals may limit the
Company's ability to market its full line of existing products within these
jurisdictions.
These factors may impact the rate at which the Company can grow. However,
management believes that it is positioning the Company to take advantage of
opportunities that exist in the markets it serves.
17
LIQUIDITY AND CAPITAL RESOURCES
Key performance indicators used by management to assess the liquidity of the
Company are as follows:
(in millions) 2003 2002 2001
- -------------------------------------------------------------------------------
Cash and cash equivalents $ 671 $ 260 $ 180
- -------------------------------------------------------------------------------
Short-term debt securities 81 17
- -------------------------------------------------------------------------------
Cash provided by operating activities 787 736 490
- -------------------------------------------------------------------------------
Cash used for investing activities (871) (485) (800)
- -------------------------------------------------------------------------------
Cash provided by (used for) financing activities 487 (175) 437
- -------------------------------------------------------------------------------
EBITDA(3) $ 879 $ 748 $ 332
- -------------------------------------------------------------------------------
EBITDA for 2003, 2002 and 2001 includes pre-tax charges of $52 million,
$33 million and $393 million, respectively. These pre-tax charges primarily
consisted of purchased research and development costs attributable to
acquisitions and certain litigation charges and credits.
Operating Activities
Cash generated by operating activities continues to provide a major source of
funds for investing in the Company's growth. The increase in cash generated by
operating activities is primarily attributable to the increase in EBITDA,
partially offset by the cash flow effect from changes in operating assets and
liabilities. The increase in EBITDA was primarily due to the growth in the
Company's Europe and Inter-Continental operating segments following the TAXUS
stent system launch in these markets. A portion of the cash generated from these
markets was invested in the Company's sales, clinical and manufacturing
capabilities in preparation for the U.S. TAXUS stent system product launch, and
in other research and development projects.
- ---------------------------
(3) The following represents a reconciliation between EBITDA and net income
(loss):
(in millions) 2003 2002 2001
- --------------------------------------------------------------------------------
Net income (loss): $ 472 $ 373 $ (54)
- --------------------------------------------------------------------------------
Income taxes 171 176 98
- --------------------------------------------------------------------------------
Interest expense 46 43 59
- --------------------------------------------------------------------------------
Interest income (6) (5) (3)
- --------------------------------------------------------------------------------
Depreciation and amortization 196 161 232
- --------------------------------------------------------------------------------
EBITDA $ 879 $ 748 $ 332
- --------------------------------------------------------------------------------
The Company discloses non-GAAP or pro forma financial information that excludes
certain items. Management uses this financial information to establish
operational goals, and believes that non-GAAP financial information may assist
users of the financial statements in analyzing the underlying trends in the
Company's business over time. Users of the financial statements should consider
this non-GAAP financial information in addition to, not as a substitute for, or
as superior to, financial information prepared in accordance with GAAP.
18
Significant cash flow effects from operating assets and liabilities in 2003
include increases in cash flow of $96 million attributable to accounts payable
and accrued expenses and decreases in cash flow of $74 million and $21 million
attributable to trade accounts receivable and inventories, respectively. The
decreases in cash flow from other operating assets and liabilities were not
individually significant. The increase in accounts payable and accrued expenses
was primarily due to amounts accrued or payable related to clinical trials,
payroll items and legal expense items. The increase in trade accounts receivable
was primarily due to increased sales of the TAXUS stent system to Europe and
Inter-Continental accounts, which generally have longer payment terms relative
to the U.S. The increase in TAXUS stent inventory was primarily due to the
accumulation of inventory in preparation for the U.S. launch.
Investing Activities
The Company made capital expenditures of $188 million in 2003 as compared to
$112 million in 2002. The increase was primarily due to capital spending to
enhance the Company's manufacturing capability in preparation for the global
launch of the TAXUS stent system and the $30 million purchase of a manufacturing
facility in the U.S., which the Company was previously leasing. The Company
expects to incur capital expenditures of approximately $250 million during 2004,
which includes expected investments in the Company's facility network. During
the fourth quarter of 2002, the Company began investing in short-term commercial
paper with maturity dates that exceeded 90 days to benefit from higher returns.
In 2003, the Company purchased approximately $130 million of these short-term
investments and approximately $66 million of these investments matured. The
Company's investing activities during 2003 also included a $13 million payment
to acquire InFlow; approximately $283 million of acquisition-related payments
primarily associated with IVT, EMT and Smart; and approximately $325 million of
payments for strategic alliances with both privately held and publicly traded
entities.
Financing Activities
The Company's cash flows from financing activities reflect proceeds from stock
issuances related to the Company's equity incentive programs, payments for stock
repurchases and fluctuations in the Company's borrowings. During 2003, the
Company received proceeds of $260 million in connection with the issuance of
shares pursuant to its stock option and employee stock purchase plans compared
to $107 million for 2002. Proceeds from the exercise of employee stock options
will vary from period to period based upon, among
19
other factors, fluctuations in the market value of the Company's stock relative
to the exercise price of employee stock options.
The Company repurchased 22 million shares of its common stock at an aggregate
cost of approximately $570 million during 2003. The Company is authorized to
purchase on the open market and in private transactions up to approximately 120
million shares of the Company's common stock. Purchased stock is principally
used to satisfy the Company's obligations pursuant to its equity incentive
plans, but may also be used for general corporate purposes, including
acquisitions. As of December 31, 2003, the Company had purchased approximately
97 million shares of its common stock under this authorization.
The Company received net proceeds of $793 million during 2003 from increased
borrowings. Proceeds from debt were used to fund cash outlays associated with
the Company's TAXUS program, to pay for acquisition-related obligations and
strategic alliances, and to repurchase Company stock on the open market.
The Company's cash and cash equivalents primarily relate to non-U.S. operations.
The repatriation of cash balances from certain of the Company's non-U.S.
operations could have adverse tax consequences; however, those balances are
generally available without legal restrictions to fund ordinary business
operations. During 2003, the Company determined that it is likely to repatriate
cash from certain non-U.S. operations; the repatriated cash available for use
will be net of the related provisions for taxes.
Borrowings and Credit Arrangements
(in millions) 2003 2002
- -----------------------------------------------------------------------------------------
Commercial paper $1,003 $ 88
- -----------------------------------------------------------------------------------------
Bank obligations 200 320
- -----------------------------------------------------------------------------------------
Long-term debt-other 522 527
- -----------------------------------------------------------------------------------------
Gross debt 1,725 935
- -----------------------------------------------------------------------------------------
Total cash, cash equivalents and short-term debt securities 752 277
- -----------------------------------------------------------------------------------------
Net debt(4) $ 973 $658
- -----------------------------------------------------------------------------------------
Revolving Credit Facilities: At December 31, 2003, the Company's revolving
credit facilities totaled $1,220 million, consisting of a $600 million 364-day
credit facility that contains an option to convert into a one-year term loan
expiring in May 2005, a $600 million credit facility that terminates in August
2006, and a $20 million uncommitted credit facility. Use of the borrowings are
unrestricted and the borrowings are unsecured. In January 2004, the Company
increased its 364-day credit facility to $645 million.
The revolving credit facilities provide borrowing capacity and support the
Company's commercial paper. The Company had approximately $1,003 million and $88
million of commercial paper outstanding at December 31, 2003 and December 31,
2002, respectively, at weighted average interest rates of 1.20 percent and 1.50
percent, respectively. The Company had no outstanding revolving credit facility
borrowings at December 31, 2003
- ---------------------
(4) This metric represents total debt less cash, cash equivalents and short-term
debt securities.
20
compared to $113 million at December 31, 2002, at a weighted average interest
rate of 0.58 percent.
In addition, the Company had a revolving credit and security facility, which is
secured by the Company's domestic trade receivables, that provides an additional
$200 million of borrowing capacity and terminates in August 2004. The maximum
amount available for borrowing under this facility changes based upon the amount
of eligible receivables, concentration of eligible receivables and other
factors. The Company had approximately $194 million and $197 million of
borrowings outstanding under its revolving credit and security facility at
December 31, 2003 and December 31, 2002, respectively. The borrowings bore
interest rates of 1.44 percent and 1.89 percent at December 31, 2003 and
December 31, 2002, respectively. Certain significant changes in the quality of
the Company's receivables may cause an amortization event under this facility.
An amortization event may require the Company to repay immediately borrowings
under the facility. The financing structure required the Company to create a
wholly owned entity, which is consolidated by the Company. This entity purchases
U.S. trade accounts receivable from the Company and then borrows from two
third-party financial institutions using these receivables as collateral. The
transactions remain on the Company's balance sheet because the Company has the
right to prepay any borrowings outstanding, allowing the Company to retain
effective control over the receivables. Accordingly, pledged receivables and the
corresponding borrowings are included as trade accounts receivable, net and bank
obligations, respectively, on the Company's consolidated balance sheets.
The Company has the ability and intent to refinance a portion of its short-term
debt on a long-term basis through its revolving credit facilities. The Company
expects that a minimum of $650 million of its short-term obligations, including
$456 million of commercial paper and $194 million of bank obligations, will
remain outstanding beyond the next twelve months and, accordingly, has
classified this portion as long-term borrowings at December 31, 2003, compared
to $320 million of short-term bank obligations classified as long-term at
December 31, 2002.
Senior Notes: The Company had $500 million of senior notes (the Notes)
outstanding at December 31, 2003 and December 31, 2002, which are registered
securities. The carrying amount of the Notes was $508 million and $511 million
at December 31, 2003 and December 31, 2002, respectively. The Notes mature in
March 2005, bear a semi-annual coupon of 6.625 percent, and are not redeemable
prior to maturity or subject to any sinking fund requirements. During the third
quarter of 2003, the Company entered a fixed to floating interest rate swap to
hedge changes in the fair value of the Notes. The Company recorded changes in
the fair value of the Notes since the inception of the interest rate swap.
Interest payments made or received under the interest rate swap agreement are
recorded as interest expense. At December 31, 2003, approximately $1 million of
unrealized gains were recorded as other long-term assets to recognize the fair
value of the interest rate swap. At December 31, 2003 and December 31, 2002, the
carrying amount of the Notes included $7 million and $11 million, respectively,
that related to a previous interest rate swap.
21
The Company had 795 million Japanese yen (translated to approximately $7
million) at December 31, 2003 and 885 million Japanese yen (translated to
approximately $7 million) at December 31, 2002 of borrowings outstanding from a
Japanese bank used to finance a facility construction project. The interest rate
on the borrowings is 2.10 percent and semi-annual principal payments are due
through 2012.
The Company has uncommitted Japanese credit facilities with several commercial
banks, which provided for borrowings and promissory notes discounting of up to
14.6 billion Japanese yen (translated to approximately $136 million) at December
31, 2003 and up to approximately 14.5 billion Japanese yen (translated to
approximately $122 million) at December 31, 2002. There were approximately $1
million and $7 million in borrowings outstanding under the Japanese credit
facilities at an interest rate of 1.38 percent at December 31, 2003 and December
31, 2002, respectively. Approximately $113 million and $102 million of notes
receivable were discounted at average interest rates of approximately 1.38
percent at December 31, 2003 and December 31, 2002, respectively. During the
first quarter of 2002, the Company repaid 6 billion Japanese yen (translated to
approximately $45 million at the date of repayment) of borrowings outstanding
with a syndicate of Japanese banks.
CONTRACTUAL OBLIGATIONS AND COMMITMENTS
The following table sets forth certain information concerning the Company's
obligations and commitments to make future payments. See Notes D, G and H to the
consolidated financial statements for additional information regarding the
Company's business combinations, long-term debt and lease arrangements.
PAYMENTS DUE BY PERIOD
- ------------------------------------------------------------------------------------------------------
LESS THAN 1-3 4-5 AFTER
(in millions) 1 YEAR YEARS YEARS 5 YEARS TOTAL
- ------------------------------------------------------------------------------------------------------
Long-term debt(5) $1,155 $ 5 $ 4 $1,164
- ------------------------------------------------------------------------------------------------------
Operating leases(6) $ 36 50 21 4 111
- ------------------------------------------------------------------------------------------------------
Purchase obligations(6)(7) 47 16 3 3 69
- ------------------------------------------------------------------------------------------------------
Minimum royalty obligations(6) $ 2 $ 6 $ 2 $ 7 $ 17
- ------------------------------------------------------------------------------------------------------
Certain of the Company's business combinations involve contingent consideration.
These payments, if and when made, are allocated to specific intangible asset
categories, including purchased research and development, with the remainder
assigned to goodwill as if the consideration had been paid as of the date of
acquisition. Payment of the additional consideration is generally contingent
upon the acquired companies reaching certain performance milestones, including
achieving specified revenue levels, product development targets or regulatory
approvals. At December 31, 2003 and December 31, 2002, the Company had accruals
for acquisition-related obligations of approximately $79 million and $195
million, respectively. These accruals were recorded primarily as
- ----------------------
(5) Long-term debt as reported in the consolidated balance sheets includes the
mark-to-market effect of interest rate swaps.
(6) In accordance with generally accepted accounted principles in the U.S.,
these obligations are not reflected in the consolidated balance sheets.
(7) These obligations relate primarily to inventory commitments entered in the
normal course of business.
22
adjustments to goodwill and purchased research and development. In addition, at
December 31, 2003, the maximum potential amount of future contingent
consideration (undiscounted) that the Company could be required to make
associated with its business combinations is approximately $500 million, 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
ranging from 2004 through 2013. The cumulative specified revenue level
associated with the maximum future contingent payments is approximately $1.3
billion. Since it is not possible to estimate when the acquired companies will
reach their performance milestones, or the amount of contingent consideration
based on future revenues, the maximum contingent consideration has not been
included in the table above.
CRITICAL ACCOUNTING POLICIES
The preparation of financial statements in conformity with accounting principles
generally accepted in the United States requires management to make estimates
and assumptions that affect the reported amounts of assets and liabilities, the
disclosure of contingent assets and liabilities at the date of the financial
statements, and the reported amounts of revenues and expenses during the
reporting period. Actual results could differ from those estimates. The Company
has formal accounting policies in place including those that address critical
and complex accounting areas. Note A to the consolidated financial statements
describes the significant accounting policies used in preparation of the
consolidated financial statements. The most significant areas involving
management judgments and estimates are described below.
REVENUE RECOGNITION: The Company's revenue primarily consists of the sale of
single-use disposable medical devices. Revenue is considered to be realized or
realizable and earned when all of the following criteria are met: persuasive
evidence of a sales arrangement exists; delivery has occurred or services have
been rendered; the price is fixed or determinable; and collectibility is
reasonably assured. These criteria are generally met at the time of shipment
when the risk of loss and title passes to the customer or distributor, unless a
consignment arrangement exists. Revenue from consignment arrangements is
recognized based on product usage indicating sales are complete.
The Company allows its customers to return defective or damaged products for
credit. The Company's estimate for sales returns is based upon contractual
commitments and historical trends and is recorded as a reduction to revenue.
The Company offers sales rebates and discounts to certain customers. Sales
rebates and discounts are treated as a reduction of revenue, with the
corresponding liability being classified as current. The Company estimates
rebates for products where there is sufficient historical information that can
be used to predict the volume of expected future rebates. If the Company is
unable to reasonably estimate the expected rebates, it records a liability for
the maximum rebate percentage offered.
The Company has entered certain agreements with group purchasing organizations
to sell its products to participating hospitals at pre-negotiated prices.
Revenue generated
23
from these agreements is recognized following the same revenue recognition
criteria discussed above.
INTANGIBLE ASSETS: Intangible assets are recorded at historical cost. Intangible
assets acquired in a business combination, including purchased research and
development, are recorded under the purchase method of accounting at their
estimated fair values at the date of acquisition. The fair values of acquired
intangible assets are determined by independent appraisers using information and
assumptions provided by management. Goodwill represents the excess purchase
price over the fair value of the net tangible and intangible assets acquired.
The Company's intangible assets are amortized using the straight-line method
over their useful lives, as applicable, as follows: patents and licenses, 2 to
20 years; definite-lived core and developed technology, 10 to 25 years; other
intangibles, various. In the first quarter of 2002, the Company ceased
amortization of its goodwill and certain other indefinite-lived intangible
assets in accordance with Statement No. 142. The Company had $830 million and
$843 million of net intangible assets that are subject to amortization at
December 31, 2003 and 2002, respectively, and $1,631 million and $1,524 million
of goodwill and other indefinite-lived intangible assets at December 31, 2003
and 2002, respectively.
The Company reviews intangible assets at least annually to determine if any
adverse conditions exist that would indicate impairment. Conditions that would
trigger a more frequent impairment assessment include, but are not limited to, a
significant adverse change in legal factors or business climate that could
affect the value of an asset, or an adverse action or assessment by a regulator.
If the carrying amount of an asset exceeds the sum of its undiscounted cash
flows, the carrying value is written down to fair value in the period
identified. Fair value is generally calculated as the present value of estimated
future cash flows using a risk-adjusted discount rate, which requires
significant management judgment with respect to revenue and expense growth
rates, and the selection and use of an appropriate discount rate. The remaining
useful life of intangible assets subject to amortization is evaluated at least
annually, or more frequently if certain indicators are present, to determine
whether events and circumstances warrant a revision to the remaining period of
amortization. If the estimate of an intangible asset's remaining useful life is
changed, the remaining carrying amount of the intangible asset is amortized
prospectively over the revised remaining useful life. Indefinite-lived
intangible assets are also reviewed at least annually for impairment by
calculating the fair value of the assets and comparing the calculated fair
values to the related carrying values.
Goodwill is reviewed each year during the second quarter for impairment, or more
frequently if certain indicators are present. Examples of such indicators that
would cause the Company to test goodwill for impairment between annual tests
include a significant adverse change in legal factors or in the business
climate, an adverse action or assessment by a regulator, unanticipated
competition, a loss of key personnel, or a more likely than not expectation that
a reporting unit or a significant portion of a reporting unit will be sold.
24
When conducting its annual impairment test of goodwill, the Company utilizes the
two-step approach prescribed under Statement No. 142. The first step requires a
comparison of the carrying value of the reporting units, as defined, to the fair
value of these units. The Company identified its six domestic divisions, which
in aggregate make up the U.S. operating segment, and its three international
operating segments as its reporting units for purposes of impairment testing. To
derive the carrying value of its reporting units, goodwill is assigned to the
reporting units that are expected to benefit from the respective business
combination. In addition, assets and liabilities, including corporate assets,
which relate to a reporting unit's operations and would be considered in
determining fair value, are allocated to the individual reporting units. Assets
and liabilities not directly related to a specific reporting unit, but from
which the reporting unit benefits, are primarily allocated based on the revenue
contribution of each reporting unit. Fair value is calculated as the present
value of estimated future cash flows using a risk-adjusted discount rate. If the
carrying amount of a reporting unit exceeds its fair value, the second step of
the goodwill impairment test would be performed to measure the amount of
impairment loss, if any. The second step of the goodwill impairment test
compares the implied fair value of reporting unit goodwill with the carrying
amount of that goodwill. Since the adoption of Statement No. 142, the Company
has not performed the second step of the impairment test because the fair value
of each reporting unit has exceeded its respective carrying value.
INVENTORIES: Inventories are stated at the lower of first-in, first-out cost or
market. Provisions for excess or expired inventory are primarily based on
management's estimates of forecasted sales levels. A significant change in the
timing and level of demand for the Company's products, as compared to forecasted
amounts, may result in the recording of additional provisions for excess or
expired inventory in the future. Provisions for inventory located in the
Company's manufacturing and distribution facilities are recorded as cost of
sales. Write-downs of consignment inventory due to physical inventory
adjustments are charged to selling, general and administrative expenses.
LEGAL COSTS: The Company is involved in various legal proceedings, including
intellectual property, breach of contract and product liability suits. In some
cases, the claimants seek damages, as well as other relief, which, if granted,
could require significant expenditures. The Company accrues costs of settlement,
damages, and, under certain conditions, costs of defense when such costs are
probable and estimable. Otherwise, such costs are expensed as incurred. As of
December 31, 2003, the range for litigation-related costs that can be estimated
is $16 million to $21 million. If the estimate of a probable loss is a range,
and no amount within the range is more likely, the minimum amount of the range
is accrued. The Company's total accrual for litigation-related costs as of
December 31, 2003 and December 31, 2002 was approximately $16 million and $9
million, respectively.
INCOME TAXES: The Company utilizes the asset and liability method for accounting
for income taxes. Under this method, deferred tax assets and liabilities are
determined based on differences between financial reporting and tax bases of
assets and liabilities. Deferred
25
tax assets and liabilities are measured using the enacted tax rates and laws
that will be in effect when the differences are expected to reverse.
The Company has recognized net deferred tax assets aggregating $94 million at
December 31, 2003 and $68 million at December 31, 2002. The assets relate
principally to the establishment of inventory and product-related reserves,
purchased research and development and net operating loss carryforwards. In
light of the Company's historical financial performance, the Company believes
that these assets will be substantially recovered.
The Company reduces its deferred tax assets by a valuation allowance if, based
upon the weight of available evidence, it is more likely than not that some
portion or all of the deferred tax assets will not be realized. Relevant
evidence, both positive and negative, is considered in determining the need for
a valuation allowance. Information evaluated includes the Company's financial
position and results of operations for the current and preceding years as well
as an evaluation of currently available information about future years.
The Company has provided for income taxes payable related to earnings of its
foreign subsidiaries that may be repatriated in the foreseeable future. Income
taxes are not provided on the unremitted earnings of the Company's foreign
subsidiaries where such earnings have been reinvested indefinitely in its
foreign operations. It is not practical to estimate the amount of income taxes
payable on the earnings that are reinvested indefinitely in foreign operations.
Unremitted earnings of the Company's foreign subsidiaries that are reinvested
indefinitely were $1,184 million and $1,046 million, at December 31, 2003 and
December 31, 2002, respectively.
In addition, the Company operates within multiple taxing jurisdictions and could
be subject to audit in these jurisdictions. These audits can involve complex
issues, which may require an extended period of time to resolve and may cover
multiple years. In management's opinion, adequate provisions for income taxes
have been made for all years subject to audit.
INVESTMENTS: Investments in companies over which Boston Scientific has the
ability to exercise significant influence are accounted for under the equity
method if Boston Scientific holds 50 percent or less of the voting stock.
Investments in companies over which Boston Scientific does not have the ability
to exercise significant influence are accounted for under the cost method. At
December 31, 2003, the Company held investments in connection with approximately
60 strategic alliances totaling $558 million. At December 31, 2002, the Company
had investments in approximately 35 entities, totaling $210 million. These
assets primarily represent investments in privately held and publicly traded
equity securities.
The Company accounts for its public investments based on the quoted market price
at the end of the reporting period. The Company reviews its public investments,
which have a readily determinable fair value and are accounted for as
available-for-sale securities, for indicators of other than temporary impairment
on a quarterly basis. Factors that the
26
Company considers when determining whether an impairment is other than temporary
include the Company's ability and intent to hold an investment for a reasonable
period of time sufficient for a market recovery up to the cost of the
investment, the extent to which the fair value of a security is below cost, the
circumstances that give rise to the impairment, forecasted market price recovery
and the length of time the investment's fair value is below its carrying amount.
If the Company determines that an impairment is other than temporary, then an
impairment loss is recognized in earnings equal to the difference between the
investment's cost and its fair value.
The Company accounts for its investments for which fair value is not readily
determinable in accordance with Accounting Principles Board Opinion No. 18, The
Equity Method of Accounting for Investments in Common Stock. Each reporting
period, the Company evaluates its investments without a readily determinable
fair value for impairment if an event or circumstance occurs that is likely to
have a significant adverse effect on the fair value of the investment. Examples
of such events or circumstances include a significant deterioration in earnings
performance, credit rating, asset quality or business prospects of the investee;
a significant adverse change in the regulatory, economic or technological
environment of the investee; and a significant concern about the investee's
ability to continue as a going concern. If the Company identifies an impairment
indicator, the Company will determine the fair value of the investment and
compare it to its carrying value. If the fair value of the investment is less
than its carrying value, the investment is impaired and a determination is made
as to whether the impairment is other than temporary. An impairment is deemed
other than temporary unless the Company has the ability and intent to hold an
investment for a reasonable period of time sufficient for a market recovery up
to the cost of the investment. Further, evidence must indicate that the cost of
the investment is recoverable within a reasonable period of time. For an other
than temporary impairment, an impairment loss is recognized in earnings equal to
the difference between the investment's cost and its fair value.
MARKET RISK DISCLOSURES
The Company operates globally, and its earnings and cash flow are exposed to
market risk from changes in currency exchange rates and interest rates. The
Company addresses these risks through a risk management program that includes
the use of derivative instruments. The program is operated pursuant to
documented corporate risk management policies. The Company does not enter into
any derivative transactions for speculative purposes. Gains and losses on
derivative instruments substantially offset losses and gains on underlying
hedged exposures. Furthermore, the Company manages its credit exposure to
nonperformance on such derivative instruments by entering into contracts with a
diversified group of major financial institutions to limit the amount of credit
exposure to any one institution.
Currency risk consists primarily of foreign currency denominated firm
commitments, forecasted foreign currency denominated intercompany and
third-party transactions, and net investments in certain subsidiaries. The
Company uses both non-derivative (primarily foreign currency denominated
borrowings) and derivative instruments to
27
manage its earnings and cash flow exposure to changes in currency exchange
rates. The Company had currency derivative instruments outstanding in the
notional amount of $1,724 million and $1,318 million at December 31, 2003 and
December 31, 2002, respectively. The Company recorded $15 million of assets and
$84 million of liabilities to recognize the fair value of these instruments at
December 31, 2003, compared to $15 million of assets and $27 million of
liabilities at December 31, 2002. A 10 percent appreciation in the U.S. dollar's
value relative to the hedged currencies would increase the derivative
instruments' fair value by $105 million and $75 million at December 31, 2003 and
December 31, 2002, respectively. A 10 percent depreciation in the U.S. dollar's
value relative to the hedged currencies would decrease the derivative
instruments' fair value by $128 million and $91 million at December 31, 2003 and
December 31, 2002, respectively. Any increase or decrease in the fair value of
the Company's currency exchange rate sensitive derivative instruments would be
substantially offset by a corresponding decrease or increase in the fair value
of the hedged underlying asset, liability or cash flow.
The Company's earnings and cash flow exposure to interest rates consists of
fixed and floating rate debt instruments that are denominated primarily in U.S.
dollars and Japanese yen. The Company uses interest rate derivative instruments
to manage its exposure to interest rate movements and to reduce borrowing costs
by converting floating rate debt into fixed rate debt or fixed rate debt into
floating rate debt. The Company had interest rate derivative instruments
outstanding in the notional amount of $500 million and $63 million at December
31, 2003 and December 31, 2002, respectively. The fair values of these
instruments recorded on the Company's consolidated balance sheets at December
31, 2003 and December 31, 2002 are not material. A 100 basis point increase in
global interest rates would decrease the derivative instruments' fair value by
$7 million at December 31, 2003, compared to an immaterial amount at December
31, 2002. A 100 basis point decrease in global interest rates would increase the
derivative instruments' fair value by $7 million at December 31, 2003, compared
to an immaterial amount at December 31, 2002. Any increase or decrease in the
fair value of the Company's interest rate sensitive derivative instruments would
be substantially offset by a corresponding decrease or increase in the fair
value of the hedged underlying liability.
LEGAL MATTERS
The interventional medicine market in which the Company primarily participates
is in large part 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. Intellectual
property litigation to defend or create market advantage is, however, 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 of not only individual cases, but
28
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 the Company's 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 companies infringe patents owned
or licensed by the Company.
In management's opinion, the Company is not currently involved in any legal
proceeding other than those specifically identified in Note L to the
consolidated financial statements herein, which, individually or in the
aggregate, could have a material effect on the financial condition, operations
and/or cash flows of the Company. Additionally, legal costs associated with
asserting the Company's patent portfolio and defending against claims that the
Company's products infringe the intellectual property rights of others are
significant; legal costs associated with non-patent litigation and compliance
activities continue to be substantial. Depending on the prevalence, significance
and complexity of these matters, the Company's legal provisions could be
adversely affected in the future.
PRODUCT LIABILITY CLAIMS
At the beginning of the third quarter of 2002, the Company elected to become
substantially self-insured with respect to general and product liability claims.
As a result of economic factors impacting the insurance industry, meaningful
liability insurance coverage became unavailable while the cost of insurance
became economically prohibitive. In the normal course of its business, product
liability claims are asserted against the Company. The Company accrues
anticipated costs of litigation and loss for product liability claims based on
historical experience, or to the extent they are probable and estimable. Losses
for claims in excess of the limits of purchased insurance are recorded in
earnings at the time and to the extent they are probable and estimable. The
Company's accrual for product liability claims is $15 million and $4 million at
December 31, 2003 and December 31, 2002, respectively. The accrual at December
31, 2003 includes an $8 million reserve for product liability settlements
recorded during the third quarter of 2003. Product liability claims against the
Company will likely be asserted in the future related to events not known to
management at the present time. The absence of third-party insurance coverage
increases the Company's exposure to unanticipated claims or adverse decisions.
However, based on product liability losses experienced in the past, the election
to become substantially self-insured is not expected to have a material impact
on future operations.
Management believes that the Company's risk management practices, including
limited insurance coverage, are reasonably adequate to protect against
anticipated general and
29
product liability losses. However, unanticipated catastrophic losses could have
a material adverse impact on the Company's financial position, results of
operations and liquidity.
CAUTIONARY STATEMENTS FOR PURPOSES OF THE SAFE HARBOR PROVISIONS OF THE PRIVATE
SECURITIES LITIGATION REFORM ACT OF 1995
This report contains forward-looking statements. The Company desires to take
advantage of the Safe Harbor Provisions of the Private Securities Litigation
Reform Act of 1995 and is including this statement for the express purpose of
availing itself of the protections of the safe harbor with respect to all
forward-looking statements. Forward-looking statements discussed in this report
include, but are not limited to, statements with respect to, and the Company's
performance may be affected by:
- volatility in the coronary stent market, competitive offerings and the
timing of receipt of regulatory approvals to market existing and
anticipated drug-eluting stent technology and other coronary and
peripheral stent platforms;
- the Company's ability to achieve significant growth in revenue, gross
profit, earnings and cash flow in 2004 following the launch of the
Express(2) coronary stent in the Japanese market and the TAXUS
drug-eluting stent system in the U.S., and to launch the TAXUS stent
system in Japan in late 2005 or early 2006;
- the Company's ability to prevent disruptions to its TAXUS manufacturing
processes and to maintain inventory levels consistent with customer
demand around the world;
- the overall rate of physician conversion to drug-eluting stents, the
expected slow but steady increase in drug-eluting stent adoption rates
in Europe and the related decline in bare metal stent sales;
- the impact of the introduction of drug-eluting stents and third-party
alliances on the size of the coronary stent market and distribution of
share within the coronary stent market in the U.S. and around the
world;
- the results of drug-eluting stent clinical trials undertaken by the
Company or its competitors;
- the Company's ability to capitalize on the opportunity in the
drug-eluting stent market for significant growth in revenue and
earnings and to achieve sustained worldwide market leadership positions
through reinvestment in the Company's drug-eluting stent program;
- the Company's ability to take advantage of its position as one of two
early entrants in the U.S. drug-eluting stent market, to anticipate
competitor products as they enter the market and to take advantage of
opportunities that exist in the markets it serves;
- changes in the mix of the Company's coronary stent platforms in the
U.S. and Japan;
- the Company's ability to manage research and development and other
operating expenses, including royalty obligations in light of
significant expected revenue growth;
- the ability of the Company to manage inventory levels, accounts
receivable and gross margins and to react effectively to the changing
managed care environment, reimbursement models and worldwide economic
and political conditions;
- the Company's ability to integrate the acquisitions and other strategic
alliances consummated since early 2001;
30
- the Company's ability to successfully complete planned clinical
trials and to develop and launch products on a timely basis within cost
estimates, including products resulting from purchased research and
development;
- the timing, size and nature of strategic initiatives, market
opportunities and research and development platforms available to the
Company and the ultimate cost and success of these initiatives;
- the Company's ability to maintain a 24 percent effective tax rate,
excluding net special charges, during 2004 and to substantially recover
its net deferred tax assets;
- the ability of the Company to meet its projected cash needs over the
next twelve months, to maintain borrowing flexibility and to refinance
its borrowings beyond the next twelve months;
- risks associated with international operations including compliance
with local legal and regulatory requirements;
- the potential effect of foreign currency fluctuations on revenues,
expenses and resulting margins;
- the effect of litigation, risk management practices and compliance
activities on the Company's loss contingency, legal provision and cash
flow; and
- the impact of stockholder, patent, product liability, Medinol Ltd. and
other litigation, as well as the ultimate outcome of the U.S.
Department of Justice investigation.
Several important factors, in addition to the specific factors discussed in
connection with each forward-looking statement individually, could affect the
future results and growth rates of the Company and could cause those results and
rates to differ materially from those expressed in the forward-looking
statements contained in this report. These additional factors include, among
other things, future economic, competitive, reimbursement and regulatory
conditions, new product introductions, demographic trends, third-party
intellectual property, financial market conditions and future business decisions
of the Company and its competitors, all of which are difficult or impossible to
predict accurately and many of which are beyond the control of the Company.
Therefore, the Company wishes to caution each reader of this report to consider
carefully these factors as well as the specific factors discussed with each
forward-looking statement in this report and as disclosed in the Company's
filings with the Securities and Exchange Commission. These factors, in some
cases, have affected, and in the future (together with other factors) could
affect, the ability of the Company to implement its business strategy and may
cause actual results to differ materially from those contemplated by the
statements expressed in this report.
31
CONSOLIDATED STATEMENTS OF OPERATIONS
(in millions, except per share data)
Year Ended December 31, 2003 2002 2001
- ----------------------------------------------------- -------- -------- --------
Net sales $ 3,476 $ 2,919 $ 2,673
Cost of products sold 961 870 919
-------- -------- --------
Gross profit 2,515 2,049 1,754
Selling, general and administrative expenses 1,171 1,002 926
Amortization expense 89 72 136
Royalties 54 36 35
Research and development expenses 452 343 275
Purchased research and development 37 85 282
Litigation-related charges (credits), net 15 (99)
-------- -------- --------
1,818 1,439 1,654
-------- -------- --------
Operating income 697 610 100
Other income (expense):
Interest expense (46) (43) (59)
Other, net (8) (18) 3
-------- -------- --------
Income before income taxes 643 549 44
Income taxes 171 176 98
-------- -------- --------
Net income (loss) $ 472 $ 373 $ (54)
======== ======== ========
Net income (loss) per common share - basic $ 0.57 $ 0.46 $ (0.07)
======== ======== ========
Net income (loss) per common share - assuming dilution $ 0.56 $ 0.45 $ (0.07)
======== ======== ========
See notes to the consolidated financial statements.
32
CONSOLIDATED BALANCE SHEETS
(in millions)
December 31, 2003 2002
- --------------------------------------------- -------- --------
ASSETS
Current assets:
Cash and cash equivalents $ 671 $ 260
Trade accounts receivable, net 542 435
Inventories 281 243
Deferred income taxes 245 168
Prepaid expenses and other current assets 141 102
-------- --------
Total current assets 1,880 1,208
Property, plant and equipment, net 744 636
Goodwill 1,275 1,168
Technology - core, net 556 553
Technology - developed, net 188 217
Patents, net 333 316
Other intangibles, net 109 113
Investments 558 210
Other assets 56 29
-------- --------
$ 5,699 $ 4,450
======== ========
See notes to the consolidated financial statements.
33
CONSOLIDATED BALANCE SHEETS
(in millions, except share data)
December 31, 2003 2002
- -------------------------------------------------------------------- --------- ---------
LIABILITIES AND STOCKHOLDERS' EQUITY
Current liabilities:
Commercial paper $ 547 $ 88
Bank obligations 6
Accounts payable 78 66
Accrued expenses 597 639
Income taxes payable 85 102
Other current liabilities 80 28
--------- ---------
Total current liabilities 1,393 923
Long-term debt 1,172 847
Deferred income taxes 151 100
Other long-term liabilities 121 113
Commitments and contingencies
Stockholders' equity:
Preferred stock, $ .01 par value - authorized 50,000,000 shares,
none issued and outstanding
Common stock, $ .01 par value - authorized 1,200,000,000 shares,
829,764,826 shares issued at December 31, 2003; authorized
600,000,000 shares, 414,882,413 shares issued at December 31, 2002 8 4
Additional paid-in capital 1,225 1,250
Treasury stock, at cost - 3,502,850 shares at December 31, 2003
and 3,490,451 shares at December 31, 2002 (111) (54)
Retained earnings 1,789 1,394
Accumulated other comprehensive income (loss):
Foreign currency translation adjustment (50) (119)
Unrealized gain (loss) on available-for-sale securities, net 50 (2)
Unrealized loss on derivative financial instruments, net (48) (4)
Minimum pension liability (1) (2)
--------- ---------
Total stockholders' equity 2,862 2,467
--------- ---------
$ 5,699 $ 4,450
========= =========
See notes to the consolidated financial statements.
34
CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY
(in millions, except share data)
Common Stock
------------------ Additional
Shares Par Paid-In Treasury Deferred Retained
Issued Value Capital Stock Compensation Earnings
----------- ----- --------- ------- ------------ --------
BALANCE AT DECEMBER 31, 2000 414,882,413 $ 4 $ 1,210 $ (282) $ (15) $ 1,116
Comprehensive loss:
Net loss (54)
Other comprehensive income, net of tax:
Foreign currency translation adjustment
Net change in equity investments
Net change in derivative financial instruments
Issuance of common stock (6) 75 (27)
Issuance of common stock for acquisitions 13 36 (9) (4)
Cancellation of restricted stock (2) 2
Tax benefit relating to incentive stock option
and employee stock purchase plans 8
Amortization of deferred compensation 12
----------- ----- -------- ------- ---------- -------
BALANCE AT DECEMBER 31, 2001 414,882,413 4 1,225 (173) (10) 1,031
Comprehensive income:
Net income
Other comprehensive income (expense), net of tax: 373
Foreign currency translation adjustment
Net change in equity investments
Net change in derivative financial instruments
Net change in minimum pension liability
Issuance of common stock (3) 120 (10)
Cancellation of restricted stock (1)
Tax benefit relating to incentive stock option
and employee stock purchase plans 28
Amortization of deferred compensation 10
----------- ----- -------- ------- ---------- -------
BALANCE AT DECEMBER 31, 2002 414,882,413 4 1,250 (54) 1,394
Comprehensive income:
Net income 472
Other comprehensive income (expense), net of tax:
Foreign currency translation adjustment
Net change in equity investments
Net change in derivative financial instruments
Net change in minimum pension liability
Issuance of common stock (179) 512 (73)
Issuance of restricted stock 1 (1)
Stock split effected in the form of a stock dividend 414,882,413 4 (4)
Purchases of common stock for treasury (570)
Tax benefit relating to incentive stock option
and employee stock purchase plans 154
Amortization of deferred compensation 1
----------- ----- -------- ------- ---------- -------
BALANCE AT DECEMBER 31, 2003 829,764,826 $ 8 $ 1,225 $ (111) $ $ 1,789
=========== ===== ======== ====== ========== =======
Accumulated Other Comprehensive
Comprehensive Income
Income (Loss) (Loss)
----------------- -------------
BALANCE AT DECEMBER 31, 2000 $ (98)
Comprehensive loss:
Net loss $ (54)
Other comprehensive income, net of tax:
Foreign currency translation adjustment 11 11
Net change in equity investments 8 8
Net change in derivative financial instruments 17 17
Issuance of common stock
Issuance of common stock for acquisitions
Cancellation of restricted stock
Tax benefit relating to incentive stock option
and employee stock purchase plans
Amortization of deferred compensation
------------- ------------
BALANCE AT DECEMBER 31, 2001 (62) $ (18)
------------
Comprehensive income:
Net income $ 373
Other comprehensive income (expense), net of tax:
Foreign currency translation adjustment 12 12
Net change in equity investments (27) (27)
Net change in derivative financial instruments (48) (48)
Net change in minimum pension liability (2) (2)
Issuance of common stock
Cancellation of restricted stock
Tax benefit relating to incentive stock option
and employee stock purchase plans
Amortization of deferred compensation
------------- ------------
BALANCE AT DECEMBER 31, 2002 (127) $ 308
------------
Comprehensive income:
Net income $ 472
Other comprehensive income (expense), net of tax:
Foreign currency translation adjustment 69 69
Net change in equity investments 52 52
Net change in derivative financial instruments (44) (44)
Net change in minimum pension liability 1 1
Issuance of common stock
Issuance of restricted stock
Stock split effected in the form of a stock dividend
Purchases of common stock for treasury
Tax benefit relating to incentive stock option
and employee stock purchase plans
Amortization of deferred compensation
------------- ------------
BALANCE AT DECEMBER 31, 2003 $ (49) $ 550
============= ============
See notes to the consolidated financial statements
35
CONSOLIDATED STATEMENTS OF CASH FLOWS
(in millions)
Year Ended December 31, 2003 2002 2001
- ----------------------- ----- ----- -----
OPERATING ACTIVITIES:
Net income (loss) $ 472 $ 373 $ (54)
Adjustments to reconcile net income (loss) to cash provided by operating activities:
Gain on sale of equity investments (26) (11)
Depreciation and amortization 196 161 232
Deferred income taxes (31) 142 8
Purchased research and development 37 85 282
Tax benefit relating to stock option and employee stock purchase plans 154 28 8
Increase (decrease) in cash flows from operating assets and liabilities:
Trade accounts receivable (74) (51) (6)
Inventories (21) 63 53
Prepaid expenses and other assets 6 (38) (9)
Accounts payable and accrued expenses 96 56 28
Accrual for restructuring and merger-related charges (11) (49) (31)
Other liabilities (19) (17) (22)
Other, net (18) 9 12
----- ----- -----
Cash provided by operating activities 787 736 490
INVESTING ACTIVITIES:
Purchases of property, plant and equipment (188) (112) (121)
Proceeds from sales of property, plant and equipment 1 2 5
Purchases of held-to-maturity short-term investments (130) (17)
Maturities of held-to-maturity short-term investments 66
Purchases of available-for-sale securities (105) (12) (3)
Sales of available-for-sale securities 1 31 20
Payments related to prior year acquisitions (283)
Acquisitions of businesses, net of cash acquired (13) (187) (620)
Payments for acquisitions of and/or investments in certain technologies, net (220) (190) (81)
----- ----- -----
Cash used for investing activities (871) (485) (800)
FINANCING ACTIVITIES:
Net increase (decrease) in commercial paper 915 (11) 43
Net (payments on) proceeds from borrowings
on revolving credit facilities (116) (237) 360
Proceeds from notes payable and long-term borrowings 2 13 4
Payments on notes payable, capital leases and long-term borrowings (8) (48) (12)
Proceeds from issuances of shares of common stock 260 107 42
Acquisitions of treasury stock (570)
Other, net 4 1
----- ----- -----
Cash provided by (used for) financing activities 487 (175) 437
Effect of foreign exchange rates on cash 8 4 (1)
----- ----- -----
Net increase in cash and cash equivalents 411 80 126
Cash and cash equivalents at beginning of year 260 180 54
----- ----- -----
Cash and cash equivalents at end of year $ 671 $ 260 $ 180
===== ===== =====
Supplemental cash flow information
Cash paid during the year for:
Income taxes $ 30 $ 36 $ 108
Interest 52 43 59
See notes to the consolidated financial statements.
36
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
NOTE A - SIGNIFICANT ACCOUNTING POLICIES
PRINCIPLES OF CONSOLIDATION: The consolidated financial statements include the
accounts of Boston Scientific Corporation (Boston Scientific or the Company) and
its subsidiaries, substantially all of which are wholly owned. Investments in
companies over which Boston Scientific has the ability to exercise significant
influence are accounted for under the equity method if Boston Scientific holds
50 percent or less of the voting stock. Investments in companies over which
Boston Scientific does not have the ability to exercise significant influence
are accounted for under the cost method. Due to the ongoing litigation between
Medinol Ltd. (Medinol) and the Company, and the lack of available financial
information, the Company believes that it no longer has the ability to exercise
significant influence over Medinol's operating and financial policies.
Therefore, during the third quarter of 2002, Boston Scientific changed to the
cost method of accounting for its investment in Medinol from the equity method.
At December 31, 2003, the Company had a 22 percent ownership interest in Medinol
at a carrying value of approximately $24 million.
ACCOUNTING ESTIMATES: The preparation of financial statements in conformity with
accounting principles generally accepted in the United States (U.S.) requires
management to make estimates and assumptions that affect the reported amounts of
assets and liabilities, the disclosure of contingent assets and liabilities at
the date of the financial statements, and the reported amounts of revenues and
expenses during the reporting period. Actual results could differ from those
estimates.
CASH AND CASH EQUIVALENTS: The Company considers all highly liquid investments
purchased with a maturity of three months or less to be cash equivalents.
CONCENTRATIONS OF CREDIT RISK: Financial instruments that potentially subject
the Company to concentrations of credit risk consist primarily of cash and cash
equivalents, marketable securities, debt securities, derivative instrument
contracts and accounts receivable. The Company invests its excess cash primarily
in high-quality securities and limits the amount of credit exposure to any one
financial institution. The Company's investment policy limits exposure to
concentrations of credit risk and changes in market conditions. Counterparties
to financial instruments expose the Company to credit-related losses in the
event of nonperformance. The Company transacts derivative instrument contracts
with major financial institutions to limit its credit exposure.
The Company provides credit, in the normal course of business, primarily to
hospitals, private and governmental institutions, and health care agencies,
clinics and doctors' offices. The Company performs ongoing credit evaluations of
its customers and maintains allowances for potential credit losses.
REVENUE RECOGNITION: The Company's revenue primarily consists of the sale of
single-use disposable medical devices. Revenue is considered to be realized or
realizable and earned when all of the following criteria are met: persuasive
evidence of a sales arrangement exists; delivery has occurred or services have
been rendered; the price is fixed or determinable; and collectibility is
reasonably assured. These criteria are generally met at the time of shipment
when the risk of
37
loss and title passes to the customer or distributor, unless a consignment
arrangement exists. Revenue from consignment arrangements is recognized based on
product usage indicating sales are complete.
The Company allows its customers to return defective or damaged products for
credit. The Company's estimate for sales returns is based upon contractual
commitments and historical trends and is recorded as a reduction to revenue.
The Company offers sales rebates and discounts to certain customers. Sales
rebates and discounts are treated as a reduction of revenue, with the
corresponding liability being classified as current. The Company estimates
rebates for products where there is sufficient historical information that can
be used to predict the volume of expected future rebates. If the Company is
unable to reasonably estimate the expected rebates, it records a liability for
the maximum rebate percentage offered.
The Company has entered certain agreements with group purchasing organizations
to sell its products to participating hospitals at pre-negotiated prices.
Revenue generated from these agreements is recognized following the same revenue
recognition criteria discussed above.
INTANGIBLE ASSETS: Intangible assets are recorded at historical cost. Intangible
assets acquired in a business combination, including purchased research and
development, are recorded under the purchase method of accounting at their
estimated fair values at the date of acquisition. The fair values of acquired
intangible assets are determined by independent appraisers using information and
assumptions provided by management. Goodwill represents the excess purchase
price over the fair value of the net tangible and intangible assets acquired.
The Company's intangible assets are amortized using the straight-line method
over their useful lives, as applicable, as follows: patents and licenses, 2 to
20 years; definite-lived core and developed technology, 10 to 25 years; other
intangibles, various. In the first quarter of 2002, the Company ceased
amortization of its goodwill and certain other indefinite-lived intangible
assets in accordance with Financial Accounting Standards Board (FASB) Statement
No. 142, Goodwill and Other Intangible Assets.
The Company reviews intangible assets at least annually to determine if any
adverse conditions exist that would indicate impairment. Conditions that would
trigger a more frequent impairment assessment include, but are not limited to, a
significant adverse change in legal factors or business climate that could
affect the value of an asset, or an adverse action or assessment by a regulator.
If the carrying amount of an asset exceeds the sum of its undiscounted cash
flows, the carrying value is written down to fair value in the period
identified. Fair value is generally calculated as the present value of estimated
future cash flows using a risk-adjusted discount rate, which requires
significant management judgment with respect to revenue and expense growth
rates, and the selection and use of an appropriate discount rate. The remaining
useful life of intangible assets subject to amortization is evaluated at least
annually, or more frequently if certain indicators are present, to determine
whether events and circumstances warrant a revision to the remaining period of
amortization. If the estimate of an intangible asset's remaining useful life is
changed, the remaining carrying amount of the intangible asset is amortized
prospectively over the revised remaining useful life.
38
Indefinite-lived intangible assets are also reviewed at least annually for
impairment by calculating the fair value of the assets and comparing the
calculated fair values to the related carrying values.
Goodwill is reviewed each year during the second quarter for impairment, or more
frequently if certain indicators are present. Examples of such indicators that
would cause the Company to test goodwill for impairment between annual tests
include a significant adverse change in legal factors or in the business
climate, an adverse action or assessment by a regulator, unanticipated
competition, a loss of key personnel, or a more likely than not expectation that
a reporting unit or a significant portion of a reporting unit will be sold.
When conducting its annual impairment test of goodwill, the Company utilizes the
two-step approach prescribed under Statement No. 142. The first step requires a
comparison of the carrying value of the reporting units, as defined, to the fair
value of these units. The Company identified its six domestic divisions, which
in aggregate make up the U.S. operating segment, and its three international
operating segments as its reporting units for purposes of impairment testing. To
derive the carrying value of its reporting units, goodwill is assigned to the
reporting units that are expected to benefit from the respective business
combination. In addition, assets and liabilities, including corporate assets,
which relate to a reporting unit's operations and would be considered in
determining fair value, are allocated to the individual reporting units. Assets
and liabilities not directly related to a specific reporting unit, but from
which the reporting unit benefits, are primarily allocated based on the revenue
contribution of each reporting unit. Fair value is calculated as the present
value of estimated future cash flows using a risk-adjusted discount rate. If the
carrying amount of a reporting unit exceeds its fair value, the second step of
the goodwill impairment test would be performed to measure the amount of
impairment loss, if any. The second step of the goodwill impairment test
compares the implied fair value of reporting unit goodwill with the carrying
amount of that goodwill. Since the adoption of Statement No. 142, the Company
has not performed the second step of the impairment test because the fair value
of each reporting unit has exceeded its respective carrying value.
INVENTORIES: Inventories are stated at the lower of first-in, first-out cost or
market. Provisions for excess or expired inventory are primarily based on
management's estimates of forecasted sales levels. A significant change in the
timing and level of demand for the Company's products, as compared to forecasted
amounts, may result in the recording of additional provisions for excess or
expired inventory in the future. Provisions for inventory located in the
Company's manufacturing and distribution facilities are recorded as cost of
sales. Write-downs of consignment inventory due to physical inventory
adjustments are charged to selling, general and administrative expenses. These
amounts were not material to the consolidated financial statements during 2003,
2002 and 2001.
PROPERTY, PLANT AND EQUIPMENT: Property, plant, equipment and leaseholds are
stated at historical cost. Expenditures for maintenance and repairs are charged
to expense; additions and improvements are capitalized. The Company provides for
depreciation using the straight-line method at rates that are intended to
depreciate the cost of these assets over their estimated useful lives. Buildings
and improvements are depreciated over a 20 to 40 year life; equipment, furniture
and fixtures are depreciated over a 3 to 7 year life; leasehold improvements are
39
amortized on a straight-line basis over the shorter of the useful life of the
improvement or the term of the lease.
The Company receives grant money equal to a percentage of expenditures on
eligible capital equipment, which is recorded as deferred income and recognized
ratably over the life of the underlying assets. The grant money would be
repayable, in whole or in part, should the Company fail to meet certain
employment goals. At December 31, 2003 and 2002, the Company had recorded
deferred income of approximately $17 million relating to these grants.
LEGAL COSTS: The Company is involved in various legal proceedings, including
intellectual property, breach of contract and product liability suits. In some
cases, the claimants seek damages, as well as other relief, which, if granted,
could require significant expenditures. The Company accrues costs of settlement,
damages, and, under certain conditions, costs of defense when such costs are
probable and estimable. Otherwise, such costs are expensed as incurred. As of
December 31, 2003, the range for litigation-related costs that can be estimated
is $16 million to $21 million. If the estimate of a probable loss is a range,
and no amount within the range is more likely, the minimum amount of the range
is accrued. The Company's total accrual for litigation-related costs as of
December 31, 2003 and December 31, 2002 was approximately $16 million and $9
million, respectively.
PRODUCT LIABILITY COSTS: The Company is substantially self-insured with respect
to general and product liability claims. The Company accrues anticipated costs
of litigation and loss for product liability claims based on historical
experience, or to the extent that they are probable and estimable. Losses for
claims in excess of the limits of purchased insurance are recorded at the time
and to the extent they are probable and estimable. The Company's accrual for
product liability claims is $15 million and $4 million at December 31, 2003 and
December 31, 2002, respectively. The accrual at December 31, 2003 includes an $8
million reserve for product liability settlements recorded during the third
quarter of 2003.
INCOME TAXES: The Company utilizes the asset and liability method for accounting
for income taxes. Under this method, deferred tax assets and liabilities are
determined based on differences between financial reporting and tax bases of
assets and liabilities. Deferred tax assets and liabilities are measured using
the enacted tax rates and laws that will be in effect when the differences are
expected to reverse.
The Company reduces its deferred tax assets by a valuation allowance if, based
upon the weight of available evidence, it is more likely than not that some
portion or all of the deferred tax assets will not be realized. Relevant
evidence, both positive and negative, is considered in determining the need for
a valuation allowance. Information evaluated includes the Company's financial
position and results of operations for the current and preceding years as well
as an evaluation of currently available information about future years.
The Company has provided for income taxes payable related to earnings of its
foreign subsidiaries that may be repatriated in the foreseeable future. Income
taxes are not provided on the unremitted earnings of the Company's foreign
subsidiaries where such earnings have been reinvested indefinitely in its
foreign operations. It is not practical to estimate the amount of
40
income taxes payable on the earnings that are reinvested indefinitely in foreign
operations. Unremitted earnings of the Company's foreign subsidiaries that are
reinvested indefinitely were $1,184 million and $1,046 million, at December 31,
2003 and December 31, 2002, respectively.
In addition, the Company operates within multiple taxing jurisdictions and could
be subject to audit in these jurisdictions. These audits can involve complex
issues, which may require an extended period of time to resolve and may cover
multiple years. In management's opinion, adequate provisions for income taxes
have been made for all years subject to audit.
INVESTMENTS: At December 31, 2003, the Company held investments in connection
with approximately 60 strategic alliances totaling $558 million. At December 31,
2002, the Company had investments in approximately 35 entities, totaling $210
million. These assets primarily represent investments in privately held and
publicly traded equity securities.
The Company accounts for its public investments based on the quoted market price
at the end of the reporting period. The Company reviews its public investments,
which have a readily determinable fair value and are accounted for as
available-for-sale securities, for indicators of other than temporary impairment
on a quarterly basis. Factors that the Company considers when determining
whether an impairment is other than temporary include the Company's ability and
intent to hold an investment for a reasonable period of time sufficient for a
market recovery up to the cost of the investment, the extent to which the fair
value of a security is below cost, the circumstances that give rise to the
impairment, forecasted market price recovery and the length of time the
investment's fair value is below its carrying amount. If the Company determines
that an impairment is other than temporary, then an impairment loss is
recognized in earnings equal to the difference between the investment's cost and
its fair value.
The Company accounts for its investments for which fair value is not readily
determinable in accordance with Accounting Principles Board (APB) Opinion No.
18, The Equity Method of Accounting for Investments in Common Stock. Each
reporting period, the Company evaluates its investments without a readily
determinable fair value for impairment if an event or circumstance occurs that
is likely to have a significant adverse effect on the fair value of the
investment. Examples of such events or circumstances include a significant
deterioration in earnings performance, credit rating, asset quality or business
prospects of the investee; a significant adverse change in the regulatory,
economic or technological environment of the investee; and a significant concern
about the investee's ability to continue as a going concern. If the Company
identifies an impairment indicator, the Company will determine the fair value of
the investment and compare it to its carrying value. If the fair value of the
investment is less than its carrying value, the investment is impaired and a
determination is made as to whether the impairment is other than temporary. An
impairment is deemed other than temporary unless the Company has the ability and
intent to hold an investment for a reasonable period of time sufficient for a
market recovery up to the cost of the investment. Further, evidence must
indicate that the cost of the investment is recoverable within a reasonable
period of time. For an other than temporary impairment, an impairment loss is
recognized in earnings equal to the difference between the investment's cost and
its fair value.
WARRANTY OBLIGATION: The Company estimates the costs that may be incurred under
its warranties based on historical experience and records a liability at the
time the product is sold. Factors that affect the Company's warranty liability
include the number of units sold, historical
41
and anticipated rates of warranty claims and cost per claim. The Company
periodically assesses the adequacy of its recorded warranty liabilities and
adjusts the amounts as necessary. Expense attributable to warranties was not
material to the results of operations for 2003, 2002 and 2001.
TRANSLATION OF FOREIGN CURRENCY: All assets and liabilities of foreign
subsidiaries are translated at the rate of exchange at year end while sales and
expenses are translated at the average rates in effect during the year. The net
effect of these translation adjustments is shown in the accompanying financial
statements as a component of stockholders' equity. Foreign currency transaction
gains and losses are included in other, net on the consolidated statements of
operations.
FINANCIAL INSTRUMENTS: Investments in debt securities are classified as
held-to-maturity if the Company has the positive intent and ability to hold the
securities to maturity. Held-to-maturity securities are stated at amortized
cost, adjusted for amortization of premiums and accretion of discounts to
maturity. Investments in debt securities or equity securities that have a
readily determinable fair value that are bought and held principally for the
purpose of selling them in the near term are classified as trading securities.
The Company has no investments that are considered to be trading securities at
December 31, 2003 and December 31, 2002. All other investments are classified as
available-for-sale. Unrealized gains and temporary losses for available-for-sale
securities are excluded from earnings and are reported, net of tax, as a
separate component of stockholders' equity until realized. The cost of
available-for-sale securities is based on the specific identification method.
Realized gains and losses on sales of available-for-sale securities are computed
based upon initial cost adjusted for any other than temporary declines in fair
value.
The Company recognizes all derivative financial instruments in the consolidated
financial statements at fair value, regardless of the purpose or intent for
holding the instrument, in accordance with FASB Statement No. 133, Accounting
for Derivative Instruments and Hedging Activities. Changes in the fair value of
derivative instruments are recorded in earnings unless hedge accounting criteria
are met. For derivative instruments designated as fair value hedges, the changes
in fair value of both the derivative instrument and the hedged item are recorded
in earnings. For derivative instruments designated as cash flow and net
investment hedges, the effective portions of changes in the fair value of the
derivative are recorded in other comprehensive income. The ineffective portions
of hedges are recognized in earnings.
SHIPPING AND HANDLING COSTS: The Company does not generally bill customers for
shipping and handling of its products. Shipping and handling costs of $55
million in 2003, $44 million in 2002 and $43 million in 2001 are included in
selling, general and administrative expenses.
RESEARCH AND DEVELOPMENT: Research and development costs, including new product
development programs, regulatory compliance and clinical research, are expensed
as incurred.
STOCK COMPENSATION ARRANGEMENTS: The Company accounts for its stock compensation
arrangements under the intrinsic value method in accordance with APB Opinion No.
25, Accounting for Stock Issued to Employees, and FASB Interpretation No. 44,
Accounting for Certain Transactions involving Stock Compensation. The Company
has adopted the disclosure-only
42
provisions of FASB Statement No. 123, Accounting for Stock-Based Compensation.
Any compensation cost on fixed awards with pro rata vesting is recognized on a
straight-line basis over the award's vesting period.
If the Company had elected to recognize compensation expense for the granting of
options under stock option plans based on the fair value at the grant dates
consistent with the methodology prescribed by Statement No. 123, net income
(loss) and net income (loss) per share would have been reported as the following
pro forma amounts:
YEAR ENDED DECEMBER 31, 2003 2002 2001
(in millions, except per share data) -------- --------- --------
Net income (loss), as reported $ 472 $ 373 $ (54)
Add: Stock-based employee compensation
expense included in net income (loss), 1 6 8
net of related tax effects
Less: Total stock-based employee
compensation expense determined under fair
value based method for all awards, net of
related tax effects (62) (48) (48)
-------- --------- --------
Pro forma net income (loss) $ 411 $ 331 $ (94)
======== ========= ========
Net income (loss) per common share -
Basic:
Reported $ 0.57 $ 0.46 $ (0.07)
Pro forma $ 0.50 $ 0.41 $ (0.12)
-------- --------- --------
Assuming Dilution:
Reported $ 0.56 $ 0.45 $ (0.07)
Pro forma $ 0.49 $ 0.40 $ (0.12)
-------- --------- --------
PENSION PLANS: The Company maintains pension plans covering certain
international employees, which the Company accounts for in accordance with FASB
Statement No. 87, Employers' Accounting for Pensions. The assets, liabilities
and costs associated with these plans were not material in 2003, 2002 and 2001.
NET INCOME (LOSS) PER COMMON SHARE: Net income (loss) per common share is based
upon the weighted average number of common shares and common share equivalents
outstanding each year.
NEW ACCOUNTING STANDARDS: In January 2003, the FASB issued Interpretation No.
46, Consolidation of Variable Interest Entities. In December 2003, the FASB
issued a revised interpretation. Interpretation No. 46 requires variable
interest entities to be consolidated if the total equity investment at risk is
not sufficient to permit the entity to finance its activities without financial
support from other parties or the equity investors lack certain specified
characteristics of a controlling financial interest. The guidelines of
Interpretation No. 46 will become applicable for the Company during the first
quarter of 2004. The Company is in the process of determining the effect of
adoption of Interpretation No. 46, but does not believe it will materially
impact the Company's consolidated financial statements.
43
During the second quarter of 2003, the Company adopted FASB Statement No. 150,
Accounting for Certain Financial Instruments with Characteristics of Both
Liabilities and Equity. Statement No. 150 establishes standards for how an
issuer classifies and measures certain financial instruments with
characteristics of both liabilities and equity. It requires that an issuer
classify a financial instrument within its scope as a liability. The Company's
adoption of Statement No. 150 had no material impact on the Company's
consolidated financial statements.
During the third quarter of 2003, the Company adopted FASB Statement No. 149,
Amendment of Statement 133 on Derivative Instruments and Hedging Activities.
Statement No. 149 amends and clarifies accounting for derivative instruments,
including certain derivative instruments embedded in other contracts, and for
hedging activities under Statement No. 133. The Company's adoption of Statement
No. 149 had no material impact on the Company's consolidated financial
statements.
RECLASSIFICATIONS: Certain prior years' amounts have been reclassified to
conform to the current year's presentation.
NOTE B - CASH, CASH EQUIVALENTS AND INVESTMENTS IN DEBT AND EQUITY SECURITIES
Cash, cash equivalents and investments, stated at fair value, consisted of the
following:
GROSS GROSS
FAIR UNREALIZED UNREALIZED AMORTIZED
(in millions) VALUE GAINS LOSSES COST
---- --- -- ---
DECEMBER 31, 2003
Cash and cash equivalents $671 $671
Short-term debt securities
(91 days-1 year) 81 81
Equity securities (with a readily
determinable fair value) 216 $82 $2 136
---- --- -- ----
$968 $82 $2 $888
---- --- -- ----
DECEMBER 31, 2002
Cash and cash equivalents $260 $260
Short-term debt securities
(91 days-1 year) 17 17
Equity securities (with a readily
determinable fair value) 14 $3 17
---- --- -- ----
$291 $3 $294
---- --- -- ----
The Company has entered strategic alliances with a number of privately held and
publicly traded companies. Many of these alliances involve equity investments by
the Company. The Company enters these strategic alliances to broaden its product
technology portfolio and to strengthen and expand the Company's reach into
existing and new markets. Many of these companies are in the developmental stage
and have not yet commenced their principal
44
operations. The Company's exposure to loss related to its strategic alliances is
generally limited to its equity investments, notes receivable and intangible
assets associated with these alliances.
At December 31, 2003, the Company held investments in connection with a variety
of strategic alliances (approximately 50 entities) totaling $342 million for
which the fair value was not readily determinable. At December 31, 2002, the
Company had investments in approximately 30 entities, totaling $196 million for
which the fair value was not readily determinable. These assets primarily
represent investments in privately held equity securities or investments where
an observable quoted market value does not exist.
Short-term debt securities are classified as a component of prepaid expenses and
other current assets in the Company's consolidated balance sheets.
NOTE C - OTHER BALANCE SHEET INFORMATION
Components of selected captions in the consolidated balance sheets at December
31 consisted of:
(in millions) 2003 2002
------ ------
TRADE ACCOUNTS RECEIVABLE
Accounts receivable $ 603 $ 493
Less: allowances 61 58
------ ------
$ 542 $ 435
====== ======
INVENTORIES
Finished goods $ 175 $ 145
Work-in-process 63 48
Raw materials 43 50
------ ------
$ 281 $ 243
====== ======
PROPERTY, PLANT AND EQUIPMENT
Land $ 69 $ 60
Buildings and improvements 470 412
Equipment, furniture and fixtures 798 645
------ ------
1,337 1,117
Less: accumulated depreciation and amortization 593 481
------ ------
$ 744 $ 636
====== ======
ACCRUED EXPENSES
Acquisition-related obligations $ 79 $ 195
Payroll and related liabilities 216 180
Other 302 264
------ ------
$ 597 $ 639
====== ======
NOTE D - BUSINESS COMBINATIONS
The Company recorded purchased research and development of $37 million, $85
million and $282 million in 2003, 2002 and 2001, respectively. The 2003
purchased research and development primarily related to acquisitions consummated
in prior years and the 2003 acquisition of InFlow Dynamics, Inc. (InFlow). The
purchased research and development associated with the prior years' acquisitions
resulted from consideration that was contingent at the date of acquisition, but
45
was earned during 2003, primarily related to the acquisition of Embolic
Protection, Inc. (EPI). The 2002 and 2001 purchased research and development
related primarily to acquisitions consummated in each of these years.
During 2003, the Company paid approximately $13 million in cash and recorded
approximately $12 million of acquisition-related obligations to acquire InFlow.
During 2002, the Company paid approximately $187 million in cash to acquire
Smart Therapeutics, Inc. (Smart), BEI Medical Systems Company, Inc. (BEI) and
Enteric Medical Technologies, Inc. (EMT). During 2001, the Company paid
approximately $620 million in cash and issued approximately 3.8 million shares
valued at $40 million to acquire RadioTherapeutics Corporation (RTC), Cardiac
Pathways Corporation (CPC), Interventional Technologies, Inc. (IVT), Quanam
Medical Corporation (Quanam), Catheter Innovations, Inc. (CI) and EPI. These
acquisitions were intended to strengthen the Company's leadership position in
interventional medicine. The acquisitions were accounted for using the purchase
method of accounting. The consolidated financial statements include the
operating results for each acquired entity from its respective date of
acquisition. Pro forma information is not presented, as the acquired companies'
results of operations prior to their date of acquisition are not material,
individually or in the aggregate, to the Company.
On February 12, 2003, the Company completed its acquisition of InFlow. InFlow is
a stent technology development company that focuses on reducing the rate of
restenosis, improving the visibility of stents during procedures and enhancing
the overall vascular compatibility of the stent. The acquisition was intended to
provide the Company with an expanded stent technology and intellectual property
portfolio.
On December 3, 2002, the Company completed its acquisition of Smart. Smart
develops self-expanding technologies for intracranial therapies. The acquisition
was intended to strengthen the Company's leadership position in interventional
stroke therapies and became part of the Company's Neurovascular division.
On June 27, 2002, the Company completed its tender offer relating to its
acquisition of BEI. BEI designs, manufactures and markets less-invasive
technology used by gynecologists to treat excessive uterine bleeding due to
benign causes. The acquisition was intended to expand the Company's product
offerings in the area of women's health and became part of the Company's
Endosurgery group.
On June 13, 2002, the Company completed its acquisition of EMT. EMT designs,
manufactures and markets Enteryx(TM), a liquid polymer technology for the
treatment of gastroesophageal reflux disease (GERD). The acquisition was
intended to expand the Company's Endosurgery product offerings in the GERD
market.
On December 11, 2001, the Company completed its acquisition of RTC. RTC develops
and manufactures proprietary radiofrequency-based therapeutic devices in the
field of interventional oncology for the ablation (destruction) of various forms
of soft tissue lesions (tumors). The acquisition was intended to expand the
Company's oncology technology portfolio.
On August 9, 2001, the Company completed its acquisition of CPC. CPC designs and
markets less-invasive systems to diagnose and treat cardiac tachyarrhythmias
(abnormally rapid heart
46
rhythms). The acquisition was intended to strengthen and broaden the Company's
product offerings in the field of electrophysiology.
On April 2, 2001, the Company completed its acquisition of IVT. IVT develops,
manufactures and markets less-invasive devices for use in interventional
cardiology, including the Cutting Balloon(R) microsurgical dilatation device.
The acquisition was intended to strengthen the Company's market leadership
position in interventional cardiology.
On March 30, 2001, the Company completed its acquisition of Quanam. Quanam
develops medical devices using novel polymer technology, with a concentration on
drug-delivery stent systems for use in cardiovascular applications. The
acquisition was intended to broaden the Company's drug-delivery portfolio.
On March 5, 2001, the Company completed its acquisition of CI. CI develops and
manufactures catheter-based venous access products used by clinicians to treat
critically ill patients through the delivery of chemotherapy drugs, antibiotics
and nutritional support. The acquisition was intended to expand the Company's
technology portfolio in the venous access market.
On February 27, 2001, the Company completed its acquisition of EPI. EPI develops
embolic protection filters for use in interventional cardiovascular procedures
and also develops carotid endovascular therapies for the prevention of stroke.
The acquisition was intended to accelerate the Company's entry into the embolic
protection market.
Certain of the Company's business combinations involve contingent consideration.
These payments, if and when made, are allocated to specific intangible asset
categories, including purchased research and development, with the remainder
assigned to goodwill as if the consideration had been paid as of the date of
acquisition. Payment of the additional consideration is generally contingent
upon the acquired companies reaching certain performance milestones, including
achieving specified revenue levels, product development targets or regulatory
approvals. At December 31, 2003 and December 31, 2002, the Company had accruals
for acquisition-related obligations of approximately $79 million and $195
million, respectively. These accruals were recorded primarily as adjustments to
goodwill and purchased research and development. In addition, at December 31,
2003, the maximum potential amount of future contingent consideration
(undiscounted) that the Company could be required to make associated with its
business combinations is approximately $500 million, 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 ranging from
2004 through 2013. The cumulative specified revenue level associated with the
maximum future contingent payments is approximately $1.3 billion.
The Company has recorded approximately $191 million of intangible assets not
subject to amortization associated with its 2003 and 2002 acquisitions, which is
comprised solely of goodwill. The goodwill is not deductible for tax purposes,
and has been allocated to the Company's reportable segments as follows: $177
million to the U.S. and $14 million to Europe.
47
The following table summarizes the purchase price assigned to the intangible
assets subject to amortization acquired in connection with the 2003 and 2002
acquisitions and the weighted average amortization periods:
AMOUNT WEIGHTED AVERAGE
(in millions) ASSIGNED AMORTIZATION PERIOD
------ ------------
Technology - core $ 25 25 years
Technology - developed 24 10 years
Patents 18 15 years
Other 3 19 years
------ --------
TOTAL $ 70 17 years
====== ========
The amounts paid for each acquisition have been allocated to the assets acquired
and liabilities assumed based on their fair values at the date of acquisition.
The estimated excess of purchase price over the fair value of the net tangible
assets acquired was allocated to identifiable intangible assets based on
detailed valuations. The Company's purchased research and development charges
are based upon these valuations. The valuation of purchased research and
development represents the estimated fair value at the date of acquisition
related to in-process projects. As of the date of acquisition, the in-process
projects had not yet reached technological feasibility and had no alternative
future uses. The primary basis for determining the technological feasibility of
these projects is obtaining regulatory approval to market the product in an
applicable geographical region. Accordingly, the value attributable to these
projects, which had not yet obtained regulatory approval, was expensed in
conjunction with the acquisition. If the projects are not successful, or
completed in a timely manner, the Company may not realize the financial benefits
expected for these projects.
The income approach was used to establish the fair values of purchased research
and development. This approach establishes fair value by estimating the
after-tax cash flows attributable to the in-process project over its useful life
and then discounting these after-tax cash flows back to a present value. Revenue
estimates were based on estimates of relevant market sizes, expected market
growth rates, expected trends in technology and expected product introductions
by competitors. In arriving at the value of the in-process research and
development projects, the Company considered, among other factors, the
in-process project's stage of completion, the complexity of the work completed
as of the acquisition date, the costs already incurred, the projected costs to
complete, the contribution of core technologies and other acquired assets, the
expected introduction date and the estimated useful life of the technology. The
discount rate used to arrive at a present value as of the date of acquisition
was based on the time value of money and medical technology investment risk
factors. For the purchased research and development programs acquired in
connection with the 2003 acquisition, a risk-adjusted discount rate of 24
percent was utilized to discount the projected cash flows. For the purchased
research and development programs acquired in connection with the 2002
acquisitions, risk-adjusted discount rates ranging from 17 percent to 26 percent
were utilized to discount the projected cash flows. For the purchased research
and development programs acquired in connection with the 2001 acquisitions,
risk-adjusted discount rates ranging from 16 percent to 28 percent were utilized
to discount the projected cash flows. The Company believes that the
48
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 in-process projects acquired in connection with the Company's 2003
acquisition were not significant to the Company. The most significant in-process
projects acquired in connection with the Company's 2002 acquisitions include
EMT's Enteryx technology for the treatment of GERD and Smart's atherosclerosis
stent, which collectively represent approximately 82 percent of the 2002
in-process value. Enteryx is a patented liquid polymer for the treatment of
GERD. During the second quarter of 2003, the Company completed the Enteryx
in-process project and received FDA approval for this technology. The total cost
to complete the project was approximately $6 million. The atherosclerosis stent
is a self-expanding nitinol stent designed to treat narrowing of the arteries
around the brain. The Company continues to pursue the development of Smart's
atherosclerosis stent and believes it has a reasonable chance of completing the
project. The Company has spent approximately $3 million on this project as of
December 31, 2003 and estimates costs of approximately $2 million to complete
the project. The Company expects that it will receive FDA approval for this
technology in 2005. These estimates are consistent with the Company's estimates
at the time of acquisition.
The most significant in-process projects acquired in connection with the
Company's 2001 acquisitions include IVT's next-generation Cutting Balloon, IVT's
next-generation Infiltrator(R) transluminal drug-delivery catheter and EPI's
next-generation embolic protection devices, which collectively represent
approximately 63 percent of the 2001 in-process value. The Cutting Balloon is a
novel balloon angioplasty device with mounted scalpels that relieve stress in
the artery, reducing the force necessary to expand the vessel. This contributes
to less inadvertent arterial trauma and injury as compared to standard balloon
angioplasty. The Company continues to pursue the development of IVT's
next-generation Cutting Balloon and believes it has a reasonable chance of
completing the project. The Company has spent approximately $3 million on this
project as of December 31, 2003 and estimates costs of approximately $4 million
to complete the project. The Company expects that it will receive FDA approval
for this technology in 2005, which is later than anticipated at the time of
acquisition, primarily as a result of the Company's continuing focus on its
drug-eluting stent program. The Company does not expect that this delay will
have a material impact on its operations. The Infiltrator transluminal
drug-delivery catheter is designed to deliver therapeutic agents directly into
the wall of the artery with high levels of efficiency. During the second quarter
of 2002, due to alternative drug-delivery products available to the Company, the
Company substantially canceled the future development of the Infiltrator
project. The Company does not believe that the cancellation of this project will
have a material impact on its future operations. The embolic protection devices
are filters that are mounted on a guidewire and are used to capture embolic
material that is dislodged during cardiovascular interventions. During the
second quarter of 2003, the Company completed EPI's FilterWire EX embolic
protection device in-process project and received FDA approval for this
technology. The total cost to complete the project was approximately $20
million.
NOTE E - GOODWILL AND OTHER INTANGIBLE ASSETS
Effective January 1, 2002, the Company fully adopted the provisions of Statement
No. 142. Statement No. 142 requires that goodwill and intangible assets with
indefinite useful lives no
49
longer be amortized, but instead be tested for impairment at least annually.
The following table provides comparative earnings and earnings per share had the
non-amortization provisions of Statement No. 142 been applied in all periods
presented:
Year Ended December 31,
(in millions, except per share data) 2003 2002 2001
- ---------------------------------------------------------------------------------------------
Reported net income (loss) $ 472 $ 373 $ (54)
Add back: amortization of goodwill, net of tax 21
Add back: amortization of indefinite-lived
intangible assets, net of tax 10
--------- --------- ---------
Adjusted net income (loss) $ 472 $ 373 $ (23)
========= ========= =========
Basic:
Weighted average shares outstanding 821.0 814.2 802.8
Net income (loss) per common share:
Reported $ 0.57 $ 0.46 $ (0.07)
Adjusted $ 0.57 $ 0.46 $ (0.03)
========= ========= =========
Assuming dilution:
Weighted average shares outstanding 845.4 830.0 802.8
Net income (loss) per common share:
Reported $ 0.56 $ 0.45 $ (0.07)
Adjusted $ 0.56 $ 0.45 $ (0.03)
========= ========= =========
The following table provides the gross carrying amount of all intangible assets
and the related accumulated amortization for intangible assets subject to
amortization at December 31:
2003 2002
Gross Carrying Accumulated Gross Carrying Accumulated
(in millions) Amount Amortization Amount Amortization
- -------------------------------------------------------------------------------------
Amortized intangible
assets:
Technology - core $ 222 $ 22 $ 210 $ 13
Technology - developed 346 158 344 127
Patents 472 139 427 111
Other intangibles 207 98 198 85
------ ------ ------ ------
Total $1,247 $ 417 $1,179 $ 336
====== ====== ====== ======
Unamortized intangible
assets:
Goodwill $1,275 $1,168
Technology- core 356 356
------ ------
Total $1,631 $1,524
====== ======
The Company's core technology that is not subject to amortization represents
technical processes, intellectual property and/or institutional understanding
acquired by the Company that is fundamental to the ongoing operation of the
Company's business, and which has no limit to its useful life. The Company's
core technology that is not subject to amortization is primarily comprised of
certain purchased stent and balloon technology, which is foundational to the
Company's continuing operation within the interventional cardiology market and
other markets within interventional medicine. All other core technology is
amortized over its estimated useful life.
50
Total amortization expense for the year ended December 31, 2003 was $89 million
as compared to $72 million and $136 million for the years ended December 31,
2002 and 2001, respectively. The Company's amortization expense in 2001 includes
a $24 million pre-tax write-down of intangible assets.
The following table provides estimated amortization expense for each of the five
succeeding fiscal years based upon the Company's intangible asset portfolio at
December 31, 2003:
Estimated
Amortization Expense
Fiscal Year (in millions)
----------- --------------------
2004 $ 85
2005 80
2006 78
2007 76
2008 63
The following table provides changes in the carrying amount of goodwill by
segment for the year ended December 31, 2003 and 2002:
United Inter-
(in millions) States Europe Japan Continental
- ----------------------------------------------------------------------------------
Balance as of December 31, 2001 $ 759 $ 95 $ 41 $ 33
Purchase price adjustments (28) (1)
Goodwill acquired 85 5
Contingent consideration 177
Foreign currency translation 2
------ ------ ------ ------
Balance as of December 31, 2002 993 101 41 33
Purchase price adjustments (22) (2)
Goodwill acquired 14
Contingent consideration 117
------ ------ ------ ------
Balance as of December 31, 2003 $1,088 $ 115 $ 39 $ 33
====== ====== ====== ======
The purchase price adjustments relate primarily to adjustments to properly
reflect the fair value of deferred tax assets and liabilities acquired in
connection with the 2001 and 2002 acquisitions.
NOTE F - GLOBAL OPERATIONS STRATEGY
During 2000, the Company approved and committed to a global operations strategy
consisting of three strategic initiatives designed to increase productivity and
enhance innovation. The global operations strategy included a plant network
optimization initiative, a manufacturing process control initiative, and a
supply chain optimization initiative.
The plant network optimization initiative has created a better allocation of the
Company's resources by forming a more effective network of manufacturing and
research and development facilities. The initiative resulted in the
consolidation of manufacturing operations along product lines and the shifting
of production to the Company's facilities in Miami and Ireland, and to contract
manufacturing. The plant network optimization initiative included the
discontinuation
51
of manufacturing activities at three facilities in the U.S. During 2000, the
Company recorded a $58 million pre-tax charge to cost of sales for severance and
related costs associated with the plant network optimization initiative. The
approximately 1,700 affected employees included manufacturing, manufacturing
support and management employees. During 2001, the Company recorded pre-tax
expense of approximately $62 million as cost of sales, primarily related to
transition costs and accelerated depreciation on fixed assets whose useful lives
were reduced as a result of the plant network optimization initiative. During
2002, the Company recorded pre-tax expense of approximately $23 million as cost
of sales for transition costs associated with the plant network optimization
initiative and abnormal production variances related to underutilized plant
capacity. The Company substantially completed the plant network optimization
initiative during the second quarter of 2002.
The manufacturing process control initiative involved the strengthening of the
Company's technical manufacturing resources to improve quality, reduce cost and
accelerate time to market. As a result, the Company has improved its
manufacturing efficiencies and yields. Due to the achievement of operational
efficiencies and its continued efforts to manage costs, during the second
quarter of 2002, the Company approved and committed to a workforce reduction
plan, impacting approximately 250 manufacturing, manufacturing support and
management employees. As a result, during the second quarter of 2002, the
Company recorded a $6 million pre-tax charge to cost of sales for severance and
related costs. The Company substantially completed the workforce reduction
during the fourth quarter of 2002.
The supply chain optimization initiative consisted of procurement and inventory
management programs, which have reduced inventory levels, lowered
inventory holding costs, and reduced inventory write-offs.
The Company did not record any significant expenses in 2003 related to its
global operations strategy.
As of December 31, 2003, the Company has made cash outlays of approximately $164
million since the inception of the global operations strategy. The cash outlays
included severance and outplacement costs, transition costs, and capital
expenditures. The Company has substantially completed its 2000 global operations
strategy and the anticipated cost savings have been achieved. During 2003, the
Company achieved pre-tax operating savings, relative to the strategy's base year
of 1999, of approximately $250 million as compared to savings of $220 million
and $130 million in 2002 and 2001, respectively, relative to the base year of
1999. These savings have been realized primarily as reduced cost of sales.
Savings to date have been impacted by the erosion of average selling prices on
certain products, changes in product mix, and foreign currency fluctuations.
The Company accrued the severance and related costs associated with the global
operations strategy in accordance with Staff Accounting Bulletin No. 100,
Restructuring and Impairment Charges, and Emerging Issues Task Force Issue No.
94-3, Liability Recognition for Certain Employee Termination Benefits and Other
Costs to Exit an Activity (Including Certain Costs Incurred in a Restructuring).
All other costs associated with the global operations strategy were expensed as
incurred. As of December 31, 2003, the Company does not have any significant
accruals remaining for its global operations strategy.
52
The activity impacting the accrual for the global operations strategy is
summarized in the table below:
Charges to Balance Payments Balance Charges to Payments Balance Payments Balance
operations at made in at operations made in at made in at
(in millions) in 2000 12/31/00 2001 12/31/01 in 2002 2002 12/31/02 2003 12/31/03
- --------------------------------------------------------------------------------------------------------------------------------
GLOBAL OPERATIONS
STRATEGY
- --------------------------------------------------------------------------------------------------------------------------------
Plant network
optimization initiative:
Workforce reductions $58 $58 $(23) $35 $(32) $ 3 $(3)
- --------------------------------------------------------------------------------------------------------------------------------
Manufacturing process
control initiative:
Workforce reductions $6 $ (5) $ 1 $(1)
- --------------------------------------------------------------------------------------------------------------------------------
Total:
Workforce reductions $58 $58 $(23) $35 $6 $(37) $ 4 $(4)
- --------------------------------------------------------------------------------------------------------------------------------
NOTE G - BORROWINGS AND CREDIT ARRANGEMENTS
The Company's borrowings at December 31 consisted of:
(in millions) 2003 2002
------ ------
Commercial paper - short-term $ 547 $ 88
Bank obligations - short-term 6
Commercial paper - long-term 456
Long-term debt - fixed rate 514 517
Long-term debt - floating rate 194 320
Capital leases - long-term (see Note H) 8 10
------ ------
Revolving Credit Facilities: At December 31, 2003, the Company's revolving
credit facilities totaled $1,220 million, consisting of a $600 million 364-day
credit facility that contains an option to convert into a one-year term loan
expiring in May 2005, a $600 million credit facility that terminates in August
2006, and a $20 million uncommitted credit facility. Use of the borrowings are
unrestricted and the borrowings are unsecured. In January 2004, the Company
increased its 364-day credit facility to $645 million.
The revolving credit facilities provide borrowing capacity and support the
Company's commercial paper. The Company had approximately $1,003 million and $88
million of commercial paper outstanding at December 31, 2003 and December 31,
2002, respectively, at weighted average interest rates of 1.20 percent and 1.50
percent, respectively. The Company had no outstanding revolving credit facility
borrowings at December 31, 2003 compared to $113 million at December 31, 2002,
at a weighted average interest rate of 0.58 percent.
In addition, the Company had a revolving credit and security facility, which is
secured by the Company's domestic trade receivables, that provides an additional
$200 million of borrowing capacity and terminates in August 2004. The maximum
amount available for borrowing under
53
this facility changes based upon the amount of eligible receivables,
concentration of eligible receivables and other factors. The Company had
approximately $194 million and $197 million of borrowings outstanding under its
revolving credit and security facility at December 31, 2003 and December 31,
2002, respectively. The borrowings bore interest rates of 1.44 percent and 1.89
percent at December 31, 2003 and December 31, 2002, respectively. Certain
significant changes in the quality of the Company's receivables may cause an
amortization event under this facility. An amortization event may require the
Company to immediately repay borrowings under the facility. The financing
structure required the Company to create a wholly owned entity, which is
consolidated by the Company. This entity purchases U.S. trade accounts
receivable from the Company and then borrows from two third-party financial
institutions using these receivables as collateral. The transactions remain on
the Company's balance sheet because the Company has the right to prepay any
borrowings outstanding, allowing the Company to retain effective control over
the receivables. Accordingly, pledged receivables and the corresponding
borrowings are included as trade accounts receivable, net and bank obligations,
respectively, on the Company's consolidated balance sheets.
The Company has the ability and intent to refinance a portion of its short-term
debt on a long-term basis through its revolving credit facilities. The Company
expects that a minimum of $650 million of its short-term obligations, including
$456 million of commercial paper and $194 million of bank obligations, will
remain outstanding beyond the next twelve months and, accordingly, has
classified this portion as long-term borrowings at December 31, 2003, compared
to $320 million of short-term bank obligations classified as long-term at
December 31, 2002.
Senior Notes: The Company had $500 million of senior notes (the Notes)
outstanding at December 31, 2003 and December 31, 2002, which are registered
securities. The carrying amount of the Notes was $508 million and $511 million
at December 31, 2003 and December 31, 2002, respectively. The Notes mature in
March 2005, bear a semi-annual coupon of 6.625 percent, and are not redeemable
prior to maturity or subject to any sinking fund requirements. During the third
quarter of 2003, the Company entered a fixed to floating interest rate swap to
hedge changes in the fair value of the Notes. The Company recorded changes in
the fair value of the Notes since the inception of the interest rate swap.
Interest payments made or received under the interest rate swap agreement are
recorded as interest expense. At December 31, 2003, approximately $1 million of
unrealized gains were recorded as other long-term assets to recognize the fair
value of the interest rate swap. At December 31, 2003 and December 31, 2002, the
carrying amount of the Notes included $7 million and $11 million, respectively,
that related to a previous interest rate swap.
The Company had 795 million Japanese yen (translated to approximately $7
million) at December 31, 2003 and 885 million Japanese yen (translated to
approximately $7 million) at December 31, 2002 of borrowings outstanding from a
Japanese bank used to finance a facility construction project. The interest rate
on the borrowings is 2.10 percent and semi-annual principal payments are due
through 2012.
The Company has uncommitted Japanese credit facilities with several commercial
banks, which provided for borrowings and promissory notes discounting of up to
14.6 billion Japanese yen (translated to approximately $136 million) at December
31, 2003 and up to approximately 14.5 billion Japanese yen (translated to
approximately $122 million) at December 31, 2002. There were
54
approximately $1 million and $7 million in borrowings outstanding under the
Japanese credit facilities at an interest rate of 1.38 percent at December 31,
2003 and December 31, 2002, respectively. Approximately $113 million and $102
million of notes receivable were discounted at average interest rates of
approximately 1.38 percent at December 31, 2003 and December 31, 2002,
respectively. During the first quarter of 2002, the Company repaid 6 billion
Japanese yen (translated to approximately $45 million at the date of repayment)
of borrowings outstanding with a syndicate of Japanese banks.
In addition, the Company had other outstanding bank obligations of $3 million
and $2 million at December 31, 2003 and December 31, 2002, respectively.
NOTE H - LEASES
Rent expense amounted to $48 million in 2003, $42 million in 2002 and $39
million in 2001. Future minimum rental commitments as of December 31, 2003 under
noncancelable operating lease agreements are as follows:
OPERATING
YEAR ENDED DECEMBER 31, (in millions) LEASES
- -------------------------------------- -------
2004 $ 36
2005 30
2006 20
2007 12
2008 9
Thereafter 4
-------
TOTAL MINIMUM LEASE PAYMENTS $ 111
=======
At December 31, 2003, the Company had approximately $11 million in future
minimum lease payments associated with its noncancelable capital leases. Of the
$11 million, approximately $8 million is classified as a component of long-term
debt and approximately $1 million is included as a component of current bank
obligations on the Company's consolidated balance sheets. The remaining $2
million represents future interest payments.
NOTE I - FAIR VALUE OF FINANCIAL INSTRUMENTS
The following methods and assumptions were used by the Company in estimating its
fair value disclosures for financial instruments. However, considerable judgment
is required in interpreting market data to develop the estimates of fair value.
Accordingly, the estimates presented herein are not necessarily indicative of
the amounts that the Company could realize in a current market exchange.
CASH AND CASH EQUIVALENTS: The carrying amounts reported in the consolidated
balance sheets for cash and cash equivalents are valued at cost, which
approximates their fair value.
INVESTMENTS: The fair values for debt and equity securities are based on quoted
market prices when readily determinable.
55
COMMERCIAL PAPER AND BANK OBLIGATIONS: The carrying amounts of the Company's
borrowings under its commercial paper program and its financing agreements
approximate their fair value.
LONG-TERM DEBT: The fair value of the Company's fixed rate long-term debt is
estimated based on quoted market prices. The carrying amounts of the Company's
floating rate long-term debt approximate their fair value.
DERIVATIVE INSTRUMENTS: The fair values of derivative instruments are estimated
based on the amount that the Company would receive or pay to terminate the
agreements at the reporting date. The Company had foreign exchange forward and
option contracts and cross currency interest rate swap contracts outstanding in
the notional amounts of $1,724 million and $1,318 million as of December 31,
2003 and December 31, 2002, respectively. In addition, the Company had interest
rate swap contracts outstanding in the notional amounts of $500 million and $63
million as of December 31, 2003 and December 31, 2002, respectively.
The carrying amounts and fair values of the Company's financial instruments at
December 31, 2003 and December 31, 2002 are as follows:
2003 2002
------------------- -------------------
CARRYING FAIR CARRYING FAIR
(in millions) AMOUNT VALUE AMOUNT VALUE
------ ------ ------ ------
ASSETS:
Cash, cash equivalents and investments
with a readily determinable fair value $ 968 $ 968 $ 291 $ 291
Foreign exchange contracts 15 15 15 15
Interest rate swap contracts 1 1
LIABILITIES:
Commercial paper - short-term $ 547 $ 547 $ 88 $ 88
Bank obligations - short-term 6 6
Commercial paper - long-term 456 456
Long-term debt - fixed rate 514 532 517 544
Long-term debt - floating rate 194 194 320 320
Foreign exchange contracts 84 84 22 22
Cross currency interest rate
swap contracts 5 5
NOTE J - DERIVATIVE INSTRUMENTS AND HEDGING ACTIVITIES
The Company operates globally and its earnings and cash flow are exposed to
market risk from changes in currency exchange rates and interest rates. The
Company addresses these risks through a risk management program that includes
the use of derivative financial instruments. The program is operated pursuant to
documented corporate risk management policies. The Company does not enter into
any derivative transaction for speculative purposes.
Currency Transaction Hedging: The Company manages its currency transaction
exposures on a consolidated basis to take advantage of natural offsets. The
Company uses foreign currency denominated borrowings and currency forward
contracts to manage the remaining transaction exposure. These currency forward
contracts are not designated as cash flow, fair value or net investment hedges
under Statement No. 133, are marked-to-market with changes in fair value
56
recorded to earnings, and are entered into for periods consistent with currency
transaction exposures, generally one to six months. These derivative instruments
do not subject the Company's earnings or cash flow to material risk since gains
and losses on these derivatives offset losses and gains on the assets and
liabilities being hedged.
Currency Translation Hedging: The Company uses currency forward and option
contracts to reduce the risk that the Company's earnings and cash flow,
associated with forecasted foreign currency denominated intercompany and
third-party transactions, will be affected by changes in currency exchange
rates. The Company, however, may be impacted by changes in currency exchange
rates related to any unhedged portion. The success of the hedging program
depends, in part, on forecasts of transaction activity in various currencies
(primarily Japanese yen, euro, British pound sterling, Australian dollar and
Canadian dollar). The Company may experience unanticipated currency exchange
gains or losses to the extent that there are timing differences between
forecasted and actual activity during periods of currency volatility. The
effective portion of any change in the fair value of the derivative instruments,
designated as cash flow hedges, is recorded in other comprehensive income until
the third-party transaction associated with the hedged forecasted transaction
occurs. Once the third-party transaction associated with the hedged forecasted
transaction occurs, the effective portion of any related gain or loss on the
cash flow hedge is reclassified from other comprehensive income to earnings. In
the event the hedged forecasted transaction does not occur, or it becomes
probable that it will not occur, the effective portion of any gain or loss on
the related cash flow hedge would be reclassified from other comprehensive
income to earnings at that time. The Company did not recognize material gains or
losses resulting from either hedge ineffectiveness or changes in forecast
probability during 2003 or 2002. The Company recognized a net loss of
approximately $8 million and a net gain of approximately $39 million in earnings
from derivative instruments designated as cash flow hedges of forecasted
transactions during 2003 and 2002, respectively. All derivative instruments,
designated as cash flow hedges, outstanding at December 31, 2003, mature within
the subsequent 36-month period. As of December 31, 2003, approximately $48
million of net losses are recorded in accumulated other comprehensive income,
net of tax, to recognize the effective portion of any fair value of derivative
instruments that are, or previously were, designated as cash flow hedges,
compared to approximately $4 million of net losses at December 31, 2002. Of the
December 31, 2003 amount, $36 million, net of tax, is expected to be
reclassified to earnings within the next twelve months to mitigate foreign
exchange risk.
Net Investment Hedging: The Company uses cross currency interest rate derivative
instruments and currency forward contracts to manage certain of its foreign
currency denominated net investments in subsidiaries and to reduce the risk that
the Company's accumulated shareholders' equity will be adversely affected by
changes in currency exchange rates (primarily Japanese yen). These derivative
instruments are designated as net investment hedges under Statement No. 133. The
effective portion of any change in the fair value of the derivative instruments,
designated as net investment hedges, is recorded in other comprehensive income.
The ineffective portion of any change in the fair value is recorded as interest
expense. The Company recognized $3 million of hedge ineffectiveness as a
reduction in interest expense during 2003, compared to $5 million in 2002. As of
December 31, 2003, approximately $4 million of unrealized net losses are
recorded in accumulated other comprehensive income, as a component of foreign
currency translation adjustment, to recognize the effective portion of the fair
value of derivative instruments that are designated as net investment hedges,
compared to $5 million of unrealized net losses at
57
December 31, 2002. In addition, the Company recorded a $3 million realized loss
in other comprehensive income to recognize the effective portion of net
investment hedges settled during 2003.
Interest Rate Hedging: The Company uses interest rate derivative instruments to
manage its exposure to interest rate movements and to reduce borrowing costs by
converting floating-rate debt into fixed-rate debt or fixed-rate debt into
floating-rate debt. These derivative instruments are designated as either fair
value or cash flow hedges under Statement No. 133. Any change in the fair value
of derivative instruments, designated as fair value hedges, is recorded in other
income and expense and is offset by changes in the fair value of the hedged debt
obligation. Interest expense related to the hedged debt obligation reflects
interest payments made or received under interest rate derivative instruments.
Any change in the fair value of the derivative instruments, designated as cash
flow hedges, is recorded in other comprehensive income, net of tax, and
reclassified to interest expense during the hedged interest payment period. The
Company recognized $7 million of interest expense reductions related to interest
rate derivative contracts during 2003, compared to $9 million during 2002. The
fair values of these instruments recorded on the Company's consolidated balance
sheets at December 31, 2003 and December 31, 2002 are not material.
NOTE K - INCOME TAXES
Income before income taxes consisted of:
YEAR ENDED DECEMBER 31,
- -----------------------
(in millions) 2003 2002 2001
----- ----- -----
Domestic $ 231 $ 305 $(226)
Foreign 412 244 270
----- ----- -----
$ 643 $ 549 $ 44
===== ===== =====
The related provision for income taxes consisted of:
YEAR ENDED DECEMBER 31 2003 2002 2001
- ----------------------- ----- ----- -----
(in millions)
CURRENT:
Federal $ 159 $ (29) $ 40
State 7 2 5
Foreign 36 61 45
----- ----- -----
202 34 90
DEFERRED:
Federal (27) 144 16
State (1) 8 2
Foreign (3) (10) (10)
----- ----- -----
(31) 142 8
----- ----- -----
$ 171 $ 176 $ 98
===== ===== =====
58
The reconciliation of taxes on income at the federal statutory rate to the
actual provision for income taxes is:
YEAR ENDED DECEMBER 31, 2003 2002 2001
- ------------------------------------ ----- ----- -----
(in millions)
Tax at statutory rate $ 225 $ 192 $ 15
State income taxes, net of federal benefit 3 8 3
Effect of foreign taxes (56) (32) (38)
Purchased research and development 13 31 111
Research credit (10)
Refund of previously paid taxes (15)
Other, net (4) (8) 7
----- ----- -----
$ 171 $ 176 $ 98
===== ===== =====
Significant components of the Company's deferred tax assets and liabilities at
December 31 consisted of:
(in millions) 2003 2002
----- -----
DEFERRED TAX ASSETS:
Inventory costs, intercompany profit and
related reserves $ 133 $ 107
Tax benefit of net operating loss and tax credits 184 106
Reserves and accruals 101 76
Restructuring and merger-related charges,
including purchased research and development 178 182
Unrealized losses on available-for-sale securities 1
Unrealized losses on derivative financial instruments 28 3
Other 22 21
----- -----
646 496
Less: valuation allowance on deferred tax assets 32 35
----- -----
$ 614 $ 461
===== =====
DEFERRED TAX LIABILITIES:
Property, plant and equipment $ (23) $ (8)
Intangible assets (242) (238)
Unremitted earnings of subsidiaries (180) (90)
Litigation settlement (23) (36)
Unrealized gains on
available-for-sale securities (30)
Other (22) (21)
----- -----
(520) (393)
===== =====
$ 94 $ 68
===== =====
During 2003, the Company determined that it is likely to repatriate cash from
certain non-U.S. operations. The Company has established tax liabilities of
approximately $180 million that management believes are adequate to provide for
the related tax impact of these transactions.
The Company operates within multiple taxing jurisdictions and could be subject
to audit in these jurisdictions. These audits can involve complex issues, which
may require an extended period of time to resolve and may cover multiple years.
The Company settled several tax audits during the
59
year and has reduced its previous estimate for accrued taxes by approximately
$139 million to reflect the resolution of these audits.
At December 31, 2003, the Company had U.S. tax net operating loss carryforwards
and tax credits, the tax effect of which is approximately $164 million. In
addition, the Company had foreign tax net operating loss carryforwards, the tax
effect of which is approximately $20 million. These carryforwards will expire
periodically beginning in the year 2004. The Company established a valuation
allowance of $32 million against these carryforwards. The decrease in the
valuation allowance from 2002 to 2003 is primarily attributable to the
expiration of foreign tax credits.
The income tax provision (benefit) of the unrealized gain or loss component of
other comprehensive income (loss) was approximately $5 million, $ (44) million
and $14 million for 2003, 2002 and 2001, respectively.
NOTE L - COMMITMENTS AND CONTINGENCIES
The interventional medicine market in which the Company primarily participates
is in large part 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. Intellectual
property litigation to defend or create market advantage is, however, 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 of not only individual cases, but 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 the Company's 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 companies infringe patents owned
or licensed by the Company.
In management's opinion, the Company is not currently involved in any legal
proceeding other than those specifically identified below, which, individually
or in the aggregate, could have a material effect on the financial condition,
operations and/or cash flows of the Company.
60
Additionally, legal costs associated with asserting the Company's patent
portfolio and defending against claims that the Company's products infringe the
intellectual property rights of others are significant; legal costs associated
with non-patent litigation and compliance activities continue to be substantial.
Depending on the prevalence, significance and complexity of these matters, the
Company's legal provisions could be adversely affected in the future.
LITIGATION WITH JOHNSON & JOHNSON
On October 22, 1997, Cordis Corporation (Cordis), a subsidiary of Johnson &
Johnson, filed a suit for patent infringement against the Company and SCIMED
Life Systems, Inc. (SCIMED), a subsidiary of the Company, alleging that the
importation and use of the NIR(R) stent infringes two patents owned by Cordis.
On April 13, 1998, Cordis filed a suit for patent infringement against the
Company and SCIMED alleging that the Company's NIR(R) stent infringes two
additional patents owned by Cordis. The suits were filed in the U.S. District
Court for the District of Delaware seeking monetary damages, injunctive relief
and that the patents be adjudged valid, enforceable and infringed. A trial on
both actions was held in late 2000. A jury found that the NIR(R) stent does not
infringe three Cordis patents, but does infringe one claim of one Cordis patent
and awarded damages of approximately $324 million to Cordis. On March 28, 2002,
the Court set aside the damage award, but upheld the remainder of the verdict,
and held that two of the four patents had been obtained through inequitable
conduct in the U.S. Patent and Trademark Office. On May 16, 2002, the Court also
set aside the verdict of infringement, requiring a new trial. On October 14,
2003, Cordis filed a motion to revise and vacate the Court's decision to grant
the Company a new trial and asked the Court to enter judgement against the
Company. The Company filed an opposition to Cordis' motion. A hearing has not
yet been scheduled.
On March 13, 1997, the Company (through its subsidiaries) filed suits against
Johnson & Johnson (through its subsidiaries) in The Netherlands and Belgium, and
on March 17, 1997 filed suit in France, seeking a declaration of noninfringement
for the NIR(R) stent relative to two European patents licensed to Ethicon, Inc.
(Ethicon), a Johnson & Johnson subsidiary, as well as a declaration of
invalidity with respect to those patents. On October 28, 1998, the Company's
motion for a declaration of noninfringement in France was dismissed for failure
to satisfy statutory requirements; the French invalidity suits were not
affected. A hearing related to the French invalidity suits was held on November
19, 2001. On January 16, 2002, the French Court found one of the patents to be
valid and the other to be invalid. The Company filed an appeal on November 4,
2002. On March 21, 1997, the Company (through its subsidiaries) filed a suit
against Johnson & Johnson (through its subsidiaries) in Italy seeking a
declaration of noninfringement for the NIR(R) stent relative to one of the
European patents licensed to Ethicon and a declaration of invalidity. A
technical expert was appointed by the Court and a hearing was held on January
30, 2002. Both parties have had an opportunity to comment on the expert report.
On May 8, 2002, the Court closed the evidentiary phase of the case. Hearings
have not yet been scheduled.
Ethicon and other Johnson & Johnson subsidiaries filed a cross-border suit in
The Netherlands on March 17, 1997, alleging that the NIR(R) stent infringes one
of the European patents licensed to Ethicon. In this action, the Johnson &
Johnson entities requested relief, including provisional relief (a preliminary
injunction), covering Austria, Belgium, France, Greece, Italy, The Netherlands,
Norway, Spain, Sweden and Switzerland. On April 2, 1997, the Johnson & Johnson
61
entities filed a similar cross-border proceeding in The Netherlands with respect
to a second European patent licensed to Ethicon. In October 1997, Johnson &
Johnson's request for provisional cross-border relief on both patents was denied
by the Dutch Court, on the ground that it is "very likely" that the NIR(R) stent
will be found not to infringe the patents. Johnson & Johnson appealed this
decision with respect to the second patent; the appeal has been denied on the
grounds that there is a "ready chance" that the patent will be declared null and
void. In January 1999, Johnson & Johnson amended the claims of the second
patent, changed the action from a cross-border case to a Dutch national action,
and indicated its intent not to pursue its action on the first patent. On June
23, 1999, the Dutch Court affirmed that there were no remaining infringement
claims with respect to either patent. In late 1999, Johnson & Johnson appealed
this decision. A hearing on the appeal has not yet been scheduled.
On May 6, 1997, Ethicon Endosurgery, Inc. (Ethicon), a subsidiary of Johnson &
Johnson, sued the Company in Dusseldorf, Germany, alleging that the Company's
NIR(R) stent infringes one of Ethicon's patents. On June 23, 1998, the case was
stayed following a decision in an unrelated nullity action in which the Ethicon
patent was found to be invalid.
On August 22, 1997, Johnson & Johnson filed a suit for patent infringement
against the Company alleging that the sale of the NIR(R) 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. The Company has answered, denying the allegations of the complaint. A
trial was originally expected to begin in March 2004. On November 27, 2003,
Cordis requested this action be stayed and, on December 15, 2003, the Company
appealed to overturn the stay and proceed to trial.
On March 30, 2000, the Company (through its subsidiary) filed suit for patent
infringement against two subsidiaries of Cordis alleging that Cordis' Bx
Velocity(R) stent delivery system infringes a published utility model owned by
Medinol Ltd. and exclusively licensed to the Company. The complaint was filed in
the District Court of Dusseldorf, Germany seeking monetary and injunctive
relief. A hearing was held on March 15, 2001, and on June 6, 2001, the Court
issued a written decision that Cordis' Bx Velocity stent delivery system
infringes the Medinol published utility model. Cordis appealed the decision of
the German court. A hearing on the appeal originally scheduled for April 3, 2003
was suspended until decisions are rendered in two actions pending in the U.S.
District Court of New York between Medinol and the Company.
On March 25, 1996, Cordis filed a suit for patent infringement against SCIMED
alleging the infringement of five U.S. patents by SCIMED's Leap(TM) balloon
material used in certain SCIMED catheter products, including SCIMED's Bandit(TM)
and Express Plus(TM) catheters. The suit was filed in the U.S. District Court
for the District of Minnesota and seeks monetary and injunctive relief. SCIMED
has answered, denying the allegations of the complaint. Pursuant to an agreement
between the parties, this action has been stayed.
On March 27, 1997, SCIMED filed suit for patent infringement against Cordis,
alleging willful infringement of several SCIMED U.S. patents by Cordis'
Trackstar 14(TM), Trackstar 18(TM), Olympix(TM), Powergrip(TM), Sleek(TM),
Sleuth(TM), Thor(TM), Titan(TM) and Valor(TM) catheters. The suit was filed in
the U.S. District Court for the District of Minnesota, seeking monetary and
62
injunctive relief. The parties have agreed to add Cordis' Charger(TM) and
Helix(TM) catheters to the suit. Cordis has answered, denying the allegations of
the complaint. Pursuant to an agreement between the parties, this action has
been stayed.
On February 14, 2002, the Company and certain of its subsidiaries filed suit for
patent infringement against Johnson & Johnson and Cordis alleging certain
balloon catheters, stent delivery systems, and guide catheter 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 counter-claim alleging certain balloon catheters and stent delivery
systems sold by the Company infringe three U.S. patents owned by Cordis and
seeking monetary and injunctive relief. On December 6, 2002, the Company filed
an amended complaint alleging two additional patents owned by the Company are
infringed by the Cordis products. Trial is expected to begin in January 2005.
On March 26, 2002, the Company and Target Therapeutics, Inc. (Target), a wholly
owned subsidiary of the Company, filed suit for patent infringement against
Cordis alleging 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. Trial is expected to begin in October 2004.
On January 13, 2003, Cordis filed suit for patent infringement against the
Company and SCIMED alleging the Company's Express(2TM) coronary stent infringes
a U.S. patent owned by Cordis. The suit was filed in the U.S. District Court for
the District of Delaware seeking monetary and injunctive relief. On February 14,
2003, Cordis filed a motion requesting a preliminary injunction. The Company
answered the complaint, denying the allegations, and filed a counterclaim
against Cordis, alleging that certain products sold by Cordis infringe a patent
owned by the Company. A hearing on the preliminary injunction motion was held
and, on November 21, 2003, the Court denied both motions for preliminary
injunctions. Cordis appealed the denial of its motion and an appeal hearing has
been scheduled for April 2004. Trial is scheduled to begin June 13, 2005.
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(R) drug-eluting stent infringes a patent owned by the Company. The suit
was filed in the District Court of Delaware seeking monetary and injunctive
relief. On March 20, 2003, the Company filed a motion seeking a preliminary
injunction with respect to the sale of the Cypher stent in the United States.
Cordis answered the complaint, denying the allegations, and filed a counterclaim
against the Company alleging that the patent is not valid and is unenforceable.
The Company filed an amended complaint alleging that the Cypher drug-eluting
stent infringes two additional patents owned by the Company. A hearing on the
preliminary injunction motion was held and, on November 21, 2003, the Court
denied both motions for preliminary injunctions. Trial is scheduled to begin
June 13, 2005.
On February 20, 2003, Janssen Pharmaceutica NV, an affiliate of Johnson &
Johnson, filed suit against the Company (through its subsidiaries) and Medinol
alleging that BX Velocity stents manufactured in Belgium do not infringe a
European patent owned by Medinol and exclusively
63
licensed to the Company. The suit was filed in Belgium seeking a declaration of
invalidity and noninfringement of the Medinol patent and monetary relief. A
hearing was held June 16, 2003, and in November 2003, the Court ruled in favor
of Janssen.
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(TM)
stent, Cypher stent, Cypher Select(TM) stent, Aqua T3(TM) balloon and U-Pass(TM)
balloon infringe one of the Company's European patents. The suit was filed in
the District Court of Brussels, Belgium seeking cross-border, injunctive and
monetary relief. A separate suit was filed in the District Court of Brussels,
Belgium against nine additional Johnson & Johnson subsidiaries.
On December 15, 2003, the Company and SCIMED filed suit for patent infringement
against Johnson & Johnson and Cordis alleging Cordis' Cypher stent coating
infringes two U.S. patents owned by the Company. The suit was filed in the
District Court of Delaware seeking monetary and injunctive relief.
LITIGATION WITH MEDTRONIC, INC.
On March 10, 1999, the Company (through its subsidiary Schneider (Europe) AG)
filed suit against Medtronic AVE, Inc. (Medtronic AVE), a subsidiary of
Medtronic, Inc. (Medtronic), alleging that Medtronic AVE's AVE GFX, AVE GFX2,
AVE LTX, CALYPSO RELY(TM), PRONTO SAMBA(TM) and SAMBA RELY(TM) rapid exchange
catheters and stent delivery systems infringe one of the Company's German
patents. The suit was filed in the District Court of Dusseldorf, Germany seeking
injunctive and monetary relief. An expert's report was submitted to the Court on
November 6, 2001 and a hearing was held on May 2, 2002. On June 11, 2002, the
Court ruled that the Medtronic AVE products infringed the Company's patents.
Medtronic AVE filed an appeal. Medtronic AVE is obligated to dismiss its appeal
pursuant to a Settlement Agreement between the parties dated September 18, 2002.
A hearing was held on January 8, 2004, and the appeal was dismissed.
On April 6, 1999, Medtronic AVE filed suit against SCIMED and another subsidiary
of the Company alleging that the Company's NIR(R) stent infringes one of
Medtronic AVE's European patents. The suit was filed in the District Court of
Dusseldorf, Germany seeking injunctive and monetary relief. A hearing was held
in Germany on September 23, 1999, and on November 4, 1999, the Court dismissed
the complaint. On December 21, 1999, Medtronic AVE appealed the dismissal. The
appeal has been stayed pending the outcome of a related nullity action. Oral
arguments in the nullity action are scheduled for March 2004.
On August 13, 1998, Medtronic AVE, Inc. filed a suit for patent infringement
against the Company and SCIMED alleging that the Company's NIR(R) 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. The Company and SCIMED have answered denying the allegations of the
complaint. A hearing on the Company's motion for summary judgment of
non-infringement was held August 11, 2003. A trial is expected in 2005.
64
On January 15, 2004, Medtronic Vascular, Inc. (Medtronic Vascular), a subsidiary
of Medtronic, filed suit against the Company and SCIMED alleging the Company's
Express(R) coronary stent and Express (2)(TM) coronary stents infringe four U.S.
patents owned by Medtronic Vascular. The suit was filed in the District Court of
Delaware seeking monetary and injunctive relief.
During the third quarter of 2002, the Company entered into an agreement to
settle a number of patent infringement lawsuits between the Company and
Medtronic. The settlement resolved the Company's damage claims against Medtronic
arising out of a German court case and a U.S. arbitration proceeding involving
Medtronic rapid exchange stent delivery systems and angioplasty dilatation
balloon catheters. In accordance with the settlement agreement, during the third
quarter of 2002, Medtronic paid the Company approximately $175 million to settle
damage award claims for past infringement. In addition, during the third quarter
of 2002, the Company recorded a net charge of approximately $76 million for
settlement of litigation related to rapid exchange catheter technology.
LITIGATION WITH GUIDANT CORPORATION
On June 7, 2002, Advanced Cardiovascular Systems, Inc. (ACS) and Guidant Ltd.,
subsidiaries of Guidant Corporation (Guidant), filed suit against the Company
and certain of its subsidiaries alleging that the Company's Express stent
infringes two patents owned by ACS. The suit was filed in the United Kingdom,
but has not been served upon the Company.
On October 15, 2002, ACS filed suit for patent infringement against the Company
and SCIMED alleging the Company's Express stent infringes a U.S. patent owned by
ACS. The suit was filed in the U.S. District Court for the Northern District of
California seeking monetary damages and injunctive relief. On December 6, 2002,
the Company answered, denying allegations of the complaint and counterclaimed
seeking a declaration of invalidity, noninfringement and unenforceability. On
August 18, 2003, the court granted the Company's motion to compel arbitration.
Arbitration hearings are scheduled for March 1, 2004.
On December 3, 2002, ACS filed suit for patent infringement against the Company
and SCIMED alleging the Company's Express(R) stent infringes a U.S. patent owned
by ACS. The suit was filed in the U.S. District Court for the Northern District
of California seeking monetary and injunctive relief. On January 30, 2003, the
Company filed an answer denying allegations of the complaint and concurrently
filed a counterclaim seeking declaratory judgment of patent invalidity and
noninfringement and alleging that certain ACS products infringe five U.S.
patents owned by the Company. The Company seeks monetary and injunctive relief.
On March 17, 2003, ACS filed an amended complaint alleging an additional patent
is infringed by the Company's product. On July 2, 2003, the Court granted the
Company's motion to compel arbitration. Arbitration hearings are scheduled to
begin on April 26, 2004.
On January 28, 2003, ACS filed suit for patent infringement against the Company
and SCIMED alleging the Company's Express stent infringes a U.S. patent owned by
ACS. The suit was filed in the U.S. District Court for the Northern District of
California seeking monetary and injunctive relief. On August 13, 2003, ACS filed
an amended complaint alleging the Company's Express stent infringes a second
U.S. patent owned by ACS. The Company has answered denying the allegations of
the complaint. A hearing has been scheduled for February 18, 2004.
65
On December 30, 2002, the Company and certain of its subsidiaries filed suit
for patent infringement against Guidant, Guidant Sales Corporation and ACS
alleging that certain stent delivery systems (Multi-Link Zeta(TM) and Multi-Link
Penta(TM)) and balloon catheter products (AGILTRAC(TM)) sold by Guidant and ACS
infringe nine 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 February 21, 2003, Guidant filed an answer denying the
allegations of the complaint and filed a counterclaim seeking declaratory
judgment of patent invalidity and noninfringement and alleging that certain
Company products infringe patents owned by ACS. Trial is expected to begin in
January 2005.
LITIGATION RELATING TO COOK, INC.
On September 10, 2001, the Company delivered a Notice of Dispute to Cook, Inc.
(Cook) asserting that Cook breached the terms of a certain License Agreement
among Angiotech Pharmaceuticals, Inc. (Angiotech), Cook and the Company (the
Agreement) relating to an improper arrangement between Cook and Guidant.On
December 13, 2001, Cook filed suit in the U.S. District Court for the Northern
District of Illinois seeking declaratory and injunctive relief. The Company
answered the complaint on December 26, 2001, denying the allegations and filed
counterclaims seeking declaratory and injunctive relief. On June 27, 2002, the
Court found in favor of the Company, ruling that Cook breached the Agreement. On
October 1, 2002, the Court granted the Company's request for a permanent
injunction prohibiting certain activities under the Agreement and enjoining the
use of the clinical data and technologies developed by Cook or Guidant in
violation of the Agreement. Cook appealed the decision to the U.S. Court of
Appeals for the Seventh Circuit. On June 19, 2003, the Court of Appeals affirmed
the District Court's decision. The Court of Appeals modified the District
Court's injunction by deleting language that would have prohibited the use of
clinical data to obtain regulatory approval, but continued to enjoin the sale of
products.
OTHER PATENT LITIGATION
On July 28, 2000, Dr. Tassilo Bonzel filed a complaint naming certain of the
Company's Schneider Worldwide subsidiaries and Pfizer Inc. (Pfizer) and certain
of its affiliates as defendants, alleging that Pfizer failed to pay Dr. Bonzel
amounts owed under a license agreement involving Dr. Bonzel's patented
Monorail(TM) technology. The suit was filed in the District Court for the State
of Minnesota seeking monetary relief. On September 26, 2001, Dr. Bonzel and the
Company reached a contingent settlement involving all but one claim asserted in
the complaint. The contingency has been satisfied and the settlement is now
final. On December 17, 2001, the remaining claim was dismissed without prejudice
with leave to refile the suit in Germany. Dr. Bonzel filed an appeal of the
dismissal of the remaining claim. On July 29, 2003, the Appellate Court affirmed
the lower court's dismissal, and on October 24, 2003, the Minnesota Supreme
Court denied Dr. Bonzel's petition for further review.
On September 12, 2002, EV3 Inc.(EV3) filed suit against The Regents of the
University of California and a subsidiary of the Company in the District Court
of The Hague, Netherlands, seeking a declaration that EV3's EDC II and VDS
embolic coil products do not infringe three patents licensed by the Company from
The Regents of the University of California. On October 22, 2003, the Court
ruled that the EV3 products infringe three patents licensed by the Company. On
December 18, 2003, EV3 appealed the Court's ruling. A hearing has not yet been
scheduled.
On January 21, 2003, Dendron GmbH, EV3 Ltd., EV3 International, Inc., Microvena
Corporation and Micro Therapeutics, Inc. (the EV3 Parties) filed suit against
The Regents of the University of California in the United Kingdom seeking a
declaration that certain of the EV3 Parties' detachable coil and microcatheter
products do not infringe a patent licensed by the Company
66
from The Regents of the University of California and revocation of the patent.
The Company has answered, denying the allegations of the complaint and filed a
counterclaim against the EV3 Parties alleging that the products infringe a
patent licensed to the Company and owned by the University. Trial is expected to
begin in May 2004.
On July 21, 2003, EV3, Micro Therapeutics, Inc., and Dendron GmbH (the EV3
Parties) filed suit against the Company and The Regents of the University of
California in the U. S. District Court for the Western District of Wisconsin
seeking a declaration that certain of the EV3 Parties' embolic coil products do
not infringe three U.S. patents licensed by the Company from The Regents of the
University of California, and further seeks a declaration of invalidity of all
three patents. The University of California and the Company filed motions to
dismiss the cases; the motions were granted on October 24, 2003.
On December 16, 2003, The Regents of the University of California (The Regents)
filed suit against Micro Therapeutics, Inc. (Micro Therapeutics) and Dendron
GmbH (Dendron) alleging Micro Therapeutics' Sapphire (TM) detachable coil
delivery systems infringe twelve patents licensed by the Company and owned by
the Regents. The complaint was filed in the U.S. District Court for the Northern
District of California seeking monetary and injunctive relief. On January 8,
2004, Micro Therapeutics and Dendron filed a third party complaint to include
the Company and Target as third party defendants.
LITIGATION WITH MEDINOL LTD.
On April 5, 2001, Medinol Ltd. (Medinol) filed a complaint against the Company
and certain of its current and former employees alleging breaches of contract,
fraud and other claims. The suit was filed in the U.S. District Court for the
Southern District of New York seeking monetary and injunctive relief. On April
26, 2001, Medinol amended its complaint to add claims alleging misappropriation
of trade secrets in relation to the Company's Express stent development program.
Medinol seeks monetary and injunctive relief, as well as an end to the Company's
right to distribute Medinol stents and to gain access to certain Company
intellectual property. On April 30, 2001, the Company answered and countersued
Medinol and its principals, seeking monetary and injunctive relief. During the
last quarter of 2001, the Court dismissed several of the individuals from the
case. Summary judgment hearings were held in November and December, 2003. No
decision has been rendered, and no trial date has been set.
On June 11, 2001, the Company filed suit in the Jerusalem District Court in
Israel against Medinol and its controlling shareholders, alleging among other
things, loss of faith among Medinol's shareholders, breach of duty by Medinol
management and misappropriation of corporate opportunities, including trade
secrets and intellectual property. The suit seeks, among other things, monetary
relief and costs. Preliminary motions were heard on October 29, 2001. Medinol
and its shareholders requested the Court to strike the claim on the grounds of
lack of jurisdiction. The Court rejected the motion except for the nomination of
a director to Medinol, which was referred to the District Court of New York. A
preliminary hearing originally scheduled for June 9, 2003 was canceled and has
not yet been rescheduled.
On April 22, 2002, Medinol filed suit against Boston Scientific Medizintechnik
GmbH (GmbH), a German subsidiary of the Company, alleging the Company's Express
stent infringes certain German patents and utility models owned by Medinol. The
suit was filed in Dusseldorf,
67
Germany. Hearings were held in May 2003, and on June 24, 2003, the German court
found that the Express stent infringes one German patent and one utility model
asserted by Medinol and enjoined sales in Germany. The Company has appealed and
a hearing on the appeal is scheduled for September 24, 2004.
On July 2, 2003, Medinol filed a motion against the Company seeking a
preliminary injunction with respect to the sale of the Express stent in Germany.
The German Court granted Medinol's motion effective September 23, 2003. The
Company appealed the German Court's decision. A hearing is scheduled for
February 26, 2004.
On January 21, 2003, Medinol filed suit against several of the Company's
international subsidiaries in the District Court of The Hague, Netherlands
seeking cross-border, monetary and injunctive relief covering The Netherlands,
Austria, Belgium, United Kingdom, Ireland, Switzerland, Sweden, Spain, France,
Portugal and Italy, alleging the Company's Express(R) stent infringes four
European patents owned by Medinol. A hearing was held on October 10, 2003, and a
decision was rendered on December 17, 2003 finding the Company infringes one
patent. The Court, however, granted no cross-border relief. The Company has
appealed the finding. The Company has filed nullity actions against one of the
patents in Ireland, France, Italy, Spain, Sweden, Portugal, and Switzerland.
On September 10, 2002, the Company filed suit against Medinol alleging Medinol's
NIRFlex(TM) and NIRFlex(TM) Royal products infringe two patents owned by the
Company. The suit was filed in Dusseldorf, Germany seeking monetary and
injunctive relief. A hearing was held on September 23, 2003. On October 28,
2003, the German Court found that Medinol infringes one of the two patents owned
by the Company. On December 8, 2003, the Company filed an appeal relative to the
other patent.
On September 25, 2002, the Company filed suit against Medinol alleging Medinol's
NIRFlex(TM) and NIRFlex(TM) Royal products infringe a patent owned by the
Company. The suit was filed in the District Court of The Hague, 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 has not yet been scheduled.
DEPARTMENT OF JUSTICE INVESTIGATION
In October 1998, the Company recalled its NIR ON(R) Ranger(TM) with Sox(TM)
coronary stent delivery system following reports of balloon leaks. Since
November 1998, the U.S. Department of Justice has been conducting an
investigation primarily regarding: the shipment, sale and subsequent recall of
the NIR ON(R) Ranger(TM) with Sox(TM) stent delivery system; aspects of the
Company's relationship with Medinol, the vendor of the stent; and related
events. The Company and two senior officials have been advised that they are
targets of the federal grand jury investigation, but that no final decision has
been made as to whether any potential charges would be brought. Although the
Company has contested certain procedural matters related to the conduct of the
investigation, the Company and the two senior officials have agreed to extend
the applicable statute of limitations, which may result in the investigation
continuing into mid 2004 or beyond. There can be no assurance that the
investigation will result in an outcome favorable to the Company, that charges
would not be brought, or that the Company would not
68
agree to a further extension of the statute. The Company believes that it will
ultimately be demonstrated that the Company and its officials acted responsibly
and appropriately.
OTHER PROCEEDINGS
On October 31, 2000, the Federal Trade Commission (FTC) filed suit against the
Company for alleged violations of a Consent Order dated May 5, 1995, pursuant to
which the Company had licensed certain intravascular ultrasound technology to
Hewlett-Packard Company (HP). The suit was filed in the U.S. District Court for
the District of Massachusetts seeking civil penalties and injunctive relief. The
Company filed a motion to dismiss the complaint and the FTC filed a motion for
summary judgment. On October 5, 2001, the Court dismissed three of the five
claims against the Company and granted summary judgment of liability in favor of
the FTC on the two remaining claims. On March 28, 2003, the Court entered a
judgment against the Company in the amount of approximately $7 million.
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, 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. On November
15, 2002, defendants moved to dismiss the complaint and, alternatively, for a
stay of this litigation pending resolution of a separate lawsuit brought by
Medinol against the Company. Plaintiffs have consented to the stay sought by
defendants.
PRODUCT LIABILITY CLAIMS
At the beginning of the third quarter of 2002, the Company elected to become
substantially self-insured with respect to general and product liability claims.
As a result of economic factors impacting the insurance industry, meaningful
liability insurance coverage became unavailable while the cost of insurance
became economically prohibitive. In the normal course of its business, product
liability claims are asserted against the Company. The Company accrues
anticipated costs of litigation and loss for product liability claims based on
historical experience, or to the extent they are probable and estimable. Losses
for claims in excess of the limits of purchased insurance are recorded in
earnings at the time and to the extent they are probable and estimable. Product
liability claims against the Company will likely be asserted in the future
related to events not known to management at the present time. The absence of
third-party insurance coverage increases the Company's exposure to unanticipated
claims or adverse decisions. However, based on product liability losses
experienced in the past, the election to become substantially self-insured is
not expected to have a material impact on future operations.
Management believes that the Company's risk management practices, including
limited insurance coverage, are reasonably adequate to protect against
anticipated general and product liability losses. However, unanticipated
catastrophic losses could have a material adverse impact on the Company's
financial position, results of operations and liquidity.
69
NOTE M - STOCKHOLDERS' EQUITY
PREFERRED STOCK: The Company is authorized to issue 50 million shares of
preferred stock in one or more series and to fix the powers, designations,
preferences and relative participating, option or other rights thereof,
including dividend rights, conversion rights, voting rights, redemption terms,
liquidation preferences and the number of shares constituting any series,
without any further vote or action by the Company's stockholders. At December
31, 2003, the Company had no shares of preferred stock outstanding.
COMMON STOCK: The Company is authorized to issue 1,200 million shares of common
stock, $.01 par value per share. Holders of common stock are entitled to one
vote per share. Holders of common stock are entitled to receive dividends if and
when declared by the Board of Directors and to share ratably in the assets of
the Company legally available for distribution to its stockholders in the event
of liquidation. Holders of common stock have no preemptive, subscription,
redemption or conversion rights. The holders of common stock do not have
cumulative voting rights. The holders of a majority of the shares of common
stock can elect all of the directors and can control the management and affairs
of the Company.
The Company paid a two-for-one stock split, effected in the form of a 100
percent stock dividend on November 5, 2003. All historical share and per share
amounts have been restated to reflect the stock split except for share amounts
presented in the consolidated statements of stockholders' equity and the
consolidated balance sheets, which reflect the actual share amounts outstanding
for each period presented.
The Company is authorized to purchase on the open market and in private
transactions up to approximately 120 million shares of the Company's common
stock. Purchased stock is principally used to satisfy the Company's obligations
pursuant to its equity incentive plans, but may also be used for general
corporate purposes, including acquisitions. The Company repurchased 22 million
shares of its common stock at an aggregate cost of approximately $570 million
during 2003. As of December 31, 2003, the Company had purchased approximately 97
million shares of its common stock under this authorization.
NOTE N - STOCK OWNERSHIP PLANS
EMPLOYEE AND DIRECTOR STOCK INCENTIVE PLANS
Boston Scientific's 1992, 1995, 2000 and 2003 Long-Term Incentive Plans provide
for the issuance of up to 170 million shares of common stock. The terms of these
four plans are similar. Together, the plans cover officers of, directors of,
employees of and consultants to the Company and provide for the grant of various
incentives, including qualified and non-qualified options, stock grants, share
appreciation rights and performance awards. Options granted to purchase shares
of common stock are either immediately exercisable or exercisable in
installments as determined by the Compensation Committee of the Board of
Directors, consisting of two or more non-employee directors (the Committee), and
expire within ten years from date of grant. In the case of qualified options, if
an employee owns more than 10 percent of the voting power of all classes of
stock, the option granted will be at 110 percent of the fair market value of the
Company's
70
common stock on the date of grant and will expire over a period not to exceed
five years. The 1992 Long-Term Incentive Plan expired on March 31, 2002, after
which time grants were issued under the 1995, 2000 and 2003 Long-Term Incentive
Plans.
The Committee may also make stock grants in which shares of common stock may be
issued to directors, officers, employees and consultants at a purchase price
less than fair market value. The terms and conditions of such issuances,
including whether achievement of individual or Company performance targets is
required for the retention of such awards, are determined by the Committee. The
Committee may also issue shares of common stock and/or authorize cash awards
under the incentive plans in recognition of the achievement of long-term
performance objectives established by the Committee.
In January 2000, the Company granted under its 1992 and 1995 Long-Term Incentive
Plans approximately 2.2 million shares of its common stock to a limited group of
employees subject to certain forfeiture restrictions. The purpose of the program
was to help retain key employees. The market value of these shares was
approximately $26 million on the date of issuance and the vesting period was
three years. This amount was recorded as deferred compensation and shown as a
separate component of stockholders' equity. The deferred compensation was
amortized to expense over the vesting period and amounted to approximately $6
million and $7 million for the years ended December 31, 2002 and 2001,
respectively. At December 31, 2002, the deferred compensation was fully
amortized. The Company reversed approximately $5 million of deferred
compensation associated with forfeitures of these restricted shares.
There were no stock grants issued to employees during 2003 and 2002. During
2001, there were stock grants of 100,000 shares issued to employees. There were
no restricted stock forfeitures during 2003. During 2002 and 2001, there were
approximately 48,000 and 182,000 shares, respectively, of restricted stock
forfeited.
Boston Scientific's 1992 Non-Employee Directors' Stock Option Plan provides for
the issuance of up to 400,000 shares of common stock and authorizes the
automatic grant to outside directors of options to acquire a specified number of
shares of common stock generally on the date of each annual meeting of the
stockholders of the Company or on the date a non-employee director is first
elected to the Board of Directors. Options under this plan are exercisable
ratably over a three-year period and expire ten years from the date of grant.
This plan expired on March 31, 2002 after which time grants to outside directors
were issued under the 2000 and 2003 Long-Term Incentive Plans.
71
A table illustrating the effect on net income (loss) and net income (loss) per
share as if the fair value method had been applied is presented in Note A. The
fair value of the stock options used to calculate the pro forma net income
(loss) and net income (loss) per share were estimated using the Black-Scholes
option pricing model with the following weighted average assumptions:
2003 2002 2001
--------- --------- ---------
Dividend yield 0% 0% 0%
Expected volatility 49.28% 49.80% 51.40%
Risk-free interest rate 3.13% 3.18% 4.86%
Actual forfeitures 958,652 2,727,872 6,632,000
Expected life 5.0 5.0 6.0
The weighted average grant-date fair value per share of options granted during
2003, 2002 and 2001, calculated using the Black-Scholes option pricing model, is
$14.96, $9.58 and $6.35, respectively.
Information related to stock options at December 31 under stock incentive plans
is as follows:
(option amounts in thousands) 2003 2002 2001
----------------------- ----------------------- -----------------------
WEIGHTED WEIGHTED WEIGHTED
AVERAGE AVERAGE AVERAGE
EXERCISE EXERCISE EXERCISE
OPTIONS PRICE OPTIONS PRICE OPTIONS PRICE
------- --------- ------- --------- ------- ---------
Outstanding at January 1 84,218 $ 12.23 87,954 $ 10.78 89,146 $ 10.68
Granted 6,857 33.33 10,668 20.55 12,014 10.83
Exercised (24,023) 10.10 (10,752) 8.53 (4,964) 6.07
Canceled (949) 13.86 (3,652) 12.68 (8,242) 12.58
------- --------- ------- --------- ------- ----------
OUTSTANDING AT DECEMBER 31 66,103 15.16 84,218 12.23 87,954 10.78
======= ========= ======= ========= ======= =========
EXERCISABLE AT DECEMBER 31 42,126 $ 12.01 48,878 $ 11.05 43,418 $ 10.52
======= ========= ======= ========= ======= =========
Below is additional information related to stock options outstanding and
exercisable at December 31, 2003:
(option amounts in thousands) STOCK OPTIONS OUTSTANDING STOCK OPTIONS EXERCISABLE
------------------------------------------ -------------------------
WEIGHTED WEIGHTED WEIGHTED
AVERAGE AVERAGE AVERAGE
REMAINING EXERCISE EXERCISE
RANGE OF EXERCISE PRICES OPTIONS CONTRACTUAL LIFE PRICE OPTIONS PRICE
------- ---------------- --------- --------- ---------
$ 0.00- 8.00 12,629 5.7 $ 6.30 11,773 $ 6.23
8.01-16.00 28,259 6.0 11.80 19,551 11.78
16.01-24.00 19,029 7.0 19.74 10,802 18.75
24.01-32.00 360 9.6 31.00
32.01-40.00 5,826 10.0 34.74
------- --------- ------- -------- -------
66,103 6.6 $ 15.16 42,126 $ 12.01
======= ========= ======= ======== +======
Shares reserved for future issuance under all of the Company's incentive plans
totaled approximately 113 million at December 31, 2003.
72
STOCK PURCHASE PLAN
Boston Scientific's Global Employee Stock Ownership Plan (Stock Purchase Plan)
provides for the granting of options to purchase up to 15 million shares of the
Company's common stock to all eligible employees. Under the Stock Purchase Plan,
each eligible employee is granted, at the beginning of each period designated by
the 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. 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.
During 2003, approximately 1,288,000 shares were issued at prices ranging from
$12.21 to $18.27 per share. During 2002, approximately 1,838,000 shares were
issued at prices ranging from $7.47 to $9.67 per share, and during 2001,
approximately 2,212,000 shares were issued at prices ranging from $5.74 to $5.82
per share. At December 31, 2003, there were approximately 4 million shares
available for future issuance.
NOTE O - EARNINGS PER SHARE
The following table sets forth the computations of basic and diluted earnings
per share:
YEAR ENDED DECEMBER 31, 2003 2002 2001
(in millions, except per share data)
--------- -------- ---------
BASIC:
Net income (loss) $ 472 $ 373 $ (54)
========= ========= =========
Weighted average shares outstanding 821.0 814.2 802.8
========= ========= =========
Net income (loss) per common share $ 0.57 $ 0.46 $ (0.07)
========= ========= =========
ASSUMING DILUTION:
Net income (loss) $ 472 $ 373 $ (54)
========= ========= =========
Weighted average shares outstanding 821.0 814.2 802.8
Net effect of dilutive stock-based
compensation 24.4 15.8
--------- --------- ---------
TOTAL 845.4 830.0 802.8
========= ========= =========
NET INCOME (LOSS) PER COMMON SHARE $ 0.56 $ 0.45 $ (0.07)
========= ========= =========
During 2003, 2002 and 2001, approximately 1 million, 21 million and 48 million
potential common shares, respectively, were not included in the computation of
earnings per share, assuming dilution, because exercise prices were greater than
the average market price of the common shares. The net effect of dilutive
stock-based compensation was approximately 9 million common share equivalents in
2001, however this amount was not included in the computation of earnings per
share, assuming dilution, because it would have been antidilutive.
73
NOTE P - 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 revenues from the sale of less-invasive medical
devices. The reportable segments represent an aggregate of operating divisions.
Sales and operating results of reportable segments are based on internally
derived standard foreign exchange rates, which may differ from year to year and
do not include inter-segment profits. The segment information for 2002 and 2001
sales and operating results has been restated based on the Company's standard
foreign exchange rates used for 2003. 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. Total assets and purchases of property, plant and equipment are
based on foreign exchange rates used in the Company's consolidated financial
statements.
UNITED INTER-
(in millions) STATES EUROPE JAPAN CONTINENTAL TOTAL
------ ------ ------ ----------- ------
2003:
Net sales $1,924 $ 600 $ 503 $ 303 $3,330
Depreciation 8 3 3 2 16
Operating income allocated to
reportable segments 693 278 285 121 1,377
------ ------ ------ ------ ------
2002:
Net sales $1,756 $ 480 $ 494 $ 205 $2,935
Depreciation 10 3 3 2 18
Operating income allocated to
reportable segments 650 200 285 58 1,193
------ ------ ------ ------ ------
2001:
Net sales $1,598 $ 416 $ 508 $ 168 $2,690
Depreciation 10 4 4 2 20
Operating income allocated to
reportable segments 548 153 300 24 1,025
------ ------ ------ ------ ------
74
A reconciliation of the totals reported for the reportable segments to the
applicable line items in the consolidated financial statements is as follows:
YEAR ENDED DECEMBER 31,
(in millions) 2003 2002 2001
------- ------- -------
NET SALES:
Total net sales allocated to
reportable segments $ 3,330 $ 2,935 $ 2,690
Foreign exchange 146 (16) (17)
------- ------- -------
$ 3,476 $ 2,919 $ 2,673
======= ======= =======
DEPRECIATION:
Total depreciation allocated to
reportable segments $ 16 $ 18 $ 20
Manufacturing operations 65 46 48
Corporate expenses and foreign exchange 26 25 28
------- ------- -------
$ 107 $ 89 $ 96
======= ======= =======
INCOME BEFORE INCOME TAXES:
Total operating income allocated to
reportable segments $ 1,377 $ 1,193 $ 1,025
Manufacturing operations (267) (248) (230)
Corporate expenses and foreign exchange (361) (349) (413)
Purchased research and development (37) (85) (282)
Litigation-related (charges) credits, net (15) 99
------- ------- -------
697 610 100
Other income (expense) (54) (61) (56)
------- ------- -------
$ 643 $ 549 $ 44
======= ======= =======
ENTERPRISE-WIDE INFORMATION
Year ended December 31,
(in millions) 2003 2002 2001
------- ------- -------
NET SALES:
Cardiovascular $ 2,504 $ 2,067 $ 1,926
Endosurgery 972 852 747
------- ------- -------
$ 3,476 $ 2,919 $ 2,673
======= ======= =======
LONG-LIVED ASSETS:
United States $ 536 $ 464 $ 439
Ireland 169 134 111
Other foreign countries 39 38 42
------- ------- -------
$ 744 $ 636 $ 592
======= ======= =======
75
REPORT OF INDEPENDENT AUDITORS
BOARD OF DIRECTORS
BOSTON SCIENTIFIC CORPORATION
We have audited the accompanying consolidated balance sheets of Boston
Scientific Corporation and subsidiaries as of December 31, 2003 and 2002, and
the related consolidated statements of operations, stockholders' equity, and
cash flows for each of the three years in the period ended December 31, 2003.
These financial statements are the responsibility of the Company's management.
Our responsibility is to express an opinion on these financial statements based
on our audits.
We conducted our audits in accordance with auditing standards generally accepted
in the United States. Those standards require that we plan and perform the audit
to obtain reasonable assurance about whether the financial statements are free
of material misstatement. An audit includes examining, on a test basis, evidence
supporting the amounts and disclosures in the financial statements. An audit
also includes assessing the accounting principles used and significant estimates
made by management, as well as evaluating the overall financial statement
presentation. We believe that our audits provide a reasonable basis for our
opinion.
In our opinion, the financial statements referred to above present fairly, in
all material respects, the consolidated financial position of Boston Scientific
Corporation and subsidiaries at December 31, 2003, and 2002, and the
consolidated results of their operations and their cash flows for each of the
three years in the period ended December 31, 2003, in conformity with accounting
principles generally accepted in the United States.
As discussed in Notes A and E to the consolidated financial statements,
effective January 1, 2002, the Company adopted Statement of Financial Accounting
Standards No. 142, Accounting for Goodwill and Other Intangible Assets.
/s/ ERNST & YOUNG LLP
Boston, Massachusetts
January 30, 2004
76
FIVE-YEAR SELECTED FINANCIAL DATA
(UNAUDITED)
(IN MILLIONS, EXCEPT PER SHARE DATA)
YEAR ENDED DECEMBER 31, 2003 2002 2001 2000 1999
- ----------------------- --------- --------- --------- --------- ---------
OPERATING DATA:
Net sales $ 3,476 $ 2,919 $ 2,673 $ 2,664 $ 2,842
Gross profit 2,515 2,049 1,754 1,832 1,856
Selling, general and administrative
expenses 1,171 1,002 926 867 842
Amortization expense 89 72 136 91 92
Royalties 54 36 35 37 46
Research and development expenses 452 343 275 199 197
Purchased research and development 37 85 282
Litigation-related charges (credits), net 15 (99)
Restructuring and merger-related
charges (credits) 58 (10)
Total operating expenses 1,818 1,439 1,654 1,252 1,167
Operating income 697 610 100 580 689
Net income (loss) 472 373 (54) 373 371
Net income (loss) per common share:
Basic $ 0.57 $ 0.46 $ (0.07) $ 0.46 $ 0.46
Assuming dilution $ 0.56 $ 0.45 $ (0.07) $ 0.46 $ 0.45
Weighted average shares outstanding -
assuming dilution 845.4 830.0 802.8 816.6 822.7
-------- -------- --------- --------- ---------
DECEMBER 31, 2003 2002 2001 2000 1999
- ----------------------- --------- --------- --------- --------- ---------
BALANCE SHEET DATA:
Working capital $ 487 $ 285 $ 275 $ 173
Total assets 5,699 4,450 3,974 3,427 $ 3,572
Commercial paper - short-term 547 88 99 56 277
Bank obligations - short-term 6 132 204 323
Long-term debt, net of current portion 1,172 847 973 574 688
Stockholders' equity 2,862 2,467 2,015 1,935 1,724
Book value per common share $ 3.46 $ 3.00 $ 2.49 $ 2.42 $ 2.11
--------- ---------- --------- --------- ---------
The Company paid a two-for-one stock split that was effected in the form of a
100 percent stock dividend on November 5, 2003. All historical amounts above
have been restated to reflect the stock split.
(see notes to the consolidated financial statements)
77
QUARTERLY RESULTS OF OPERATIONS
(unaudited)
(in millions, except per share data)
THREE MONTHS ENDED MARCH 31, JUNE 30, SEPTEMBER 30, DECEMBER 31,
--------- --------- ------------- ------------
2003
Net sales $ 807 $ 854 $ 876 $ 939
Gross profit 581 619 633 682
Operating income 155 173 173 196
Net income 97 114 124 137
Net income per common share - basic $0.12 $0.14 $0.15 $0.17
Net income per common share - assuming dilution $0.11 $0.13 $0.15 $0.16
----- ----- ----- -----
2002
Net sales $ 675 $ 708 $ 722 $ 814
Gross profit 468 483 511 587
Operating income 125 82 246 157
Net income 82 25 161 105
Net income per common share - basic $0.10 $0.03 $0.20 $0.13
Net income per common share - assuming dilution $0.10 $0.03 $0.19 $0.12
----- ----- ----- -----
During the first, second, third and fourth quarters of 2003, the Company
recorded after-tax charges of $20 million, $12 million, $13 million and $4
million, respectively. The net charges for the year consisted of purchased
research and development costs primarily attributable to acquisitions, and
charges related to litigation with the Federal Trade Commission and product
liability settlements.
During the first, second, third and fourth quarters of 2002, the Company
recorded after-tax charges (credits) of $7 million, $70 million, $(62) million
and $25 million, respectively. The net charges (credits) for the year consisted
of purchased research and development associated with acquisitions, costs
related to the Company's global operations strategy, a charitable donation to
fund the Boston Scientific Foundation, special credits for net amounts received
in connection with settlements of litigation related to rapid exchange catheter
technology, and a tax refund of previously paid taxes.
The Company paid a two-for-one stock split that was effected in the form of a
100 percent stock dividend on November 5, 2003. All historical amounts above
have been restated to reflect the stock split.
(see notes to the consolidated financial statements)
78
MARKET FOR THE COMPANY'S COMMON STOCK AND RELATED MATTERS
(unaudited)
The following table shows the market range for the Company's common stock based
on reported sales prices on the New York Stock Exchange. All amounts below
reflect the impact of the Company's two-for-one common stock split that was
effected in the form of a 100 percent stock dividend on November 5, 2003.
2003 HIGH LOW
- ---- ---- ---
First Quarter $ 23.70 $ 19.84
Second Quarter 32.30 20.63
Third Quarter 34.21 28.33
Fourth Quarter 36.76 31.09
2002 HIGH LOW
- ---- ---- ---
First Quarter $ 12.55 $ 10.56
Second Quarter 15.84 12.12
Third Quarter 15.78 11.65
Fourth Quarter 22.11 16.14
The Company has not paid a cash dividend during the past five years. The Company
currently intends to retain all of its earnings to finance the continued growth
of its business. Boston Scientific may consider declaring and paying a dividend
in the future; however, there can be no assurance that it will do so.
At December 31, 2003, there were 8,798 recordholders of the Company's common
stock.
(see notes to the consolidated financial statements)
79