NOTES TO THE CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)
NOTE A – BASIS OF PRESENTATION
The accompanying unaudited condensed consolidated financial statements of Boston Scientific Corporation have been prepared in accordance with accounting principles generally accepted in the United States (U.S. GAAP) and with the instructions to Form 10-Q and Article 10 of Regulation S-X. Accordingly, they do not include all of the information and footnotes required by U.S. GAAP for complete financial statements. In the opinion of management, all adjustments (consisting only of normal recurring adjustments) considered necessary for fair presentation have been included. Operating results for the three and
nine months ended
September 30, 2014
are not necessarily indicative of the results that may be expected for the year ending
December 31, 2014
. For further information, refer to the consolidated financial statements and footnotes thereto included in Item 8 of our 2013 Annual Report on Form 10-K.
Additionally, certain prior year cash outflows from net share settling employee equity awards to satisfy their tax withholding requirement have been reclassified from an operating activity to a financing activity within our condensed consolidated statements of cash flows. Amounts reclassified from operating to financing activities on the cash flows were not material. In addition, we have reclassified certain other prior year amounts to conform to the current year presentation. Refer to
Note L - Segment Reporting
for more information.
Subsequent Events
We evaluate events occurring after the date of our most recent accompanying unaudited condensed consolidated balance sheets for potential recognition or disclosure in our financial statements. We did not identify any material subsequent events requiring adjustment to our accompanying unaudited condensed consolidated financial statements (recognized subsequent events) for the three and nine month periods ended
September 30, 2014
. Those items requiring disclosure (unrecognized subsequent events) in the financial statements have been disclosed accordingly. Refer to
Note J - Commitments and Contingencies
for more information.
NOTE B – ACQUISITIONS
Interventional Business of Bayer AG
On August 29, 2014, we completed the acquisition of the Interventional Division of Bayer AG (Bayer), for a total cash consideration of
$414 million
. We believe that this acquisition enhances our ability to offer physicians and healthcare systems a more complete portfolio of solutions to treat challenging vascular conditions. The transaction includes the AngioJet® Thrombectomy System and the Fetch® 2 Aspiration Catheter, which are used in endovascular procedures to remove blood clots from blocked arteries and veins, and the JetStream® Atherectomy System, used to remove plaque and thrombi from diseased arteries. We plan to integrate the operations of the Bayer business with our Peripheral Intervention and Interventional Cardiology divisions.
IoGyn, Inc.
On May 7, 2014, we completed the acquisition of the remaining fully diluted equity of IoGyn, Inc. (IoGyn). Prior to the acquisition, we held approximately
28 percent
minority interest in IoGyn in addition to notes receivable of approximately
$8 million
. Total consideration was comprised of a net cash payment of
$65 million
at closing to acquire the remaining
72 percent
of IoGyn equity and repay outstanding debt. IoGyn has developed the Symphion
TM
System, a next generation system for hysteroscopic intrauterine tissue removal including fibroids (myomas) and polyps. In March 2014, IoGyn received U.S. Food & Drug Administration (FDA) approval for the system and in October 2014, we launched the system in the United States. We will integrate the operations of the IoGyn business with our gynecological surgery business, which is part of our Urology and Women’s Health division.
Purchase Price Allocation
We accounted for these acquisitions as business combinations and, in accordance with ASC Topic 805,
Business Combinations
, we have recorded the assets acquired and liabilities assumed at their respective fair values as of the acquisition date. The components of the aggregate preliminary purchase price for the acquisition consummated in 2014 are as follows (in millions):
|
|
|
|
|
|
|
|
Cash, net of cash acquired
|
$
|
479
|
|
|
Fair value of prior interests
|
31
|
|
|
|
$
|
510
|
|
Total consideration for the 2014 acquisitions included cash payments of
$510 million
, net of cash acquired, at closing of the transaction.
In addition, prior to the acquisition of IoGyn, we had an equity interest in IoGyn and held
$8 million
of notes receivables. We re-measured our previously held investments to their estimated acquisition-date fair value of
$31 million
and recorded a gain of
$19 million
in other, net, in the accompanying condensed consolidated statements of operations during the second quarter of 2014. We measured the fair values of the previously held investments based on the liquidation preferences and priority of the equity interest and debt, including accrued interest.
The following summarizes the aggregate preliminary purchase price allocation for the 2014 acquisition as of
September 30, 2014
:
|
|
|
|
|
|
|
|
Goodwill
|
$
|
210
|
|
|
Amortizable intangible assets
|
263
|
|
|
Inventory
|
23
|
|
|
Property, Plant and Equipment
|
17
|
|
|
Prepaid Transaction Service Agreement
|
5
|
|
|
Other net assets
|
(1
|
)
|
|
Deferred income taxes
|
(7
|
)
|
|
|
$
|
510
|
|
We allocated a portion of the preliminary purchase price to specific intangible asset categories as follows:
|
|
|
|
|
|
|
|
|
|
|
|
|
Amount
Assigned
(in millions)
|
|
Weighted
Average
Amortization
Period
(in years)
|
|
Range of Risk-
Adjusted Discount
Rates used in
Purchase Price
Allocation
|
|
Amortizable intangible assets:
|
|
|
|
|
|
|
Technology-related
|
$
|
233
|
|
|
10 - 14
|
|
14 - 18 %
|
|
Customer Relationships
|
29
|
|
|
10
|
|
18%
|
|
Other intangible assets
|
1
|
|
|
2
|
|
14%
|
|
|
$
|
263
|
|
|
|
|
|
Our technology-related intangible assets consist of technical processes, intellectual property, and institutional understanding with respect to products and processes that we will leverage in future products or processes and will carry forward from one product generation to the next. We used the income approach to derive the fair value of the technology-related intangible assets, and are amortizing them on a straight-line basis over their assigned estimated useful lives.
Customer relationships represent the estimated fair value of the non-contractual customer and distributor relationships. Customer relationships are direct relationships with physicians and hospitals performing procedures with the acquired products, and distributor relationships are relationships with third parties used to sell products, both as of the acquisition date. These relationships were valued separately from goodwill as there is a history and pattern of conducting relationships with the customers and distributors on a contractual basis. We used the replacement cost and lost profits methodology to derive the fair value of the customer relationships. The customer relationships intangible assets are being amortized on a straight-line basis over their assigned estimated useful lives.
We believe that the estimated intangible asset values represent the fair value at the date of acquisition and do not exceed the amount a third party would pay for the assets. These fair value measurements are based on significant unobservable inputs, including management estimates and assumptions and, accordingly, are classified as Level 3 within the fair value hierarchy prescribed by ASC Topic 820,
Fair Value Measurements and Disclosures
.
We recorded the excess of the aggregate purchase price over the estimated fair values of the identifiable assets acquired as goodwill, the majority of which is deductible for tax purposes. Goodwill was established due primarily to cost synergies expected to be gained from the integration of the businesses into our existing operations, as well as revenue and cash flow projections associated
with future technologies, and has been allocated to our reportable segments based on the relative expected benefit. See
Note D - Goodwill and Other Intangible Assets
for more information related to goodwill allocated to our reportable segments.
We did not close any material acquisitions during the first nine months of 2013.
Contingent Consideration
Certain of our acquisitions involve contingent consideration arrangements. Payment of additional consideration is generally contingent on the acquired company reaching certain performance milestones, including attaining specified revenue levels, achieving product development targets and/or obtaining regulatory approvals. In accordance with U.S. GAAP, we recognize a liability equal to the fair value of the contingent payments we expect to make as of the acquisition date. We re-measure this liability each reporting period and record changes in the fair value through a separate line item within our consolidated statements of operations.
We recorded a net benefit related to the change in fair value of our contingent consideration liabilities of
$4 million
and
$122 million
in the
third
quarter of
2014
and
first nine months
of
2014
, respectively. We recorded a net expenses related to the change in fair value of our contingent consideration liabilities of
$23 million
during the
third
quarter of
2013
and a net benefit of
$18 million
during the
first nine months
of
2013
. We made no contingent consideration payments in the
third
quarter of
2014
,
$15 million
in the
first nine months
of
2014
and we paid
$100 million
and
$115 million
during the
third
quarter and
first nine months
of
2013
.
Changes in the fair value of our contingent consideration liability were as follows (in millions):
|
|
|
|
|
|
|
|
Balance as of December 31, 2013
|
$
|
(501
|
)
|
|
Amounts recorded related to new acquisitions
|
(3
|
)
|
|
Other amounts recorded related to prior acquisitions
|
4
|
|
|
Net fair value adjustments
|
122
|
|
|
Payments made
|
15
|
|
|
Balance as of September 30, 2014
|
$
|
(363
|
)
|
As of
September 30, 2014
, the maximum amount of future contingent consideration (undiscounted) that we could be required to pay was approximately
$2.1 billion
.
Contingent consideration liabilities are re-measured to fair value each reporting period using projected revenues, discount rates, probabilities of payment and projected payment dates. The recurring Level 3 fair value measurements of our contingent consideration liability include the following significant unobservable inputs:
|
|
|
|
|
|
|
|
|
Contingent Consideration Liability
|
Fair Value as of September 30, 2014
|
Valuation Technique
|
Unobservable Input
|
Range
|
|
R&D, Regulatory and Commercialization-based Milestones
|
$62 million
|
Probability Weighted Discounted Cash Flow
|
Discount Rate
|
0.9%-1.4%
|
|
Probability of Payment
|
60% - 95%
|
|
Projected Year of Payment
|
2014 - 2015
|
|
Revenue-based Payments
|
$48 million
|
Discounted Cash Flow
|
Discount Rate
|
11.5% - 15%
|
|
Probability of Payment
|
0% - 100%
|
|
Projected Year of Payment
|
2014 - 2018
|
|
$253 million
|
Monte Carlo
|
Revenue Volatility
|
11% - 13%
|
|
Risk Free Rate
|
LIBOR Term Structure
|
|
Projected Year of Payment
|
2014-2018
|
Increases or decreases in the fair value of our contingent consideration liability can result from changes in discount periods and rates, as well as changes in the timing and amount of revenue estimates or in the timing or likelihood of achieving regulatory-, revenue- or commercialization-based milestones. Projected contingent payment amounts related to research and development, regulatory- and commercialization-based milestones and certain revenue-based milestones are discounted back to the current period using a discounted cash flow (DCF) model. Other revenue-based payments are valued using a Monte Carlo valuation model,
which simulates future revenues during the earn-out period using management's best estimates. Projected revenues are based on our most recent internal operational budgets and long-range strategic plans. Increases in projected revenues and probabilities of payment may result in higher fair value measurements. Increases in discount rates and the time to payment may result in lower fair value measurements. Increases or decreases in any of those inputs in together, or in isolation, may result in a significantly lower or higher fair value measurement.
NOTE C – DIVESTITURES
In January 2011, we closed the sale of our Neurovascular business to Stryker Corporation for a purchase price of
$1.500 billion
in cash. We received
$1.450 billion
during 2011, including an upfront payment of
$1.426 billion
, and
$24 million
which was placed into escrow and released throughout 2011 upon the completion of local closings in certain foreign jurisdictions. We received
$10 million
during 2012,
$28 million
during the second quarter of 2013 and we received the final
$12 million
of consideration in January 2014. At the time of divestiture, due to our continuing involvement in the operations of the Neurovascular business following the transaction, the divestiture did not meet the criteria for presentation as a discontinued operation. Our sales related to our divested Neurovascular business have declined as the various transition services and supply agreements have terminated.
Revenue generated by the Neurovascular business was
$1 million
in the
third
quarter of
2014
,
$4 million
in the
first nine months
of
2014
,
$2 million
in the
third
quarter of
2013
, and
$56 million
in the
first nine months
of
2013
.
NOTE D – GOODWILL AND OTHER INTANGIBLE ASSETS
The gross carrying amount of goodwill and other intangible assets and the related accumulated amortization for intangible assets subject to amortization and accumulated write-offs of goodwill as of
September 30, 2014
and
December 31, 2013
are as follows:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
As of
|
|
|
|
September 30, 2014
|
|
December 31, 2013
|
|
|
|
Gross Carrying
|
|
Accumulated
Amortization/
|
|
Gross Carrying
|
|
Accumulated
Amortization/
|
|
(in millions)
|
|
Amount
|
|
Write-offs
|
|
Amount
|
|
Write-offs
|
|
Amortizable intangible assets
|
|
|
|
|
|
|
|
|
|
Technology-related
|
|
$
|
8,407
|
|
|
$
|
(3,607
|
)
|
|
$
|
8,272
|
|
|
$
|
(3,342
|
)
|
|
Patents
|
|
518
|
|
|
(337
|
)
|
|
513
|
|
|
(326
|
)
|
|
Other intangible assets
|
|
874
|
|
|
(519
|
)
|
|
845
|
|
|
(479
|
)
|
|
|
|
$
|
9,799
|
|
|
$
|
(4,463
|
)
|
|
$
|
9,630
|
|
|
$
|
(4,147
|
)
|
|
Unamortizable intangible assets
|
|
|
|
|
|
|
|
|
|
Goodwill
|
|
$
|
15,801
|
|
|
$
|
(9,900
|
)
|
|
$
|
15,593
|
|
|
$
|
(9,900
|
)
|
|
Technology-related
|
|
197
|
|
|
—
|
|
|
197
|
|
|
—
|
|
|
|
|
$
|
15,998
|
|
|
$
|
(9,900
|
)
|
|
$
|
15,790
|
|
|
$
|
(9,900
|
)
|
In addition, we had
$199 million
and
$270 million
of in-process research and development intangible assets as of
September 30, 2014
and
December 31, 2013
, respectively.
The following represents our goodwill balance by global reportable segment:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
(in millions)
|
|
Cardiovascular
|
|
Rhythm Management
|
|
MedSurg
|
|
Total
|
|
Balance as of December 31, 2013
|
|
$
|
3,252
|
|
|
$
|
294
|
|
|
$
|
2,147
|
|
|
$
|
5,693
|
|
|
Purchase price adjustments
|
|
(1
|
)
|
|
(3
|
)
|
|
(1
|
)
|
|
(5
|
)
|
|
Goodwill acquired
|
|
169
|
|
|
—
|
|
|
44
|
|
|
213
|
|
|
Goodwill written off
|
|
—
|
|
|
—
|
|
|
—
|
|
|
—
|
|
|
Other changes in carrying amount*
|
|
7
|
|
|
—
|
|
|
(7
|
)
|
|
—
|
|
|
Balance as of September 30, 2014
|
|
$
|
3,427
|
|
|
$
|
291
|
|
|
$
|
2,183
|
|
|
$
|
5,901
|
|
*In the first nine months of 2014, we reallocated
$7 million
of goodwill between Cardiovascular and MedSurg as a result of the realignment of certain product lines from Endoscopy to Peripheral Interventions as of January 1, 2014.
2014 Goodwill Impairment Testing
We test our goodwill balances during the second quarter of each year for impairment, or more frequently if indicators are present or changes in circumstances suggest that impairment may exist.
In the second quarter of 2014, we performed our annual goodwill impairment test for all of our reporting units. In conjunction with our annual test, the fair value of each reporting unit exceeded its carrying value. Therefore, it was deemed not necessary to proceed to the second step of the impairment test. As a result of the 2014 annual goodwill impairment test, we have identified our global Neuromodulation and global Electrophysiology reporting units as being at higher risk of potential failure of the first step of the goodwill impairment test in future reporting periods. As of the date of our annual goodwill impairment test, our global Neuromodulation reporting unit had excess fair value over carrying values of approximately
55 percent
and held
$1.356 billion
of allocated goodwill. As of the date of our annual goodwil impairment test, our global Electrophysiology reporting unit had excess fair value over carrying values of approximately
38 percent
and held
$292 million
of allocated goodwill. Our global Cardiac Rhythm Management (CRM) reporting unit had a fair value approximately equal to its carrying value; however, due to goodwill impairment charges in prior years, no goodwill remains within our CRM reporting unit. Changes in our reporting units or in the structure of our business as a result of future reorganizations, acquisitions or divestitures of assets or businesses could result in future impairments of goodwill within our reporting units including global CRM. Further, the recoverability of our CRM-related amortizable intangibles (
$4.167 billion
globally as of
September 30, 2014
) is sensitive to future cash flow assumptions and our global CRM business performance. The
$4.167 billion
of CRM-related amortizable intangibles are at higher risk of potential failure of the first step of the amortizable intangible recoverability test in future reporting periods. An impairment of a material portion of our CRM-related amortizable intangibles carrying value would occur if the second step of the amortizable intangible test is required in a future reporting period. Refer to
Critical Accounting Policies and Estimates
within our Management's Discussion and Analysis of Financial Condition and Results of Operations contained in Item 2 of this Quarterly Report on Form 10-Q for a discussion of key assumptions used in our testing.
On a quarterly basis, we monitor the key drivers of fair value to detect events or other changes that would warrant an interim impairment test of our goodwill and intangible assets. The key variables that drive the cash flows of our reporting units and amortizable intangibles are estimated revenue growth rates and levels of profitability. Terminal value growth rate assumptions, as well as the Weighted Average Cost of Capital (WACC) rate applied are additional key variables for reporting unit cash flows. These assumptions are subject to uncertainty, including our ability to grow revenue and improve profitability levels. Relatively
small declines in the future performance and cash flows of a reporting unit or asset group or small changes in other key assumptions may result in the recognition of significant goodwill or intangible asset impairment charges. For example, as of the date of our annual goodwill impairment test, keeping all other variables constant, an increase in the WACC applied of
100
basis points combined with a
150
basis points decrease in the terminal value growth rate would require that we perform the second step of the goodwill impairment test for both our global Electrophysiology and global Neuromodulation reporting units. The estimates used for our future cash flows and discount rates represent management's best estimates, which we believe to be reasonable, but future declines in business performance may impair the recoverability of our goodwill and intangible asset balances.
Future events that could have a negative impact on the levels of excess fair value over carrying value of our reporting units and/or amortizable intangible assets include, but are not limited to:
|
|
|
|
•
|
decreases in estimated market sizes or market growth rates due to greater-than-expected declines in procedural volumes, pricing pressures, reductions in reimbursement levels, product actions, and/or competitive technology developments;
|
|
|
|
|
•
|
declines in our market share and penetration assumptions due to increased competition, an inability to develop or launch new and next-generation products and technology features in line with our commercialization strategies, product actions, and market and/or regulatory conditions that may cause significant launch delays or product recalls;
|
|
|
|
|
•
|
decreases in our forecasted profitability due to an inability to successfully implement and achieve timely and sustainable cost improvement measures consistent with our expectations, increases in our market-participant tax rate, and/or changes in tax laws;
|
|
|
|
|
•
|
negative developments in intellectual property litigation that may impact our ability to market certain products or increase our costs to sell certain products;
|
|
|
|
|
•
|
the level of success of on-going and future research and development efforts, including those related to recent acquisitions, and increases in the research and development costs necessary to obtain regulatory approvals and launch new products;
|
|
|
|
|
•
|
the level of success in managing the growth of acquired companies, achieving sustained profitability consistent with our expectations, establishing government and third-party payer reimbursement, supplying the market, and increases in the costs and time necessary to integrate acquired businesses into our operations successfully;
|
|
|
|
|
•
|
changes in our reporting units or in the structure of our business as a result of future reorganizations, acquisitions or divestitures of assets or businesses; and
|
|
|
|
|
•
|
increases in our market-participant risk-adjusted WACC.
|
Negative changes in one or more of these factors, among others, could result in additional impairment charges.
2013 Charge
Following our reorganization from regions to global business units and our reallocation of goodwill on a relative fair value basis as of January 1, 2013, we conducted the first step of the goodwill impairment test for all global reporting units. As of January 1, 2013, the fair value of each global reporting unit exceeded its carrying value, with the exception of the global CRM reporting unit. In accordance with ASC Topic 350,
Intangibles—Goodwill and Other
(Topic 350) and our accounting policies
,
we tested the global CRM intangible assets and goodwill for impairment and recorded a non-cash goodwill impairment charge of
$423 million
(
$421 million
after-tax) to write down the goodwill to its implied fair value as of January 1, 2013 as a result of this analysis. The primary driver of this impairment charge was our reorganization from geographic regions to global business units as of January 1, 2013, which changed the composition of our reporting units. As a result of the reorganization, any goodwill allocated to the global CRM reporting unit was no longer supported by the cash flows of other businesses. Under our former reporting unit structure, the goodwill allocated to our regional reporting units was supported by the cash flows from all businesses in each international region. The hypothetical tax structure of the global CRM business and the global CRM business discount rate applied were also contributing factors to the goodwill impairment charge. Refer to
Note D - Goodwill and Other Intangible Assets
contained in Item 8 of our 2013 Annual Report filed on Form 10-K for details on the 2013 goodwill impairment charge.
The following is a rollforward of accumulated goodwill write-offs by global reportable segment:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
(in millions)
|
Cardiovascular
|
|
Rhythm Management
|
|
MedSurg
|
|
Total
|
|
Accumulated write-offs as of December 31, 2013
|
$
|
(1,479
|
)
|
|
$
|
(6,960
|
)
|
|
$
|
(1,461
|
)
|
|
$
|
(9,900
|
)
|
|
Goodwill written off
|
—
|
|
|
—
|
|
|
—
|
|
|
—
|
|
|
Accumulated write-offs as of September 30, 2014
|
$
|
(1,479
|
)
|
|
$
|
(6,960
|
)
|
|
$
|
(1,461
|
)
|
|
$
|
(9,900
|
)
|
Intangible Asset Impairment Testing
On a quarterly basis, we monitor for events or other potential indicators of an impairment that would warrant an interim impairment test of our intangible assets. Refer to
Note D - Goodwill and Other Intangible Assets
contained in Item 8 of our 2013 Annual Report on Form 10-K for a discussion of future events that would have a negative impact on the recoverability of our
$4.167 billion
of CRM-related amortizable intangible assets. Our CRM-related amortizable intangible assets are at higher risk of potential failure of the first step of the amortizable intangible asset recoverability test in future reporting periods. An impairment of a material portion of our CRM-related amortizable intangible assets carrying value would likely occur if the second step of the amortizable intangible asset test is required in a future reporting period. Refer to
Critical Accounting Policies and Estimates
within our Management's Discussion and Analysis of Financial Condition and Results of Operations contained in Item 7 of our 2013 Annual Report on Form 10-K for a discussion of key assumptions used in our testing.
2014 Charges
During the third quarter of 2014, we performed our annual impairment test of all in-process research and development projects, and our indefinite lived core technology assets. Indefinite-lived intangible assets are tested for impairment on an annual basis during the third quarter of each year, or more frequently if impairment indicators are present, in accordance with U.S. GAAP and our accounting policies described in our 2013 Annual Report on Form 10-K. Based on the results of our annual test, we recorded total impairment charges of
$4 million
to write-down the balances of certain in-process projects to their fair value. In addition, as a result of revised estimates in conjunction with our annual operating plan, we performed an interim impairment test of core technology associated with certain of our acquisitions, and recorded an impairment charge of
$8 million
, for a total of
$12 million
of impairment charges in the third quarter of 2014.
During the second quarter of 2014, as a result of revised estimates developed in conjunction with our annual strategic planning process and annual goodwill impairment test, we performed an interim impairment test of our in-process research and development projects and core technology associated with certain of our acquisitions. Based on our impairment assessment, and lower expected future cash flows associated with our intangible assets, we recorded pre-tax impairment charges of
$110 million
in the second
quarter of 2014. As a result of changes in our clinical strategy and lower estimates of the European and global hypertension markets, and the resulting amount of future revenue and cash flows associated with the technology acquired from Vessix Vascular Inc. (Vessix), we recorded impairment charges of
$67 million
related to technology intangible assets during the second quarter of 2014. In addition, in the second quarter of 2014, due to revised expectations and timing as a result of the announcement of a third FDA Circulatory System Devices Panel, we recorded impairment charges of
$35 million
related to the in-process research and development intangible assets acquired from Atritech, Inc. (Atritech). We also recorded an additional
$8 million
intangible asset impairment charge associated with changes in the amount of the expected cash flows related to certain other acquired in-process research and development projects.
During the first quarter of 2014, as a result of lower estimates of the resistant hypertension market following the announcement of data from a competitor's clinical trial, we performed an interim impairment test of our in-process research and development projects and core technology associated with our acquisition of Vessix. The impairment assessments were based upon probability-weighted cash flows of potential future scenarios. Based on our impairment assessment, and lower expected future cash flows associated with our Vessix-related intangible assets, we recorded pre-tax impairment charges of
$55 million
in the first quarter of 2014 to write-down the balance of these intangible assets to their fair value.
2013 Charges
During the second quarter of 2013, as a result of revised estimates developed in conjunction with our annual strategic planning process and annual goodwill impairment test, we performed an interim impairment test of our in-process research and development projects associated with certain of our acquisitions. Based on the results of our impairment analysis, we revised our expectations of the market size related to Sadra Medical, Inc. (Sadra), and the resulting timing and amount of future revenue and cash flows associated with the technology acquired from Sadra. As a result of these changes, we recorded pre-tax impairment charges of
$51 million
in the second quarter of 2013 to write-down the balance of these intangible assets to their fair value. During the second quarter of 2013, we also recorded an additional
$2 million
intangible asset impairment charge associated with changes in the amount of the expected cash flows related to certain other acquired in-process research and development projects.
We recorded these amounts in the intangible asset impairment charges caption in our accompanying unaudited condensed consolidated statements of operations.
The nonrecurring Level 3 fair value measurements of our intangible asset impairment analysis included the following significant unobservable inputs:
|
|
|
|
|
|
|
|
|
|
Intangible Asset
|
Valuation Date
|
Fair Value
|
Valuation Technique
|
Unobservable Input
|
Rate
|
|
In-Process R&D
|
September 30, 2014
|
$16 million
|
Income Approach - Excess Earnings Method
|
Discount Rate
|
16.5 - 20%
|
|
In-Process R&D
|
June 30, 2014
|
$83 million
|
Income Approach - Excess Earnings Method
|
Discount Rate
|
16.5 - 20%
|
|
Core Technology
|
June 30, 2014
|
$8 million
|
Income Approach - Excess Earnings Method
|
Discount Rate
|
15%
|
|
In-Process R&D
|
March 31, 2014
|
$6 million
|
Income Approach - Excess Earnings Method
|
Discount Rate
|
20%
|
|
Core Technology
|
March 31, 2014
|
$64 million
|
Income Approach - Excess Earnings Method
|
Discount Rate
|
15%
|
|
In-Process R&D
|
June 30, 2013
|
$178 million
|
Income Approach - Excess Earnings Method
|
Discount Rate
|
16.5%
|
NOTE E – FAIR VALUE MEASUREMENTS
Derivative Instruments and Hedging Activities
We develop, manufacture and sell medical devices globally and our earnings and cash flows are exposed to market risk from changes in foreign currency exchange rates and interest rates. We address these risks through a risk management program that includes the use of derivative financial instruments, and operate the program pursuant to documented corporate risk management policies. We recognize all derivative financial instruments in our consolidated financial statements at fair value in accordance with ASC Topic 815,
Derivatives and Hedging
(Topic 815). In accordance with Topic 815, for those derivative instruments that are designated and qualify as hedging instruments, the hedging instrument must be designated, based upon the exposure being hedged, as a fair value hedge, cash flow hedge, or a hedge of a net investment in a foreign operation. The accounting for changes in the fair value (i.e., gains or losses) of a derivative instrument depends on whether it has been designated and qualifies as part of a hedging relationship and, further, on the type of hedging relationship. Our derivative instruments do not subject our earnings or cash flows to material risk, as gains and losses on these derivatives generally offset losses and gains on the item being hedged. We do not enter into derivative transactions for speculative purposes and we do not have any non-derivative instruments that are designated as hedging instruments pursuant to Topic 815.
Currency Hedging
We are exposed to currency risk consisting primarily of foreign currency denominated monetary assets and liabilities, forecasted foreign currency denominated intercompany and third-party transactions and net investments in certain subsidiaries. We manage our exposure to changes in foreign currency exchange rates on a consolidated basis to take advantage of offsetting transactions. We use both derivative instruments (currency forward and option contracts), and non-derivative transactions (primarily European manufacturing and distribution operations) to reduce the risk that our earnings and cash flows associated with these foreign currency denominated balances and transactions will be adversely affected by foreign currency exchange rate changes.
Designated Foreign Currency Hedges
All of our designated currency hedge contracts outstanding as of
September 30, 2014
and
December 31, 2013
were cash flow hedges under Topic 815 intended to protect the U.S. dollar value of our forecasted foreign currency denominated transactions. We record the effective portion of any change in the fair value of foreign currency cash flow hedges in other comprehensive income (OCI) until the related third-party transaction occurs. Once the related third-party transaction occurs, we reclassify the effective portion of any related gain or loss on the foreign currency cash flow hedge to earnings. In the event the hedged forecasted transaction does not occur, or it becomes no longer probable that it will occur, we reclassify the amount of any gain or loss on the related cash
flow hedge to earnings at that time. We had currency derivative instruments designated as cash flow hedges outstanding in the contract amount of
$2.442 billion
as of
September 30, 2014
and
$2.564 billion
as of
December 31, 2013
.
We recognized
net gains
of
$25 million
in earnings on our cash flow hedges during the
third
quarter of
2014
and
$68 million
for the
first nine months
of
2014
, as compared to
net gains
of
$15 million
during the
third
quarter of
2013
and
$15 million
for the
first nine months
of
2013
. All currency cash flow hedges outstanding as of
September 30, 2014
mature within
36
months. As of
September 30, 2014
,
$169 million
of net gains, net of tax, were recorded in accumulated other comprehensive income (AOCI) to recognize the effective portion of the fair value of any currency derivative instruments that are, or previously were, designated as foreign currency cash flow hedges, as compared to net gains of
$139 million
as of
December 31, 2013
. As of
September 30, 2014
,
$99 million
of net gains, net of tax, may be reclassified to earnings within the next twelve months.
The success of our 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). We may experience unanticipated currency exchange gains or losses to the extent that there are differences between forecasted and actual activity during periods of currency volatility. In addition, changes in foreign currency exchange rates related to any unhedged transactions may impact our earnings and cash flows.
Non-designated Foreign Currency Contracts
We use currency forward contracts as a part of our strategy to manage exposure related to foreign currency denominated monetary assets and liabilities. These currency forward contracts are not designated as cash flow, fair value or net investment hedges under Topic 815; are marked-to-market with changes in fair value recorded to earnings; and are entered into for periods consistent with currency transaction exposures, generally less than one year. We had currency derivative instruments not designated as hedges under Topic 815 outstanding in the contract amount of
$2.479 billion
as of
September 30, 2014
and
$1.952 billion
as of
December 31, 2013
.
Interest Rate Hedging
Our interest rate risk relates primarily to U.S. dollar borrowings, partially offset by U.S. dollar cash investments. We have historically used interest rate derivative instruments to manage our earnings and cash flow exposure to changes in interest rates by converting floating-rate debt into fixed-rate debt or fixed-rate debt into floating-rate debt.
We designate these derivative instruments either as fair value or cash flow hedges under Topic 815. We record changes in the value of fair value hedges in interest expense, which is generally offset by changes in the fair value of the hedged debt obligation. Interest payments made or received related to our interest rate derivative instruments are included in interest expense. We record the effective portion of any change in the fair value of derivative instruments designated as cash flow hedges as unrealized gains or losses in OCI, net of tax, until the hedged cash flow occurs, at which point the effective portion of any gain or loss is reclassified to earnings. We record the ineffective portion of our cash flow hedges in interest expense. In the event the hedged cash flow does not occur, or it becomes no longer probable that it will occur, we reclassify the amount of any gain or loss on the related cash flow hedge to interest expense at that time.
In the fourth quarter of 2013, we entered into interest rate derivative contracts having a notional amount of
$450 million
to convert fixed-rate debt into floating-rate debt, which we designated as fair value hedges, and had
$450 million
outstanding as of
September 30, 2014
. We assessed at inception, and re-assess on an ongoing basis, whether the interest rate derivative contracts are highly effective in offsetting changes in the fair value of the hedged fixed-rate debt. During the
third
quarter of
2014
we recognized, in interest expense, a
$1 million
gain on our hedged debt and a
$1 million
loss on the related interest rate derivative contract. During the
first nine months
of 2014 we recognized, in interest expense, a
$17 million
loss on our hedged debt and a
$17 million
gain on the related interest rate derivative contract.
In prior years, we terminated certain interest rate derivative contracts, including fixed-to-floating interest rate contracts, designated as fair value hedges, and floating-to-fixed treasury locks, designated as cash flow hedges. We are amortizing the gains and losses on these derivative instruments upon termination into earnings as a reduction of interest expense over the remaining term of the hedged debt, in accordance with Topic 815. The carrying amount of certain of our senior notes included unamortized gains of
$47 million
as of
September 30, 2014
and
$54 million
as of
December 31, 2013
, and unamortized losses of
$2 million
as of
September 30, 2014
and
$2 million
as of
December 31, 2013
, related to the fixed-to-floating interest rate contracts. In addition, we had pre-tax net gains within AOCI related to terminated floating-to-fixed treasury locks of
$2 million
as of
September 30, 2014
and
$3 million
as of
December 31, 2013
. We recorded approximately
$2 million
during the
third
quarter of
2014
and
$7 million
during the
first nine months
of
2014
as a reduction to interest expense, resulting from the amortization of previously terminated interest rate derivative contracts. As of
September 30, 2014
,
$9 million
of pre-tax net gains may be reclassified to earnings within the next twelve months as a reduction to interest expense from amortization of our previously terminated interest rate derivative contracts.
Counterparty Credit Risk
We do not have significant concentrations of credit risk arising from our derivative financial instruments, whether from an individual counterparty or a related group of counterparties. We manage our concentration of counterparty credit risk on our derivative instruments by limiting acceptable counterparties to a diversified group of major financial institutions with investment grade credit ratings, limiting the amount of credit exposure to each counterparty, and by actively monitoring their credit ratings and outstanding fair values on an on-going basis. Furthermore, none of our derivative transactions are subject to collateral or other security arrangements and none contain provisions that are dependent on our credit ratings from any credit rating agency.
We also employ master netting arrangements that reduce our counterparty payment settlement risk on any given maturity date to the net amount of any receipts or payments due between us and the counterparty financial institution. Thus, the maximum loss due to counterparty credit risk is limited to the unrealized gains in such contracts net of any unrealized losses should any of these counterparties fail to perform as contracted. Although these protections do not eliminate concentrations of credit risk, as a result of the above considerations, we do not consider the risk of counterparty default to be significant.
Fair Value of Derivative Instruments
The following presents the effect of our derivative instruments designated as cash flow hedges under Topic 815 on our accompanying unaudited condensed consolidated statements of operations during the
third
quarter and
first nine months
of
2014
and
2013
(in millions):
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Amount of Pre-tax
Gain (Loss)
Recognized in OCI
(Effective Portion)
|
|
Amount of Pre-tax Gain (Loss) Reclassified from AOCI into Earnings
(Effective Portion)
|
|
Location in Statement of
Operations
|
|
Three Months Ended September 30, 2014
|
|
|
|
|
|
|
Currency hedge contracts
|
$
|
156
|
|
|
$
|
25
|
|
|
Cost of products sold
|
|
|
$
|
156
|
|
|
$
|
25
|
|
|
|
|
Three Months Ended September 30, 2013
|
|
|
|
|
|
|
Currency hedge contracts
|
$
|
(45
|
)
|
|
$
|
15
|
|
|
Cost of products sold
|
|
|
$
|
(45
|
)
|
|
$
|
15
|
|
|
|
|
Nine Months Ended September 30, 2014
|
|
|
|
|
|
|
Currency hedge contracts
|
$
|
115
|
|
|
$
|
68
|
|
|
Cost of products sold
|
|
|
$
|
115
|
|
|
$
|
68
|
|
|
|
|
Nine Months Ended September 30, 2013
|
|
|
|
|
|
|
Currency hedge contracts
|
$
|
144
|
|
|
$
|
15
|
|
|
Cost of products sold
|
|
|
$
|
144
|
|
|
$
|
15
|
|
|
|
The amount of gain (loss) recognized in earnings related to the ineffective portion of hedging relationships was de minimis for all periods presented.
Net gains and losses on currency hedge contracts not designated as hedging instruments were offset by net losses and gains from foreign currency transaction exposures, as shown in the following table:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
in millions
|
|
Location in Statement of Operations
|
|
Three Months Ended
|
|
Nine Months Ended
|
|
|
|
September 30,
|
|
September 30,
|
|
|
|
2014
|
|
2013
|
|
2014
|
|
2013
|
|
Gain (loss) on currency hedge contracts
|
|
Other, net
|
|
$
|
40
|
|
|
$
|
12
|
|
|
$
|
20
|
|
|
$
|
66
|
|
|
Gain (loss) on foreign currency transaction exposures
|
|
Other, net
|
|
(45
|
)
|
|
(15
|
)
|
|
(31
|
)
|
|
(72
|
)
|
|
Net foreign currency gain (loss)
|
|
Other, net
|
|
$
|
(5
|
)
|
|
$
|
(3
|
)
|
|
$
|
(11
|
)
|
|
$
|
(6
|
)
|
Topic 815 requires all derivative instruments to be recognized at their fair values as either assets or liabilities on the balance sheet. We determine the fair value of our derivative instruments using the framework prescribed by ASC Topic 820,
Fair Value
Measurements and Disclosures
(Topic 820), by considering the estimated amount we would receive or pay to transfer these instruments at the reporting date and by taking into account current interest rates, foreign currency exchange rates, the creditworthiness of the counterparty for assets, and our creditworthiness for liabilities. In certain instances, we may utilize financial models to measure fair value. Generally, we use inputs that include quoted prices for similar assets or liabilities in active markets; quoted prices for identical or similar assets or liabilities in markets that are not active; other observable inputs for the asset or liability; and inputs derived principally from, or corroborated by, observable market data by correlation or other means. As of
September 30, 2014
, we have classified all of our derivative assets and liabilities within Level 2 of the fair value hierarchy prescribed by Topic 820, as discussed below, because these observable inputs are available for substantially the full term of our derivative instruments.
The following are the balances of our derivative assets and liabilities as of
September 30, 2014
and
December 31, 2013
:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
As of
|
|
|
|
September 30,
|
|
December 31,
|
|
(in millions)
|
Location in Balance Sheet (1)
|
2014
|
|
2013
|
|
Derivative Assets:
|
|
|
|
|
|
Designated Hedging Instruments
|
|
|
|
|
|
Currency hedge contracts
|
Prepaid and other current assets
|
$
|
143
|
|
|
$
|
117
|
|
|
Currency hedge contracts
|
Other long-term assets
|
112
|
|
|
120
|
|
|
Interest rate contracts
|
Prepaid and other current assets
|
7
|
|
|
1
|
|
|
Interest rate contracts
|
Other long-term assets
|
10
|
|
|
—
|
|
|
|
|
272
|
|
|
238
|
|
|
Non-Designated Hedging Instruments
|
|
|
|
|
|
Currency hedge contracts
|
Prepaid and other current assets
|
70
|
|
|
27
|
|
|
Total Derivative Assets
|
|
$
|
342
|
|
|
$
|
265
|
|
|
|
|
|
|
|
|
Derivative Liabilities:
|
|
|
|
|
|
Designated Hedging Instruments
|
|
|
|
|
|
Currency hedge contracts
|
Other current liabilities
|
$
|
2
|
|
|
$
|
13
|
|
|
Currency hedge contracts
|
Other long-term liabilities
|
2
|
|
|
19
|
|
|
Interest rate contracts
|
Other long-term liabilities
|
—
|
|
|
8
|
|
|
|
|
4
|
|
|
40
|
|
|
Non-Designated Hedging Instruments
|
|
|
|
|
|
Currency hedge contracts
|
Other current liabilities
|
29
|
|
|
23
|
|
|
Total Derivative Liabilities
|
|
$
|
33
|
|
|
$
|
63
|
|
|
|
|
|
(1)
|
We classify derivative assets and liabilities as current when the remaining term of the derivative contract is one year or less.
|
Other Fair Value Measurements
Recurring Fair Value Measurements
On a recurring basis, we measure certain financial assets and financial liabilities at fair value based upon quoted market prices, where available. Where quoted market prices or other observable inputs are not available, we apply valuation techniques to estimate fair value. Topic 820 establishes a three-level valuation hierarchy for disclosure of fair value measurements. The categorization of financial assets and financial liabilities within the valuation hierarchy is based upon the lowest level of input that is significant to the measurement of fair value. The three levels of the hierarchy are defined as follows:
|
|
|
|
•
|
Level 1 – Inputs to the valuation methodology are quoted market prices for identical assets or liabilities.
|
|
|
|
|
•
|
Level 2 – Inputs to the valuation methodology are other observable inputs, including quoted market prices for similar assets or liabilities and market-corroborated inputs.
|
|
|
|
|
•
|
Level 3 – Inputs to the valuation methodology are unobservable inputs based on management’s best estimate of inputs market participants would use in pricing the asset or liability at the measurement date, including assumptions about risk.
|
Assets and liabilities measured at fair value on a recurring basis consist of the following as of
September 30, 2014
and
December 31, 2013
:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
As of September 30, 2014
|
|
As of December 31, 2013
|
|
(in millions)
|
Level 1
|
|
Level 2
|
|
Level 3
|
|
Total
|
|
Level 1
|
|
Level 2
|
|
Level 3
|
|
Total
|
|
Assets
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Money market and government funds
|
$
|
29
|
|
|
$
|
—
|
|
|
$
|
—
|
|
|
$
|
29
|
|
|
$
|
38
|
|
|
$
|
—
|
|
|
$
|
—
|
|
|
$
|
38
|
|
|
Currency hedge contracts
|
—
|
|
|
325
|
|
|
—
|
|
|
325
|
|
|
—
|
|
|
264
|
|
|
—
|
|
|
264
|
|
|
Interest rate contracts
|
—
|
|
|
17
|
|
|
—
|
|
|
17
|
|
|
—
|
|
|
1
|
|
|
—
|
|
|
1
|
|
|
|
$
|
29
|
|
|
$
|
342
|
|
|
$
|
—
|
|
|
$
|
371
|
|
|
$
|
38
|
|
|
$
|
265
|
|
|
$
|
—
|
|
|
$
|
303
|
|
|
Liabilities
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Currency hedge contracts
|
$
|
—
|
|
|
$
|
33
|
|
|
$
|
—
|
|
|
$
|
33
|
|
|
$
|
—
|
|
|
$
|
55
|
|
|
$
|
—
|
|
|
$
|
55
|
|
|
Accrued contingent consideration
|
—
|
|
|
—
|
|
|
363
|
|
|
363
|
|
|
—
|
|
|
—
|
|
|
501
|
|
|
501
|
|
|
Interest rate contracts
|
—
|
|
|
—
|
|
|
—
|
|
|
—
|
|
|
—
|
|
|
8
|
|
|
—
|
|
|
8
|
|
|
|
$
|
—
|
|
|
$
|
33
|
|
|
$
|
363
|
|
|
$
|
396
|
|
|
$
|
—
|
|
|
$
|
63
|
|
|
$
|
501
|
|
|
$
|
564
|
|
Our investments in money market and government funds are generally classified within Level 1 of the fair value hierarchy because they are valued using quoted market prices. These investments are classified as cash and cash equivalents within our accompanying unaudited condensed consolidated balance sheets, in accordance with U.S. GAAP and our accounting policies.
In addition to
$29 million
invested in money market and government funds as of
September 30, 2014
, we had
$48 million
in short-term time deposits and
$169 million
in interest bearing and non-interest bearing bank accounts. In addition to
$38 million
invested in money market and government funds as of
December 31, 2013
, we had
$31 million
in short-term deposits and
$148 million
in interest bearing and non-interest bearing bank accounts.
Our recurring fair value measurements using significant unobservable inputs (Level 3) relate solely to our contingent consideration liabilities. Refer to
Note B - Acquisitions
in this Quarterly Report on Form 10-Q, for a discussion of the changes in the fair value of our contingent consideration liabilities.
Non-Recurring Fair Value Measurements
We hold certain assets and liabilities that are measured at fair value on a non-recurring basis in periods subsequent to initial recognition. The fair value of a cost method investment is not estimated if there are no identified events or changes in circumstances that may have a significant adverse effect on the fair value of the investment. The aggregate carrying amount of our cost method investments was
$25 million
as of
September 30, 2014
and
$20 million
as of
December 31, 2013
.
During the
third
quarter of
2014
, we recorded
$2 million
of losses to write down certain investments to their fair values. These adjustments fell within Level 3 of the fair value hierarchy due to the use of significant unobservable inputs to determine fair value. During the third quarter of 2013, we recorded
$4 million
of losses to write down certain investments to their fair values. These adjustments fall within Level 3 of the fair value hierarchy, due to the use of significant unobservable inputs to determine fair value.
During the
first nine months
of
2014
, we recorded
$177 million
of losses to adjust our intangible asset balances to their fair value. During the
first nine months
of 2013, we recorded
$476 million
of losses, to adjust our goodwill and certain other intangible asset balances to their fair value. Refer to
Note D - Goodwill and Other Intangible Assets
in this Quarterly Report on Form 10-Q
,
for further information related to these charges and significant unobservable inputs (Level 3).
The fair value of our outstanding debt obligations was
$4.657 billion
as of
September 30, 2014
and
$4.602 billion
as of
December 31, 2013
, which was determined by using primarily quoted market prices for our publicly registered senior notes, classified as Level 1 within the fair value hierarchy. Refer to
Note F – Borrowings and Credit Arrangements
in this Quarterly Report on Form 10-Q
,
for a discussion of our debt obligations.
NOTE F – BORROWINGS AND CREDIT ARRANGEMENTS
We had total debt of
$4.252 billion
as of
September 30, 2014
and
$4.240 billion
as of
December 31, 2013
. The debt maturity schedule for the significant components of our debt obligations as of
September 30, 2014
is as follows:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
(in millions)
|
2014
|
|
2015
|
|
2016
|
|
2017
|
|
2018
|
|
Thereafter
|
|
Total
|
|
Senior notes
|
$
|
—
|
|
|
$
|
400
|
|
|
$
|
600
|
|
|
$
|
250
|
|
|
$
|
600
|
|
|
$
|
1,950
|
|
|
$
|
3,800
|
|
|
Term loan
|
—
|
|
|
—
|
|
|
80
|
|
|
80
|
|
|
240
|
|
|
—
|
|
|
400
|
|
|
|
$
|
—
|
|
|
$
|
400
|
|
|
$
|
680
|
|
|
$
|
330
|
|
|
$
|
840
|
|
|
$
|
1,950
|
|
|
$
|
4,200
|
|
|
|
|
|
|
|
|
|
Note:
|
The table above does not include unamortized discounts associated with our senior notes, or amounts related to interest rate contracts used to hedge the fair value of certain of our senior notes.
|
Revolving Credit Facility
We maintain a
$2.000 billion
revolving credit facility, maturing in April 2017, with a global syndicate of commercial banks. Eurodollar and multicurrency loans under this revolving credit facility bear interest at LIBOR plus an interest margin of between
0.875 percent
and
1.475 percent
, based on our corporate credit ratings and consolidated leverage ratio (
1.275 percent
as of
September 30, 2014
). In addition, we are required to pay a facility fee based on our credit ratings, consolidated leverage ratio, and the total amount of revolving credit commitments, regardless of usage, under the agreement (
0.225 percent
as of
September 30, 2014
). There were no amounts borrowed under our revolving credit facility as of
September 30, 2014
or
December 31, 2013
.
Our revolving credit facility agreement requires that we maintain certain financial covenants, as follows:
|
|
|
|
|
|
|
|
|
Covenant
Requirement
|
|
Actual as of
September 30, 2014
|
|
Maximum leverage ratio (1)
|
3.5 times
|
|
2.5 times
|
|
Minimum interest coverage ratio (2)
|
3.0 times
|
|
7.9 times
|
|
|
|
|
(1)
|
Ratio of total debt to consolidated EBITDA, as defined by the credit agreement, for the preceding four consecutive fiscal quarters.
|
|
|
|
|
(2)
|
Ratio of consolidated EBITDA, as defined by the credit agreement, to interest expense for the preceding four consecutive fiscal quarters.
|
The credit agreement provides for an exclusion from the calculation of consolidated EBITDA, as defined by the agreement, through the credit agreement maturity, of any non-cash charges and up to
$500 million
in restructuring charges and restructuring-related expenses related to our current or future restructuring plans. As of
September 30, 2014
, we had
$164 million
of the restructuring charge exclusion remaining. In addition, any cash litigation payments (net of any cash litigation receipts), as defined by the agreement, are excluded from the calculation of consolidated EBITDA and any new debt issued to fund any tax deficiency payments is excluded from consolidated total debt, as defined in the agreement, provided that the sum of any excluded net cash litigation payments and any new debt issued to fund any tax deficiency payments shall not exceed
$2.300 billion
in the aggregate. As of
September 30, 2014
, we had
$2.130 billion
of the combined legal and debt exclusion remaining. As of and through
September 30, 2014
, we were in compliance with the required covenants.
Any inability to maintain compliance with these covenants could require us to seek to renegotiate the terms of our credit facilities or seek waivers from compliance with these covenants, both of which could result in additional borrowing costs. Further, there can be no assurance that our lenders would agree to such new terms or grant such waivers.
Term Loan
We had
$400 million
outstanding under an unsecured term loan facility as of
September 30, 2014
and
December 31, 2013
. Term loan borrowings under this facility bear interest at LIBOR plus an interest margin of between
1.0 percent
and
1.75 percent
(currently
1.5 percent
), based on our corporate credit ratings and consolidated leverage ratio. The term loan borrowings are payable over a five-year period, with quarterly principal payments of
$20 million
commencing in the first quarter of 2016 and the remaining principal amount due at the final maturity date in August 2018, and are repayable at any time without premium or penalty. Our term loan facility requires that we comply with certain covenants, including financial covenants with respect to maximum leverage and minimum interest coverage, consistent with our revolving credit facility. The maximum leverage ratio requirement is
3.5 times
and our actual leverage ratio as of
September 30, 2014
is
2.5 times
. The minimum interest coverage ratio requirement is
3.0 times
and our actual interest coverage ratio as of
September 30, 2014
is
7.9 times
.
Senior Notes
We had senior notes outstanding of
$3.800 billion
as of
September 30, 2014
and
December 31, 2013
. Our senior notes are publicly registered securities, are redeemable prior to maturity and are not subject to any sinking fund requirements. Our senior notes are unsecured, unsubordinated obligations and rank on parity with each other. These notes are effectively junior to borrowings under our credit and security facility and liabilities of our subsidiaries (see
Other Arrangements
below).
Other Arrangements
We also maintain a
$300 million
credit and security facility secured by our U.S. trade receivables maturing in June 2015, subject to further extension. The credit and security facility requires that we maintain a maximum leverage covenant consistent with our revolving credit facility. The maximum leverage ratio requirement is
3.5 times
and our actual leverage ratio as of
September 30, 2014
is
2.5 times
. We had no borrowings outstanding under this facility as of
September 30, 2014
and
December 31, 2013
.
We have accounts receivable factoring programs in certain European countries that we account for as sales under ASC Topic 860,
Transfers and Servicing.
These agreements provide for the sale of accounts receivable to third parties, without recourse, of up to approximately
$285 million
as of
September 30, 2014
. We have no retained interests in the transferred receivables, other than collection and administrative responsibilities and, once sold, the accounts receivable are no longer available to satisfy creditors in the event of bankruptcy. We de-recognized
$135 million
of receivables as of
September 30, 2014
at an average interest rate of
2.9 percent
, and
$146 million
as of
December 31, 2013
at an average interest rate of
3.3 percent
. Within Italy, Spain, Portugal and Greece, the number of days our receivables are outstanding has remained above historical levels. We believe we have adequate allowances for doubtful accounts related to our Italy, Spain, Portugal and Greece accounts receivable; however, we continue to monitor the European economic environment for any collectibility issues related to our outstanding receivables. During the first nine months of 2014, we received cash payments of approximately
$80 million
related to a government-funded settlement of long outstanding receivables in Spain. As of
September 30, 2014
, our net receivables in these countries greater than 180 days past due totaled
$31 million
, of which
$13 million
were past due greater than 365 days.
In addition, we have uncommitted credit facilities with a commercial Japanese bank that provide for borrowings, promissory notes discounting and receivables factoring of up to
21.000 billion
Japanese yen (approximately
$191 million
as of
September 30, 2014
). We de-recognized
$147 million
of notes receivable as of
September 30, 2014
at an average interest rate of
1.8 percent
and
$147 million
of notes receivable as of
December 31, 2013
at an average interest rate of
1.8 percent
. De-recognized accounts and notes receivable are excluded from trade accounts receivable, net in the accompanying unaudited condensed consolidated balance sheets.
As of
September 30, 2014
and
December 31, 2013
, we had outstanding letters of credit of
$78 million
, which consisted primarily of bank guarantees and collateral for workers' compensation insurance arrangements. As of
September 30, 2014
and
December 31, 2013
, none of the beneficiaries had drawn upon the letters of credit or guarantees; accordingly, we did not recognize a related liability for our outstanding letters of credit in our consolidated balance sheets as of
September 30, 2014
or
December 31, 2013
. We believe we will generate sufficient cash from operations to fund these arrangements and intend to fund these arrangements without drawing on the letters of credit.
NOTE G – RESTRUCTURING-RELATED ACTIVITIES
On an ongoing basis, we monitor the dynamics of the economy, the healthcare industry, and the markets in which we compete. We continue to assess opportunities for improved operational effectiveness and efficiency, and better alignment of expenses with revenues, while preserving our ability to make the investments in research and development projects, capital and our people that we believe are essential to our long-term success. As a result of these assessments, we have undertaken various restructuring initiatives in order to enhance our growth potential and position us for long-term success. These initiatives are described below.
2014 Restructuring Plan
On October 22, 2013, the Board of Directors approved, and we committed to, a restructuring initiative (the 2014 Restructuring plan). The 2014 Restructuring plan is intended to build on the progress we have made to address financial pressures in a changing global marketplace, further strengthen our operational effectiveness and efficiency and support new growth investments. Key activities under the plan include continued implementation of our ongoing Plant Network Optimization (PNO) strategy, continued focus on driving operational efficiencies and ongoing business and commercial model changes. The PNO strategy is intended to simplify our manufacturing plant structure by transferring certain production lines among facilities. Other activities involve rationalizing organizational reporting structures to streamline various functions, eliminate bureaucracy, increase productivity and better align resources to business strategies and marketplace dynamics. These activities were initiated in the fourth quarter of 2013 and are expected to be substantially completed by the end of 2015.
We estimate that the implementation of the 2014 Restructuring plan will result in total pre-tax charges of approximately
$175 million
to
$225 million
, and approximately
$160 million
to
$210 million
of these charges is estimated to result in cash outlays, of which we have made payments of
$61 million
to date. We have recorded related costs of
$95 million
since the inception of the plan, and recorded a portion of these expenses as restructuring charges and the remaining portion through other lines within our consolidated statements of operations.
The following table provides a summary of our estimates of costs associated with the 2014 Restructuring plan by major type of cost:
|
|
|
|
|
|
Type of cost
|
Total estimated amount expected to
be incurred
|
|
Restructuring charges:
|
|
|
Termination benefits
|
$100 million to $120 million
|
|
Other (1)
|
$10 million to $20 million
|
|
Restructuring-related expenses:
|
|
|
Other (2)
|
$65 million to $85 million
|
|
|
$175 million to $225 million
|
(1) Consists primarily of consultant fees and costs associated with contractual cancellations.
(2) Comprised of other costs directly related to the 2014 Restructuring plan, including program management, accelerated depreciation, and costs to transfer product lines among facilities.
2011 Restructuring Plan
On July 26, 2011, our Board of Directors approved, and we committed to, a restructuring initiative (the 2011 Restructuring plan) designed to strengthen operational effectiveness and efficiencies, increase competitiveness and support new investments, thereby increasing shareholder value. Key activities under the 2011 Restructuring plan included standardizing and automating certain processes and activities; relocating select administrative and functional activities; rationalizing organizational reporting structures; leveraging preferred vendors; and other efforts to eliminate inefficiency. Among these efforts, we expanded our ability to deliver best-in-class global shared services for certain functions and divisions at several locations in emerging markets. This action was intended to enable us to grow our global commercial presence in key geographies and take advantage of many cost-reducing and productivity-enhancing opportunities. In addition, we undertook efforts to streamline various corporate functions, eliminate bureaucracy, increase productivity and better align corporate resources to our key business strategies. On January 25, 2013, our Board of Directors approved, and we committed to, an expansion of the 2011 Restructuring plan (the Expansion). The Expansion was intended to further strengthen our operational effectiveness and efficiencies and support new investments. Activities under the 2011 Restructuring plan were initiated in the third quarter of 2011 and all activities, including those related to the Expansion, were substantially completed by the end of 2013.
The 2011 Restructuring plan, including the Expansion, is estimated to result in total pre-tax charges of approximately
$289 million
to
$292 million
, and approximately
$287 million
to
$291 million
of these charges is estimated to result in cash outlays, of which we have made payments of
$287 million
to date. We have recorded related costs of
$288 million
since the inception of the plan, and recorded a portion of these expenses as restructuring charges and the remaining portion through other lines within our consolidated statements of operations.
The following provides a summary of our expected total costs associated with the 2011 Restructuring plan, including the Expansion, by major type of cost:
|
|
|
|
|
|
Type of cost
|
Total estimated amount expected to
be incurred
|
|
Restructuring charges:
|
|
|
Termination benefits
|
$138 million to $141 million
|
|
Other (1)
|
$112 million
|
|
Restructuring-related expenses:
|
|
|
Other (2)
|
$39 million
|
|
|
$289 million to $292 million
|
|
|
|
|
(1)
|
Includes primarily consulting fees, gains and losses on disposals of fixed assets and costs associated with contractual cancellations.
|
|
|
|
|
(2)
|
Comprised of other costs directly related to the 2011 Restructuring plan, including the Expansion, such as program management, accelerated depreciation, retention and infrastructure-related costs.
|
Plant Network Optimization Program
In January 2009, our Board of Directors approved, and we committed to, a PNO program, intended to simplify our manufacturing plant structure by transferring certain production lines among facilities and by closing certain other facilities. The program was intended to improve our overall gross profit margins. Activities under the PNO program were initiated in the first quarter of 2009 and were substantially completed during 2012.
The PNO program resulted in total pre-tax charges of
$126 million
, and resulted in cash outlays of
$103 million
. We recorded a portion of these expenses as restructuring charges and the remaining portion through cost of products sold within our unaudited condensed consolidated statements of operations.
The following provides a summary of our costs associated with the PNO program by major type of cost:
|
|
|
|
|
|
Type of cost
|
Total amount incurred
|
|
Restructuring charges:
|
|
|
Termination benefits
|
$30 million
|
|
|
|
|
Restructuring-related expenses:
|
|
|
Accelerated depreciation
|
$22 million
|
|
Transfer costs (1)
|
$74 million
|
|
|
$126 million
|
|
|
|
|
(1)
|
Consists primarily of costs to transfer product lines among facilities, including costs of transfer teams, freight, idle facility and product line validations.
|
In the aggregate, we recorded net restructuring charges pursuant to our restructuring plans of
$2 million
in the
third
quarter of
2014
,
$19 million
in the
third
quarter of
2013
,
$37 million
in the
first nine months
of
2014
, and
$55 million
in the
first nine months
of
2013
. During the
first nine months
of
2013
, our restructuring charges were partially offset by a
$19 million
gain recognized on the sale of our Natick, Massachusetts headquarters. In addition, we recorded expenses within other lines of our accompanying unaudited condensed consolidated statements of operations related to our restructuring initiatives of
$15 million
in the
third
quarter of
2014
,
$7 million
in the
third
quarter of
2013
,
$33 million
in the
first nine months
of
2014
, and
$16 million
in the
first nine months
of
2013
.
The following presents these costs (credits) by major type and line item within our accompanying unaudited condensed consolidated statements of operations, as well as by program:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Three Months Ended September 30, 2014
|
|
|
|
|
|
|
|
|
|
|
|
|
(in millions)
|
Termination
Benefits
|
|
Accelerated
Depreciation
|
|
Transfer
Costs
|
|
Fixed Asset
Write-offs
|
|
Other
|
|
Total
|
|
Restructuring charges
|
$
|
—
|
|
|
$
|
—
|
|
|
$
|
—
|
|
|
$
|
—
|
|
|
$
|
2
|
|
|
$
|
2
|
|
|
Restructuring-related expenses:
|
|
|
|
|
|
|
|
|
|
|
|
|
Cost of products sold
|
—
|
|
|
—
|
|
|
9
|
|
|
—
|
|
|
—
|
|
|
9
|
|
|
Selling, general and administrative expenses
|
—
|
|
|
1
|
|
|
—
|
|
|
—
|
|
|
5
|
|
|
6
|
|
|
|
—
|
|
|
1
|
|
|
9
|
|
|
—
|
|
|
5
|
|
|
15
|
|
|
|
$
|
—
|
|
|
$
|
1
|
|
|
$
|
9
|
|
|
$
|
—
|
|
|
$
|
7
|
|
|
$
|
17
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
(in millions)
|
Termination
Benefits
|
|
Accelerated
Depreciation
|
|
Transfer
Costs
|
|
Fixed Asset
Write-offs
|
|
Other
|
|
Total
|
|
2014 Restructuring plan
|
$
|
(1
|
)
|
|
$
|
1
|
|
|
$
|
9
|
|
|
$
|
—
|
|
|
$
|
7
|
|
|
$
|
16
|
|
|
2011 Restructuring plan (including the Expansion)
|
1
|
|
|
—
|
|
|
—
|
|
|
—
|
|
|
—
|
|
|
1
|
|
|
|
$
|
—
|
|
|
$
|
1
|
|
|
$
|
9
|
|
|
$
|
—
|
|
|
$
|
7
|
|
|
$
|
17
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Three Months Ended September 30, 2013
|
|
|
|
|
|
|
|
|
|
|
|
|
(in millions)
|
Termination
Benefits
|
|
Accelerated
Depreciation
|
|
Transfer
Costs
|
|
Net Gain on Fixed Asset Disposals
|
|
Other
|
|
Total
|
|
Restructuring charges
|
$
|
5
|
|
|
$
|
—
|
|
|
$
|
—
|
|
|
$
|
—
|
|
|
$
|
14
|
|
|
$
|
19
|
|
|
Restructuring-related expenses:
|
|
|
|
|
|
|
|
|
|
|
|
|
Selling, general and administrative expenses
|
—
|
|
|
1
|
|
|
—
|
|
|
—
|
|
|
6
|
|
|
7
|
|
|
|
—
|
|
|
1
|
|
|
—
|
|
|
—
|
|
|
6
|
|
|
7
|
|
|
|
$
|
5
|
|
|
$
|
1
|
|
|
$
|
—
|
|
|
$
|
—
|
|
|
$
|
20
|
|
|
$
|
26
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
(in millions)
|
Termination
Benefits
|
|
Accelerated
Depreciation
|
|
Transfer
Costs
|
|
Net Gain on Fixed Asset Disposals
|
|
Other
|
|
Total
|
|
2011 Restructuring plan (including the Expansion)
|
$
|
5
|
|
|
$
|
1
|
|
|
$
|
—
|
|
|
$
|
—
|
|
|
$
|
20
|
|
|
$
|
26
|
|
|
|
$
|
5
|
|
|
$
|
1
|
|
|
$
|
—
|
|
|
$
|
—
|
|
|
$
|
20
|
|
|
$
|
26
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Nine Months Ended September 30, 2014
|
|
|
|
|
|
|
|
|
|
|
|
|
(in millions)
|
Termination
Benefits
|
|
Accelerated
Depreciation
|
|
Transfer
Costs
|
|
Fixed Asset
Write-offs
|
|
Other
|
|
Total
|
|
Restructuring charges
|
$
|
19
|
|
|
$
|
—
|
|
|
$
|
—
|
|
|
$
|
—
|
|
|
$
|
18
|
|
|
$
|
37
|
|
|
Restructuring-related expenses:
|
|
|
|
|
|
|
|
|
|
|
|
|
Cost of products sold
|
—
|
|
|
—
|
|
|
15
|
|
|
—
|
|
|
—
|
|
|
15
|
|
|
Selling, general and administrative expenses
|
—
|
|
|
3
|
|
|
—
|
|
|
—
|
|
|
15
|
|
|
18
|
|
|
|
—
|
|
|
3
|
|
|
15
|
|
|
—
|
|
|
15
|
|
|
33
|
|
|
|
$
|
19
|
|
|
$
|
3
|
|
|
$
|
15
|
|
|
$
|
—
|
|
|
$
|
33
|
|
|
$
|
70
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
(in millions)
|
Termination
Benefits
|
|
Accelerated
Depreciation
|
|
Transfer
Costs
|
|
Fixed Asset
Write-offs
|
|
Other
|
|
Total
|
|
2014 Restructuring plan
|
$
|
18
|
|
|
$
|
3
|
|
|
$
|
15
|
|
|
$
|
—
|
|
|
$
|
30
|
|
|
$
|
66
|
|
|
2011 Restructuring plan (including the Expansion)
|
1
|
|
|
—
|
|
|
—
|
|
|
—
|
|
|
3
|
|
|
4
|
|
|
|
$
|
19
|
|
|
$
|
3
|
|
|
$
|
15
|
|
|
$
|
—
|
|
|
$
|
33
|
|
|
$
|
70
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Nine Months Ended September 30, 2013
|
|
|
|
|
|
|
|
|
|
|
|
|
(in millions)
|
Termination
Benefits
|
|
Accelerated
Depreciation
|
|
Transfer
Costs
|
|
Net Gain on Fixed Asset Disposals
|
|
Other
|
|
Total
|
|
Restructuring charges
|
$
|
26
|
|
|
$
|
—
|
|
|
$
|
—
|
|
|
$
|
(16
|
)
|
|
$
|
45
|
|
|
$
|
55
|
|
|
Restructuring-related expenses:
|
|
|
|
|
|
|
|
|
|
|
|
|
Selling, general and administrative expenses
|
—
|
|
|
2
|
|
|
—
|
|
|
—
|
|
|
14
|
|
|
16
|
|
|
|
—
|
|
|
2
|
|
|
—
|
|
|
—
|
|
|
14
|
|
|
16
|
|
|
|
$
|
26
|
|
|
$
|
2
|
|
|
$
|
—
|
|
|
$
|
(16
|
)
|
|
$
|
59
|
|
|
$
|
71
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
(in millions)
|
Termination
Benefits
|
|
Accelerated
Depreciation
|
|
Transfer
Costs
|
|
Net Gain on Fixed Asset Disposals
|
|
Other
|
|
Total
|
|
2011 Restructuring plan (including the Expansion)
|
$
|
30
|
|
|
$
|
2
|
|
|
$
|
—
|
|
|
$
|
(16
|
)
|
|
$
|
59
|
|
|
$
|
75
|
|
|
Plant Network Optimization program
|
(4
|
)
|
|
—
|
|
|
—
|
|
|
—
|
|
|
—
|
|
|
(4
|
)
|
|
|
$
|
26
|
|
|
$
|
2
|
|
|
$
|
—
|
|
|
$
|
(16
|
)
|
|
$
|
59
|
|
|
$
|
71
|
|
Termination benefits represent amounts incurred pursuant to our on-going benefit arrangements and amounts for “one-time” involuntary termination benefits, and have been recorded in accordance with ASC Topic 712,
Compensation – Non-retirement Postemployment Benefits
and ASC Topic 420,
Exit or Disposal Cost Obligations
(Topic 420). We expect to record additional termination benefits related to our restructuring initiatives in 2014 when we identify with more specificity the job classifications, functions and locations of the remaining head count to be eliminated. Other restructuring costs, which represent primarily consulting fees, are being recorded as incurred in accordance with Topic 420. Accelerated depreciation is being recorded over the adjusted remaining useful life of the related assets, and production line transfer costs are being recorded as incurred.
As of
September 30, 2014
, we have incurred cumulative restructuring charges related to our 2014 Restructuring plan, 2011 Restructuring plan (including the Expansion), and PNO program of
$341 million
and restructuring-related costs of
$168 million
since we committed to each plan. The following presents these costs by major type and by plan:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
(in millions)
|
2014
Restructuring
plan
|
|
2011
Restructuring
plan (including the Expansion)
|
|
Plant
Network
Optimization program
|
|
Total
|
|
Termination benefits
|
$
|
47
|
|
|
$
|
137
|
|
|
$
|
30
|
|
|
$
|
214
|
|
|
Fixed asset write-offs
|
—
|
|
|
(1
|
)
|
|
—
|
|
|
(1
|
)
|
|
Other
|
15
|
|
|
113
|
|
|
—
|
|
|
128
|
|
|
Total restructuring charges
|
62
|
|
|
249
|
|
|
30
|
|
|
341
|
|
|
Accelerated depreciation
|
3
|
|
|
5
|
|
|
22
|
|
|
30
|
|
|
Transfer costs
|
15
|
|
|
—
|
|
|
74
|
|
|
89
|
|
|
Other
|
15
|
|
|
34
|
|
|
—
|
|
|
49
|
|
|
Restructuring-related expenses
|
33
|
|
|
39
|
|
|
96
|
|
|
168
|
|
|
|
$
|
95
|
|
|
$
|
288
|
|
|
$
|
126
|
|
|
$
|
509
|
|
We made cash payments of
$27 million
in the
third
quarter of
2014
and
$80 million
in the
first nine months
of
2014
associated with restructuring initiatives pursuant to these plans, and as of
September 30, 2014
, we had made total cash payments of
$451 million
related to our 2014 Restructuring plan, 2011 Restructuring plan (including the Expansion), and PNO program since committing to each plan. These payments were made using cash generated from operations, and are comprised of the following:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
(in millions)
|
2014
Restructuring
plan
|
|
2011
Restructuring
plan (including the Expansion)
|
|
Plant
Network
Optimization program
|
|
Total
|
|
Three Months Ended September 30, 2014
|
|
|
|
|
|
|
|
|
Termination benefits
|
$
|
7
|
|
|
$
|
2
|
|
|
$
|
—
|
|
|
$
|
9
|
|
|
Transfer costs
|
9
|
|
|
—
|
|
|
—
|
|
|
9
|
|
|
Other
|
7
|
|
|
2
|
|
|
—
|
|
|
9
|
|
|
|
$
|
23
|
|
|
$
|
4
|
|
|
$
|
—
|
|
|
$
|
27
|
|
|
|
|
|
|
|
|
|
|
|
Nine Months Ended September 30, 2014
|
|
|
|
|
|
|
|
|
Termination benefits
|
$
|
19
|
|
|
$
|
9
|
|
|
$
|
—
|
|
|
$
|
28
|
|
|
Transfer costs
|
15
|
|
|
—
|
|
|
—
|
|
|
15
|
|
|
Other
|
27
|
|
|
10
|
|
|
—
|
|
|
37
|
|
|
|
$
|
61
|
|
|
$
|
19
|
|
|
$
|
—
|
|
|
$
|
80
|
|
|
|
|
|
|
|
|
|
|
|
Program to Date
|
|
|
|
|
|
|
|
|
Termination benefits
|
$
|
19
|
|
|
$
|
133
|
|
|
$
|
30
|
|
|
$
|
182
|
|
|
Transfer costs
|
15
|
|
|
—
|
|
|
73
|
|
|
88
|
|
|
Other
|
27
|
|
|
154
|
|
|
—
|
|
|
181
|
|
|
|
$
|
61
|
|
|
$
|
287
|
|
|
$
|
103
|
|
|
$
|
451
|
|
Our restructuring liability is primarily comprised of accruals for termination benefits. The following is a rollforward of the termination benefit liability associated with our 2014 Restructuring plan and 2011 Restructuring plan (including the Expansion), which is reported as a component of accrued expenses included in our accompanying unaudited condensed balance sheets:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
(in millions)
|
|
2014
Restructuring
plan
|
|
2011
Restructuring
plan (including the Expansion)
|
|
Total
|
|
Accrued as of December 31, 2013
|
|
$
|
29
|
|
|
$
|
12
|
|
|
$
|
41
|
|
|
Charges (credits)
|
|
18
|
|
|
1
|
|
|
19
|
|
|
Cash payments
|
|
(19
|
)
|
|
(9
|
)
|
|
(28
|
)
|
|
Accrued as of September 30, 2014
|
|
$
|
28
|
|
|
$
|
4
|
|
|
$
|
32
|
|
In addition to our accrual for termination benefits, we had a
$3 million
liability as of
September 30, 2014
and an
$8 million
liability as of
December 31, 2013
for other restructuring-related items.
NOTE H – SUPPLEMENTAL BALANCE SHEET INFORMATION
Components of selected captions in our accompanying unaudited condensed consolidated balance sheets are as follows:
Trade accounts receivable, net
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
As of
|
|
(in millions)
|
|
September 30, 2014
|
|
December 31, 2013
|
|
Accounts receivable
|
|
$
|
1,346
|
|
|
$
|
1,419
|
|
|
Less: allowance for doubtful accounts
|
|
(75
|
)
|
|
(81
|
)
|
|
Less: allowance for sales returns
|
|
(38
|
)
|
|
(31
|
)
|
|
|
|
$
|
1,233
|
|
|
$
|
1,307
|
|
The following is a rollforward of our allowance for doubtful accounts for the
third
quarter and
first nine months
of
2014
and
2013
:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Three Months Ended
September 30,
|
|
Nine Months Ended
September 30,
|
|
(in millions)
|
|
2014
|
|
2013
|
|
2014
|
|
2013
|
|
Beginning balance
|
|
$
|
80
|
|
|
$
|
84
|
|
|
$
|
81
|
|
|
$
|
88
|
|
|
Charges to expenses
|
|
—
|
|
|
2
|
|
|
4
|
|
|
7
|
|
|
Utilization of allowances
|
|
(5
|
)
|
|
(1
|
)
|
|
(10
|
)
|
|
(10
|
)
|
|
Ending balance
|
|
$
|
75
|
|
|
$
|
85
|
|
|
$
|
75
|
|
|
$
|
85
|
|
Inventories
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
As of
|
|
(in millions)
|
|
September 30, 2014
|
|
December 31, 2013
|
|
Finished goods
|
|
$
|
666
|
|
|
$
|
598
|
|
|
Work-in-process
|
|
118
|
|
|
90
|
|
|
Raw materials
|
|
205
|
|
|
209
|
|
|
|
|
$
|
989
|
|
|
$
|
897
|
|
Property, plant and equipment, net
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
As of
|
|
(in millions)
|
|
September 30, 2014
|
|
December 31, 2013
|
|
Land
|
|
$
|
80
|
|
|
$
|
81
|
|
|
Buildings and improvements
|
|
942
|
|
|
917
|
|
|
Equipment, furniture and fixtures
|
|
2,580
|
|
|
2,461
|
|
|
Capital in progress
|
|
186
|
|
|
211
|
|
|
|
|
3,788
|
|
|
3,670
|
|
|
Less: accumulated depreciation
|
|
2,266
|
|
|
2,124
|
|
|
|
|
$
|
1,522
|
|
|
$
|
1,546
|
|
Depreciation expense was
$71 million
for the
third
quarter of
2014
,
$72 million
for the
third
quarter of
2013
,
$205 million
for the
first nine months
of
2014
, and
$199 million
for the
first nine months
of
2013
.
Accrued expenses
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
As of
|
|
(in millions)
|
|
September 30, 2014
|
|
December 31, 2013
|
|
Payroll and related liabilities
|
|
$
|
449
|
|
|
$
|
488
|
|
|
Accrued contingent consideration
|
|
178
|
|
|
148
|
|
|
Legal reserves
|
|
75
|
|
|
84
|
|
|
Other
|
|
586
|
|
|
628
|
|
|
|
|
$
|
1,288
|
|
|
$
|
1,348
|
|
Other long-term liabilities
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
As of
|
|
(in millions)
|
|
September 30, 2014
|
|
December 31, 2013
|
|
Accrued income taxes
|
|
$
|
1,260
|
|
|
$
|
1,283
|
|
|
Legal reserves
|
|
870
|
|
|
523
|
|
|
Accrued contingent consideration
|
|
185
|
|
|
353
|
|
|
Other long-term liabilities
|
|
409
|
|
|
410
|
|
|
|
|
$
|
2,724
|
|
|
$
|
2,569
|
|
Accrued warranties
We offer warranties on certain of our product offerings. The majority of our warranty liability as of
September 30, 2014
related to implantable devices offered by our CRM business, which include defibrillator and pacemaker systems. Our CRM products come with a standard limited warranty covering the replacement of these devices. We offer a full warranty for a portion of the period post-implant, and a partial warranty over the substantial remainder of the useful life of the product. We estimate the costs that we may incur under our warranty programs based on the number of units sold, historical and anticipated rates of warranty claims and cost per claim, and record a liability equal to these estimated costs as cost of products sold at the time the product sale occurs. We reassess the adequacy of our recorded warranty liabilities on a quarterly basis and adjust these amounts as necessary. The current portion of our warranty accrual is included in other accrued expenses in the table above and the non-current portion of our warranty accrual is included in other long-term liabilities in the table above. Changes in our product warranty accrual during the
first nine months
of
2014
and
2013
consisted of the following (in millions):
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Nine Months Ended
September 30,
|
|
|
|
2014
|
|
2013
|
|
Beginning Balance
|
|
$
|
28
|
|
|
$
|
26
|
|
|
Provision
|
|
6
|
|
|
11
|
|
|
Settlements/reversals
|
|
(9
|
)
|
|
(9
|
)
|
|
Ending Balance
|
|
$
|
25
|
|
|
$
|
28
|
|
NOTE I – INCOME TAXES
Our effective tax rates from continuing operations for the three months ended
September 30, 2014
and
September 30, 2013
, were negative
1,343.2 percent
and
87.6 percent
, respectively. For the
first nine months
of
2014
and
2013
our effective tax rates from continuing operations were negative
296.0 percent
and
18.9 percent
, respectively. The change in our reported tax rate for the
third
quarter and
first nine months
of
2014
, as compared to the same periods in
2013
, relates primarily to the impact of certain receipts and charges that are taxed at different rates than our effective tax rate, including debt extinguishment charges, goodwill and intangible asset impairment charges, acquisition- and divestiture-related items, and litigation- and restructuring-related items. In addition, the reported tax rate in the
third
quarter of
2013
was affected favorably by discrete tax items, primarily related to re-measurement of uncertain tax positions, while the
first nine months
of
2013
was favorably affected by discrete tax items primarily related to the reinstatement of tax legislation that was retroactively applied, offset in part by the resolution of the uncertain tax positions related to audit settlements and findings.
As of
September 30, 2014
, we had
$1.043 billion
of gross unrecognized tax benefits, of which a net
$933 million
, if recognized, would affect our effective tax rate. As of
December 31, 2013
, we had
$1.069 billion
of gross unrecognized tax benefits, of which a net
$939 million
, if recognized, would affect our effective tax rate.
During the first quarter of 2014, we received a Revenue Agent Report from the Internal Revenue Services (IRS) reflecting significant proposed audit adjustments for our 2008, 2009 and 2010 tax years based upon the same transfer pricing methodologies that are currently being contested in U.S. Tax Court for our tax years from 2001 to 2007. As with the prior years, we disagree with the transfer pricing methodologies being applied by the IRS and we expect to contest any adjustments received through applicable IRS and judicial procedures, as appropriate. We believe that our income tax reserves associated with these matters are adequate as of
September 30, 2014
. However, final resolution is uncertain and could have a material impact on our financial condition, results of operations, or cash flows. During the
nine months ended
September 30, 2014
, there were no other material changes to significant unresolved matters with the IRS or foreign tax authorities from what we disclosed in our 2013 Annual Report on Form 10-K.
We recognize interest and penalties related to income taxes as a component of income tax expense. We had
$445 million
accrued for gross interest and penalties as of
September 30, 2014
and
$402 million
as of
December 31, 2013
. The increase in gross interest and penalties was
$43 million
, recognized in our unaudited condensed consolidated statements of operations. We recognized net tax expense related to interest and penalties of
$9 million
during the
third
quarter of
2014
,
$9 million
during the
third
quarter of
2013
,
$28 million
in the
first nine months
of
2014
, and
$28 million
in the
first nine months
of
2013
.
It is reasonably possible that within the next 12 months we will resolve multiple issues including transfer pricing and transactional-related issues with foreign, federal and state taxing authorities, in which case we could record a reduction in our balance of unrecognized tax benefits of up to approximately
$9 million
.
NOTE J – COMMITMENTS AND CONTINGENCIES
The medical device market in which we primarily participate is largely technology driven. As a result, intellectual property rights, particularly patents and trade secrets, play a significant role in product development and differentiation. Over the years, there has been litigation initiated against us by others, including our competitors, claiming that our current or former product offerings infringe patents owned or licensed by them. Intellectual property litigation is inherently complex and unpredictable. In addition, competing parties frequently file multiple suits to leverage patent portfolios across product lines, technologies and geographies and to balance risk and exposure between the parties. In some cases, several competitors are parties in the same proceeding, or in a series of related proceedings, or litigate multiple features of a single class of devices. These forces frequently drive settlement not only for individual cases, but also for a series of pending and potentially related and unrelated cases. Although monetary and injunctive relief is typically sought, remedies and restitution are generally not determined until the conclusion of the trial court proceedings and can be modified on appeal. Accordingly, the outcomes of individual cases are difficult to time, predict or quantify and are often dependent upon the outcomes of other cases in other geographies.
During recent years, we successfully negotiated closure of several long-standing legal matters and have received favorable legal rulings in several other matters; however, there continues to be outstanding intellectual property litigation. Adverse outcomes in one or more of these matters could have a material adverse effect on our ability to sell certain products and on our operating margins, financial position, results of operations and/or liquidity.
In the normal course of business, product liability, securities and commercial claims are asserted against us. Similar claims may be asserted against us in the future related to events not known to management at the present time. We maintain an insurance policy providing limited coverage against securities claims, and we are substantially self-insured with respect to product liability claims and fully self-insured with respect to intellectual property infringement claims. The absence of significant third-party insurance coverage increases our potential exposure to unanticipated claims or adverse decisions. Product liability claims, securities and commercial litigation, and other legal proceedings in the future, regardless of their outcome, could have a material adverse effect on our financial position, results of operations and/or liquidity.
In addition, like other companies in the medical device industry, we are subject to extensive regulation by national, state and local government agencies in the United States and other countries in which we operate. From time to time we are the subject of
qui tam
actions and governmental investigations often involving regulatory, marketing and other business practices. These
qui tam
actions and governmental investigations could result in the commencement of civil and criminal proceedings, substantial fines, penalties and administrative remedies and have a material adverse effect on our financial position, results of operations and/or liquidity.
We record losses for claims in excess of the limits of purchased insurance in earnings at the time and to the extent they are probable and estimable. In accordance with ASC Topic 450,
Contingencies
, we accrue anticipated costs of settlement, damages, losses for general product liability claims and, under certain conditions, costs of defense, based on historical experience or to the extent specific losses are probable and estimable. Otherwise, we expense these costs as incurred. If the estimate of a probable loss is a range and no amount within the range is more likely, we accrue the minimum amount of the range.
Our accrual for legal matters that are probable and estimable was
$945 million
as of
September 30, 2014
and
$607 million
as of
December 31, 2013
, and includes estimated costs of settlement, damages and defense. The increase in our legal accrual was primarily due to
$399 million
of litigation-related charges during the
first nine months
of
2014
. During the
first nine months
of
2013
we recorded
$206 million
of litigation-related charges. We continue to assess certain litigation and claims to determine the amounts, if any, that management believes will be paid as a result of such claims and litigation and, therefore, additional losses may be accrued and paid in the future, which could materially adversely impact our operating results, cash flows and/or our ability to comply with our debt covenants.
In management's opinion, we are not currently involved in any legal proceedings other than those disclosed in our 2013 Annual Report on Form 10-K and our Quarterly Reports on Form 10-Q for the quarters ended March 31, 2014 and June 30, 2014 and those specifically identified below, which, individually or in the aggregate, could have a material adverse effect on our financial condition, operations and/or cash flows. Unless included in our legal accrual or otherwise indicated below, a range of loss associated with any individual material legal proceeding cannot be estimated.
Patent Litigation
On May 19, 2005, G. David Jang, M.D. filed suit against us alleging breach of contract relating to certain patent rights covering stent technology. The suit was filed in the U.S. District Court for the Central District of California seeking monetary damages and rescission of contract. After a Markman ruling relating to the Jang patent rights, Dr. Jang stipulated to the dismissal of certain claims alleged in the complaint with a right to appeal and the parties subsequently agreed to settle the other claims. In May 2007, Dr. Jang filed an appeal with respect to the remaining patent claims and in July 2008, the Court of Appeals vacated the District Court's consent judgment and remanded the case back to the District Court for further clarification. In August 2011, the District Court entered a stipulated judgment that we did not infringe the Jang patent. Dr. Jang filed an appeal on September 21, 2011 and on August 22, 2012, the Court of Appeals vacated the District Court's judgment and remanded the case to the District Court for further proceedings. On April 18, 2014, the case was stayed pending consideration of an interlocutory appeal. September 16, 2014, the Court of Appeals for the Federal Circuit denied our request for an interlocutory appeal.
On August 2, 2013, Medtronic Ardian Luxembourg S.a.r.l. filed a complaint against Boston Scientific Corporation and Boston Scientific Medizintechnik, GmbH in the Düsseldorf District Court in Germany alleging that the sale of our Vessix renal denervation product infringes a German patent owned by Medtronic Ardian. A hearing is scheduled for January 15, 2015.
On February 18, 2014, Atlas IP, LLC filed a complaint in the United States District Court for the Southern District of Florida alleging that the sale of our LATITUDE® Patient Management System and implantable devices that communicate with the LATITUDE® device infringe a patent owned by Atlas. On July 9, 2014, the District Court granted our motion to transfer venue to the United States District Court for the District of Minnesota.
On September 22, 2014, The Board of Trustees for the University of Alabama filed a complaint in the United States District Court for the Northern District of Alabama alleging that the sale of our cardiac resynchronization therapy devices infringe a patent owned by the University of Alabama.
On October 14, 2014, MK Optics, LLC filed a complaint in the United States District Court for the District of Delaware alleging that the sale of our Spyglass Direct Visualization System infringes a patent owned by MK Optics.
Product Liability Litigation
Fewer than ten individual lawsuits remain pending in various state and federal jurisdictions against Guidant Corporation (Guidant) alleging personal injuries associated with defibrillators or pacemakers involved in certain 2005 and 2006 product communications. Further, we are aware of approximately 30 Guidant product liability lawsuits pending in international jurisdictions associated with defibrillators or pacemakers, including devices involved in the 2005 and 2006 product communications. Six of these suits are pending in Canada and were filed as class actions, four of which are stayed pending the outcome of two lead class actions. On April 10, 2008, the Justice of Ontario Court certified a class of persons in whom defibrillators were implanted in Canada and a class of family members with derivative claims. On May 8, 2009, the Justice of Ontario Court certified a class of persons in whom pacemakers were implanted in Canada and a class of family members with derivative claims. In each case, these matters generally seek monetary damages from us. The parties in the defibrillator class action have reached an agreement in principle to settle the matter for approximately
$3 million
. The presiding judge approved the settlement at a hearing on March 24, 2014. We paid the initial required payments during the second quarter of 2014 and funded the publication of the settlement notice during the third quarter of 2014.
As of November 4, 2014, there were over
24,000
product liability cases or claims related to transvaginal surgical mesh products designed to treat stress urinary incontinence and pelvic organ prolapse pending against us. The cases are pending in various federal and state courts in the United States and include eight putative class actions. There were also fewer than
20
cases in Canada, inclusive of three putative class actions, and fewer than
10
claims in the United Kingdom. Generally, the plaintiffs allege personal injury associated with use of our transvaginal surgical mesh products. The plaintiffs assert design and manufacturing claims, failure to warn, breach of warranty, fraud, violations of state consumer protection laws and loss of consortium claims. Over 2,500 of the cases have been specially assigned to one judge in state court in Massachusetts. On February 7, 2012, the Judicial Panel on Multi-District Litigation (MDL) established MDL-2326 in the U.S. District Court for the Southern District of West Virginia and transferred the federal court transvaginal surgical mesh cases to MDL-2326 for coordinated pretrial proceedings. During the fourth quarter of 2013, we received written discovery requests from certain state attorneys general offices regarding our transvaginal surgical mesh products. We have responded to those requests. We have established a product liability accrual for known and estimated future cases and claims asserted against us as well as costs of defense thereof associated with our transvaginal surgical mesh products. While we believe that our accrual associated with this matter is adequate, changes to this accrual may be required in the future as additional information becomes available. We intend to vigorously contest the cases and claims asserted against us; however, the final resolution is uncertain and could have a material impact on our results of operations, financial condition and/
or liquidity. Initial trials involving our transvaginal surgical mesh products have resulted in both favorable and unfavorable judgments for us. We do not believe that the judgment in any one trial is representative of potential outcomes of all cases or claims related to our transvaginal surgical mesh products.
Governmental Investigations and Qui Tam Matters
On June 27, 2008, the Republic of Iraq filed a complaint against our wholly-owned subsidiary, BSSA France, and 92 other defendants in the U.S. District Court of the Southern District of New York. The complaint alleges that the defendants acted improperly in connection with the sale of products under the United Nations Oil for Food Program. The complaint also alleges Racketeer Influenced and Corrupt Organizations Act (RICO) violations, conspiracy to commit fraud and the making of false statements and improper payments, and it seeks monetary and punitive damages. On February 6, 2013, the District Court dismissed the complaint with prejudice on standing and jurisdictional grounds. On September 18, 2014, the U.S. Court of Appeals for the Second Circuit affirmed the District Court’s decision to dismiss the complaint with prejudice. On October 2, 2014, the plaintiff filed a petition for rehearing en banc.
On August 3, 2012, we were served with a qui tam complaint that had previously been filed under seal against Boston Scientific Neuromodulation Corp. in the U.S. District Court for the District of New Jersey on March 2, 2011. On August 8, 2012, we learned that the federal government had previously declined to intervene in this matter. The relators’ complaint, now unsealed, alleges that Boston Scientific Neuromodulation Corp. violated the federal and various states' false claims acts through submission of fraudulent bills for implanted devices, under-reporting of certain adverse events, and promotion of off-label uses. On September 10, 2012, the relators filed an amended complaint revising and restating certain of the claims in the original complaint. Our motion to dismiss, filed subsequently, was denied on May 31, 2013, and on June 28, 2013, we answered the amended complaint and brought certain counterclaims arising from relators’ unauthorized removal of documents from the business during their employments, which the relators moved to dismiss on July 22, 2013. The Court denied relators’ motion to dismiss the counterclaims on September 4, 2014.
On July 11, 2014, we were served with a subpoena from the U.S. Attorney for the District of New Jersey. The subpoena seeks information relating to BridgePoint Medical, Inc., which we acquired in October 2012, including information relating to its sale of CrossBoss and Stingray products, educational and training activities that relate to those sales and our acquisition of BridgePoint Medical. We are cooperating with this request.
Other Proceedings
On September 25, 2006, Johnson & Johnson filed a lawsuit against us, Guidant and Abbott Laboratories in the U.S. District Court for the Southern District of New York. The complaint alleges that Guidant breached certain provisions of the amended merger agreement between Johnson & Johnson and Guidant (Merger Agreement) as well as the implied duty of good faith and fair dealing. The complaint further alleges that Abbott and we tortiously interfered with the Merger Agreement by inducing Guidant's breach. The complaint seeks certain factual findings, damages in an amount no less than
$5.5 billion
and attorneys' fees, costs, and interest. In August 2007, the judge dismissed the tortious interference claims against us and Abbott and the implied duty of good faith and fair dealing claim against Guidant. On June 20, 2011, Guidant filed a motion for summary judgment, and the hearing on this motion was held on July 25, 2012. On July 7, 2014, the judge denied Guidant’s motion. The bench trial is scheduled to begin on November 20, 2014.
On October 5, 2007, Dr. Tassilo Bonzel filed a complaint against Pfizer, Inc. and our Schneider subsidiaries and us in the District Court in Kassel, Germany alleging that a 1995 license agreement related to a catheter patent is invalid under German law and seeking monetary damages. In June 2009, the District Court dismissed all but one of Dr. Bonzel's claims and in October 2009, he added new claims. We opposed the addition of the new claims. The District Court ordered Dr. Bonzel to select the claims he would pursue and in January 2011, he made that selection. A hearing was held on March 28, 2014 and a decision was made to take evidence at a hearing to be set at a later date.
On September 28, 2011, we served a complaint against Mirowski Family Ventures LLC in the U.S. District Court for the Southern District of Indiana for a declaratory judgment that we have paid all royalties owed and did not breach any contractual or fiduciary obligations arising out of a license agreement. Mirowski answered and filed counterclaims requesting damages. On May 13, 2013, Mirowski Family Ventures served us with a complaint alleging breach of contract in Montgomery County Circuit Court, Maryland, and they amended this complaint on August 1, 2013. On July 29, 2013, the Indiana case was dismissed. On September 10, 2013, we removed the case to the United States District Court for the District of Maryland. On June 5, 2014, the District Court granted Mirowski’s motion to remand the case to the Montgomery County Circuit Court. On September 24, 2014, following a jury verdict against us, the Montgomery County Circuit Court entered a judgment that we breached our license agreement with Mirowski and awarded damages of
$308 million
. On October 28, 2014, the Montgomery County Circuit Court denied our post-trial motions seeking to overturn the judgment. We plan to seek to overturn the judgment through the appeals process.
Refer to
Note I - Income Taxes
for information regarding our tax litigation.
Matters Concluded Since December 31, 2013
On February 1, 2008, Wyeth Corporation (Wyeth) and Cordis Corporation filed an amended complaint for patent infringement against Abbott Laboratories, adding us and Boston Scientific Scimed, Inc. as additional defendants to the complaint. The suit alleged that the PROMUS® coronary stent system, supplied to us by Abbott, infringes three U.S. patents owned by Wyeth and licensed to Cordis. The suit was filed in the U.S. District Court for the District of New Jersey seeking monetary and injunctive relief. Wyeth and Cordis subsequently withdrew their infringement claim as to one of the patents, and the District Court found the remaining two patents invalid. Wyeth and Cordis filed an appeal and, on June 26, 2013, the Court of Appeals for the Federal Circuit affirmed the District Court’s judgment in favor of Boston Scientific. On October 13, 2013, Wyeth’s motion for rehearing or rehearing en banc was denied. The deadline for further appeals lapsed on January 13, 2014.
On May 25, 2010, G. David Jang, M.D. filed suit against Boston Scientific Scimed, Inc. and us alleging breach of contract relating to certain patent rights covering stent technology. In October 2011, the U.S. District Court for the District of Delaware entered judgment in favor of us on the pleadings. Dr. Jang filed an appeal on August 28, 2012. On September 5, 2013, the Court of Appeals for the Third Circuit vacated the ruling and remanded the case to the District Court. On March 31, 2014, the parties entered into a confidential settlement agreement. On April 2, 2014, the case was dismissed.
On May 16, 2013, Vascular Solutions, Inc. filed suit against us, alleging that our Guidezilla™ guide extension catheter infringes three U.S. patents owned by Vascular Solutions. The suit was filed in the U.S. District Court for the District of Minnesota seeking monetary and injunctive relief. On May 28, 2013, Vascular Solutions filed an amended complaint adding an allegation of copyright infringement. On June 10, 2013, Vascular Solutions filed a motion requesting a preliminary injunction. On July 11, 2013, we answered the amended complaint and filed a counterclaim against Vascular Solutions, alleging that its Guideliner™ guide extension catheter infringes a U.S. patent owned by us. On December 12, 2013, the District Court granted the motion for a preliminary injunction and on December 26, 2013, we filed an appeal. On April 15, 2014, the Court of Appeals for the Federal Circuit vacated the preliminary injunction. On July 30, 2014, we and Vascular Solutions entered into a confidential settlement agreement and the case was subsequently dismissed.
On September 23, 2013, Kardiametrics, LLC filed a complaint in the United States District Court for the District of Delaware alleging that the sale of our FilterWire EZ Embolic Protection System, Sterling balloon catheters, Carotid NexStent and Carotid WallStent products infringe two patents owned by Kardiametrics. On January 24, 2014, we filed a motion to dismiss the case or, in the alternative, to stay the case pending an arbitration. On February 18, 2014, Kardiametrics dismissed its original complaint and filed a new complaint. On March 14, 2014, we filed a motion to dismiss the new case or, in the alternative, to stay the new case pending an arbitration. On May 28, 2014, Kardiametrics voluntarily dismissed its case.
NOTE K – WEIGHTED AVERAGE SHARES OUTSTANDING
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Three Months Ended
September 30,
|
|
Nine Months Ended
September 30,
|
|
|
(in millions)
|
|
2014
|
|
2013
|
|
2014
|
|
2013
|
|
|
Weighted average shares outstanding - basic
|
|
1,325.5
|
|
|
1,340.3
|
|
|
1,323.5
|
|
|
1,345.2
|
|
|
|
Net effect of common stock equivalents
|
|
22.1
|
|
|
—
|
|
*
|
23.8
|
|
|
—
|
|
*
|
|
Weighted average shares outstanding - assuming dilution
|
|
1,347.6
|
|
|
1,340.3
|
|
|
1,347.3
|
|
|
1,345.2
|
|
|
* We generated net losses in the third quarter and first nine months of 2013. Our weighted-average shares outstanding for earnings per share calculations exclude common stock equivalents of
23.6 million
for the third quarter of 2013 and
17.2 million
for the first nine months of 2013 due to our net loss position in these periods.
Weighted average shares outstanding, assuming dilution, excludes the impact of
13 million
stock options for the
third
quarter of
2014
,
18 million
stock options for the
third
quarter of
2013
,
13 million
stock options for the
first nine months
of
2014
, and
18 million
stock options for the
first nine months
of
2013
, due to the exercise prices of these stock options being greater than the average fair market value of our common stock during the period.
We issued approximately
two million
shares of our common stock in the
third
quarter of
2014
,
six million
shares of our common stock in the
third
quarter of
2013
,
13 million
shares of our common stock in the
first nine months
of
2014
, and
16 million
shares of our common stock in the
first nine months
of
2013
, following the exercise or vesting of underlying stock options or deferred stock units, or purchases under our employee stock purchase plans. We did not repurchase any shares of our common stock during the
third
quarter of
2014
. We repurchased
seven million
shares of our common stock during the
third
quarter of
2013
for approximately
$75 million
,
10 million
shares of our common stock during the
first nine months
of
2014
for approximately
$125 million
, and
32 million
shares of our common stock during the
first nine months
of
2013
for approximately
$275 million
, pursuant to our authorized repurchase programs as discussed in
Note L – Stockholders' Equity
to our audited financial statements contained in Item 8 of our 2013 Annual Report filed on Form 10-K.
NOTE L – SEGMENT REPORTING
Effective as of January 1, 2013, we reorganized our business from geographic regions to fully operationalized global business units. Following the reorganization, based on information regularly reviewed by our chief operating decision maker, we have
three
reportable segments comprised of: Cardiovascular, Rhythm Management, and MedSurg. Our reportable segments represent an aggregate of operating segments.
Each of our reportable segments generates revenues from the sale of medical devices. We measure and evaluate our reportable segments based on segment net sales and operating income, excluding the impact of changes in foreign currency and sales from divested businesses. Sales generated from reportable segments and divested businesses, as well as operating results of reportable segments and corporate expenses, are based on internally-derived standard currency exchange rates, which may differ from year to year, and do not include intersegment profits. We restated segment information for the prior period based on our internally-derived standard currency exchange rates used for the current period in order to remove the impact of foreign currency exchange fluctuation. In addition, we realigned certain product lines from Endoscopy to Peripheral Interventions as of January 1, 2014, which did not have a material impact on the restated information. We exclude from segment operating income certain corporate-related expenses and certain charges or credits that our chief operating decision maker considers to be non-recurring and/or non-operational, such as amounts related to goodwill and other intangible asset impairment charges; acquisition-, divestiture-, restructuring- and litigation-related charges and credits; and amortization expense. Although we exclude these amounts from segment operating income, they are included in reported consolidated operating income (loss) and are included in the reconciliation below.
A reconciliation of the totals reported for the reportable segments to the applicable line items in our accompanying unaudited condensed consolidated statements of operations is as follows:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Three Months Ended
September 30,
|
|
Nine Months Ended
September 30,
|
|
(in millions)
|
|
2014
|
|
2013
|
|
2014
|
|
2013
|
|
|
|
|
|
(restated)
|
|
|
|
(restated)
|
|
Net sales
|
|
|
|
|
|
|
|
|
|
Interventional Cardiology
|
|
$
|
514
|
|
|
$
|
474
|
|
|
$
|
1,543
|
|
|
$
|
1,493
|
|
|
Peripheral Interventions
|
|
217
|
|
|
200
|
|
|
631
|
|
|
597
|
|
|
Cardiovascular
|
|
731
|
|
|
674
|
|
|
2,174
|
|
|
2,090
|
|
|
|
|
|
|
|
|
|
|
|
|
Cardiac Rhythm Management
|
|
482
|
|
|
465
|
|
|
1,441
|
|
|
1,416
|
|
|
Electrophysiology
|
|
54
|
|
|
35
|
|
|
167
|
|
|
105
|
|
|
Rhythm Management
|
|
536
|
|
|
500
|
|
|
1,608
|
|
|
1,521
|
|
|
|
|
|
|
|
|
|
|
|
|
Endoscopy
|
|
340
|
|
|
319
|
|
|
990
|
|
|
939
|
|
|
Urology and Women's Health
|
|
138
|
|
|
131
|
|
|
397
|
|
|
372
|
|
|
Neuromodulation
|
|
115
|
|
|
116
|
|
|
338
|
|
|
316
|
|
|
MedSurg
|
|
593
|
|
|
566
|
|
|
1,725
|
|
|
1,627
|
|
|
Net sales allocated to reportable segments
|
|
1,860
|
|
|
1,740
|
|
|
5,507
|
|
|
5,238
|
|
|
Sales generated from divested businesses
|
|
1
|
|
|
2
|
|
|
4
|
|
|
57
|
|
|
Impact of foreign currency fluctuations
|
|
(15
|
)
|
|
(7
|
)
|
|
(18
|
)
|
|
10
|
|
|
|
|
$
|
1,846
|
|
|
$
|
1,735
|
|
|
$
|
5,493
|
|
|
$
|
5,305
|
|
|
|
|
|
|
|
|
|
|
|
|
Income (loss) before income taxes
|
|
|
|
|
|
|
|
|
|
Cardiovascular
|
|
$
|
201
|
|
|
$
|
175
|
|
|
$
|
565
|
|
|
$
|
515
|
|
|
Rhythm Management
|
|
76
|
|
|
63
|
|
|
209
|
|
|
176
|
|
|
MedSurg
|
|
192
|
|
|
176
|
|
|
535
|
|
|
487
|
|
|
Operating income allocated to reportable segments
|
|
469
|
|
|
414
|
|
|
1,309
|
|
|
1,178
|
|
|
Corporate expenses and currency exchange
|
|
(90
|
)
|
|
(78
|
)
|
|
(205
|
)
|
|
(168
|
)
|
|
Goodwill and other intangible asset impairment charges; and acquisition-, divestiture-, restructuring-, and litigation related charges or credits
|
|
(206
|
)
|
|
(132
|
)
|
|
(586
|
)
|
|
(711
|
)
|
|
Amortization expense
|
|
(109
|
)
|
|
(101
|
)
|
|
(327
|
)
|
|
(305
|
)
|
|
Operating income (loss)
|
|
64
|
|
|
103
|
|
|
191
|
|
|
(6
|
)
|
|
Other expense, net
|
|
(61
|
)
|
|
(143
|
)
|
|
(146
|
)
|
|
(276
|
)
|
|
Income (loss) before income taxes
|
|
$
|
3
|
|
|
$
|
(40
|
)
|
|
$
|
45
|
|
|
$
|
(282
|
)
|
NOTE M – CHANGES IN OTHER COMPREHENSIVE INCOME
The following table provides the reclassifications out of other comprehensive income for the three and
nine months ended
September 30, 2014
and
September 30, 2013
. Amounts in the chart below are presented net of tax.
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Three Months Ended September 30, 2014
|
|
|
|
|
|
|
|
|
|
(in millions)
|
|
Foreign currency translation adjustments
|
|
Unrealized gains/losses on derivative financial instruments
|
|
Defined benefit pension items / Other
|
|
Total
|
|
Balance as of June 30, 2014
|
|
$
|
(24
|
)
|
|
$
|
86
|
|
|
$
|
(20
|
)
|
|
$
|
42
|
|
|
Other comprehensive income (loss) before reclassifications
|
|
(15
|
)
|
|
99
|
|
|
—
|
|
|
84
|
|
|
Amounts reclassified from accumulated other comprehensive income
|
|
—
|
|
|
(16
|
)
|
|
—
|
|
|
(16
|
)
|
|
Net current-period other comprehensive income
|
|
(15
|
)
|
|
83
|
|
|
—
|
|
|
68
|
|
|
Balance as of September 30, 2014
|
|
$
|
(39
|
)
|
|
$
|
169
|
|
|
$
|
(20
|
)
|
|
$
|
110
|
|
|
|
|
|
|
|
|
|
|
|
|
Three Months Ended September 30, 2013
|
|
|
|
|
|
|
|
|
|
(in millions)
|
|
Foreign currency translation adjustments
|
|
Unrealized gains/losses on derivative financial instruments
|
|
Defined benefit pension items / Other
|
|
Total
|
|
Balance as of June 30, 2013
|
|
$
|
(28
|
)
|
|
$
|
153
|
|
|
$
|
(41
|
)
|
|
$
|
84
|
|
|
Other comprehensive income (loss) before reclassifications
|
|
10
|
|
|
(29
|
)
|
|
—
|
|
|
(19
|
)
|
|
Amounts reclassified from accumulated other comprehensive income
|
|
—
|
|
|
(9
|
)
|
|
—
|
|
|
(9
|
)
|
|
Net current-period other comprehensive income
|
|
10
|
|
|
(38
|
)
|
|
—
|
|
|
(28
|
)
|
|
Balance as of September 30, 2013
|
|
$
|
(18
|
)
|
|
$
|
115
|
|
|
$
|
(41
|
)
|
|
$
|
56
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Nine Months Ended September 30, 2014
|
|
|
|
|
|
|
|
|
|
(in millions)
|
|
Foreign currency translation adjustments
|
|
Unrealized gains/losses on derivative financial instruments
|
|
Defined benefit pension items / Other
|
|
Total
|
|
Balance as of December 31, 2013
|
|
$
|
(16
|
)
|
|
$
|
141
|
|
|
$
|
(19
|
)
|
|
$
|
106
|
|
|
Other comprehensive income (loss) before reclassifications
|
|
(23
|
)
|
|
72
|
|
|
(1
|
)
|
|
48
|
|
|
Amounts reclassified from accumulated other comprehensive income
|
|
—
|
|
|
(44
|
)
|
|
—
|
|
|
(44
|
)
|
|
Net current-period other comprehensive income
|
|
(23
|
)
|
|
28
|
|
|
(1
|
)
|
|
4
|
|
|
Balance as of September 30, 2014
|
|
$
|
(39
|
)
|
|
$
|
169
|
|
|
$
|
(20
|
)
|
|
$
|
110
|
|
|
|
|
|
|
|
|
|
|
|
|
Nine Months Ended September 30, 2013
|
|
|
|
|
|
|
|
|
|
(in millions)
|
|
Foreign currency translation adjustments
|
|
Unrealized gains/losses on derivative financial instruments
|
|
Defined benefit pension items / Other
|
|
Total
|
|
Balance as of December 31, 2012
|
|
$
|
(26
|
)
|
|
$
|
34
|
|
|
$
|
(41
|
)
|
|
$
|
(33
|
)
|
|
Other comprehensive income (loss) before reclassifications
|
|
8
|
|
|
91
|
|
|
—
|
|
|
99
|
|
|
Amounts reclassified from accumulated other comprehensive income
|
|
—
|
|
|
(10
|
)
|
|
—
|
|
|
(10
|
)
|
|
Net current-period other comprehensive income
|
|
8
|
|
|
81
|
|
|
—
|
|
|
89
|
|
|
Balance as of September 30, 2013
|
|
$
|
(18
|
)
|
|
$
|
115
|
|
|
$
|
(41
|
)
|
|
$
|
56
|
|
The income tax impact of the amounts in other comprehensive income for unrealized gains/losses on derivative financial instruments before reclassifications was a
expense
of
$57 million
in the
third
quarter of
2014
, a
benefit
of
$16 million
in the
third
quarter of
2013
, an
expense
of
$42 million
in the
first nine months
of
2014
, and an
expense
of
$53 million
in the
first nine months
of
2013
. The gains and losses on derivative financial instruments reclassified were reduced by income tax impacts of
$9 million
in the
third
quarter of
2014
,
$6 million
in the third quarter of
2013
,
$25 million
in the
first nine months
of
2014
, and there was
$5 million
impact in the
first nine months
of
2013
,. Refer to
Note E – Fair Value Measurements
in this Quarterly Report on Form 10-Q for further detail on the reclassifications related to derivatives.
NOTE N – NEW ACCOUNTING PRONOUNCEMENTS
Standards Implemented
ASC Update No. 2013-11
In July 2013, the FASB issued ASC Update No. 2013-11,
Income Taxes (Topic 740): Presentation of an Unrecognized Tax Benefit When a Net Operating Loss Carryforward, a Similar Tax Loss, or a Tax Credit Carryforward Exists.
Update No. 2013-11 requires that entities present an unrecognized tax benefit, or portion of an unrecognized tax benefit, as a reduction to a deferred tax asset in the financial statements for a net operating loss carryforward, a similar tax loss, or a tax credit carryforward, with certain exceptions. We adopted Update No. 2013-11 beginning in our first quarter ended March 31, 2014. The adoption of Update No. 2013-11 did not impact our results of operations or financial position.
Standards to be Implemented
ASC Update No. 2014-08
In April 2014, the FASB issued ASC Update No. 2014-08,
Presentation of Financial Statements (Topic 205) and Property, Plant, and Equipment (Topic 360): Reporting Discontinued Operations and Disclosures of Disposals of Components of an Entity.
Update No. 2014-08 changed the criteria for reporting discontinued operations and enhanced convergence of the FASB's and the International Accounting Standard Board's (IASB) reporting requirements for discontinued operations. We are required to apply this amendment, prospectively to: (1) all disposals (or classifications as held for sale) of components of an entity that occur within annual periods beginning on or after December 15, 2014 and interim periods within those years and (2) all businesses that, on acquisition, are classified as held for sale that occur within annual periods beginning on or after December 15, 2014 and interim periods within those years. The adoption of Update No. 2014-08 is not expected to have a material impact on our financial position or results of operations.
ASC Update No. 2014-09
In May 2014, the FASB issued ASC Update No. 2014-09,
Revenue from Contracts with Customers (Topic 606).
Update No. 2014-09 provides enhancements to the quality and consistency of how revenue is reported while also improving comparability in the financial statements of companies using International Financial Reporting Standards and U.S. GAAP. The core principle requires entities to recognize revenue in a manner that depicts the transfer of goods or services to customers in amounts that reflect the consideration an entity expects to be entitled to in exchange for those goods or services. We are required to apply Update No. 2014-09 for annual periods beginning after December 15, 2016 and early application is not permitted. We are in the process of determining the effect, if any, that the adoption of this standard will have on our financial position or results of operations.
ASC Update No. 2014-10
In June 2014, the FASB issued ASC Update No. 2014-10,
Development Stage Entities (Topic 915):
Elimination of Certain Financial Reporting Requirements, Including an Amendment to Variable Interest Entities Guidance in Topic 810, Consolidation.
The amendments remove the definition of a development stage entity from the Master Glossary of the Accounting Standards Codification, thereby removing the financial reporting distinction between development stage entities and other reporting entities. The amendments also eliminate an exception provided to development stage entities in Topic 810,
Consolidation
, for determining whether an entity is a variable interest entity on the basis of the amount of investment equity that is at risk. The elimination of the exception may change the consolidation analysis, consolidation decision, and disclosure requirements for a reporting entity that has an interest in an entity in the development stage. We are required to apply Update No. 2014-10 for annual reporting periods beginning after December 15, 2014, and interim periods within those years. The adoption of Update No. 2014-10 is not expected to have a material impact on our financial position or results of operations.
ASC Update No. 2014-11
In June 2014, the FASB issued ASC Update No. 2014-11,
Transfers and Servicing (Topic 860): Repurchase-to-Maturity Transactions, Repurchase Financings, and Disclosures.
Update No. 2014-11 changes the accounting for repurchase-to-maturity transactions and repurchase financings and expands disclosure requirements. The amendments (1) require entities to account for repurchase-to-maturity transactions as secured borrowings, (2) eliminate accounting guidance on linked repurchase financing transactions, and (3) expand disclosure requirements related to certain transfers of financial assets that are accounted for as sales and certain transfers accounted for as secured borrowings. Update No. 2014-11 also clarifies that repurchase and securities lending transactions that do not meet all of the criteria in ASC 860-10-40-5 should be accounted for as secured borrowings. We are required to apply the accounting changes and disclosure for certain transactions accounted for as a sale for periods beginning after December 15, 2014 and early application is not permitted. The disclosure for transactions accounted for as secured borrowings is required for annual periods beginning after December 15, 2014, and for interim periods within those years. The disclosures are not required to be presented for comparative periods before the effective date. The adoption of Update No. 2014-11 is not expected to have a material impact on our financial position or results of operations.
ASC Update No. 2014-13
In August 2014, the FASB issued ASC Update No. 2014-13,
Consolidation (Topic 810): Measuring the Financial Assets and Financial Liabilities of a Consolidated Collateralized Financing Entity
. The fair value of the financial assets of a collateralized financing entity, as determined under GAAP, may differ from the fair value of its financial liabilities even when the financial liabilities have recourse only to the financial assets. Update 2014-13 provides an alternative to Topic 820 for measuring the financial assets and the financial liabilities of a consolidated collateralized financing entity to eliminate that difference. When the measurement alternative is not elected for a consolidated collateralized financing entity within the scope of this Update, the amendments clarify that (1) the fair value of the financial assets and the fair value of the financial liabilities of the consolidated collateralized financing entity should be measured using the requirements of Topic 820 and (2) any differences in the fair value of the financial assets and the fair value of the financial liabilities of that consolidated collateralized financing entity should be reflected in earnings and attributed to the reporting entity in the consolidated statement of income (loss). The amendments to Update 2014-13 are effective for annual periods, and interim periods within those annual periods, beginning after December 15, 2015. Early adoption is permitted as of the beginning of an annual period. The adoption of Update No. 2014-12 is not expected to have a material impact on our financial position or results of operations.
ASC Update No. 2014-15
In August 2014, the FASB issued ASC Update No. 2014-15,
Presentation of Financial Statements - Going Concern: Disclosure of Uncertainties about an Entity's Ability to Continue as a Going Concern (Subtopic 205-40).
Update 2014-15
requires management to assess an entity’s ability to continue as a going concern every reporting period, and provide certain disclosures if management has substantial doubt about the entities ability to operate as a going concern, or an express statement if not, by incorporating and expanding upon certain principles that are currently in U.S. auditing standards. Update 2014-15 is effective for the annual period ending after December 15, 2016, and for annual periods and interim periods thereafter. Early application is permitted. The adoption of Update No. 2014-15 is not expected to have an impact on our financial position or results of operations.
