ITEM 1. BUSINESS

 

The Company

 

Boston Scientific Corporation is a worldwide developer, manufacturer and marketer of medical devices that are used in a broad range of interventional medical specialties including interventional cardiology, cardiac rhythm management, peripheral interventions, cardiac surgery, vascular surgery, electrophysiology, neurovascular intervention, oncology, endoscopy, urology, gynecology and neuromodulation. When used in this report, the terms “ we, ” “us,” “our” and the “Company” mean Boston Scientific Corporation and its divisions and subsidiaries.

 

Since we were formed in 1979, we have advanced the practice of less-invasive medicine by helping physicians and other medical professionals treat a variety of diseases and improve patients ’ quality of life by providing alternatives to surgery and other medical procedures that are typically traumatic to the body. Some of our medical products are used for enlarging narrowed blood vessels to prevent heart attack and stroke; clearing passages blocked by plaque to restore blood flow; detecting and managing fast, slow or irregular heart rhythms; mapping electrical problems in the heart; opening obstructions and bringing relief to patients suffering from various forms of cancer; performing biopsies and intravascular ultrasounds; placing filters to prevent blood clots from reaching the lungs, heart or brain; treating urological, gynecological, renal, pulmonary, neurovascular and gastrointestinal diseases; and modulating nerve activity to treat deafness and chronic pain.

 

Our history began in the late 1960s when our co-founder, John Abele, acquired an equity interest in Medi-tech, Inc., a research and development company focused on developing alternatives to surgery. Medi-tech’s initial products, a family of steerable catheters, were introduced in 1969 and were used in some of the first less-invasive procedures performed. In 1979, John Abele joined with Pete Nicholas to form Boston Scientific Corporation, which indirectly acquired Medi-tech. This acquisition began a period of active and focused marketing, new product development and organizational growth. Since then, our net sales have increased substantially, growing from $1.8 million in 1979 to approximately $7.8 billion in 2006.

 

Our growth has been fueled in part by strategic acquisitions and alliances designed to improve our ability to take advantage of growth opportunities in the medical device industry. In 2006, we experienced a transforming event with our acquisition of Guidant Corporation, a world leader in the treatment of cardiac disease. This acquisition enabled us to become a major provider in the more than $9 billion global Cardiac Rhythm Management (CRM) business,  enhancing our overall competitive position and long-term growth potential and further diversifying our product portfolio. With this acquisition, we have become one of the world’s largest cardiovascular device companies and a global leader in microelectronic therapies. This and other acquisitions have helped us add promising new technologies to our pipeline and to offer one of the broadest product portfolios in the world for use in less-invasive procedures. We believe that the depth and breadth of our product portfolio has also enabled us to compete more effectively in, and better absorb the pressures of, the current healthcare environment of cost containment, managed care, large buying groups and hospital consolidation.

 

Information on revenues, profits and total assets for our business segments and by geographical area appears in our consolidated financial statements for the year ended December 31, 2006, which are included in Item 8 of this report.

 

The Drug-Eluting Stent Opportunity

 

Our broad, innovative product offerings have enabled us to become a leader in the interventional cardiology market. This leadership is in large part due to our coronary stent product offerings. Coronary stents are tiny, mesh tubes used in the treatment of coronary artery disease and implanted in patients to prop open arteries and facilitate blood flow from the heart. We have further enhanced the outcomes associated with the use of coronary stents, particularly the processes that lead to restenosis (the growth of neointimal tissue within an artery after angioplasty and stenting), through dedicated internal and external product development and scientific research of drug-eluting stent systems.

 

Use of our products in the United States and abroad has demonstrated that drug-eluting stents reduce the need for repeat procedures—or more expensive surgical procedures—and reduce healthcare costs, as well as overall patient risk, trauma, procedure time and the need for aftercare. Since its U.S. launch in March 2004 and its launch in our Europe and Inter-Continental markets in 2003, our proprietary polymer-based paclitaxel-eluting stent technology for reducing coronary restenosis, the TAXUS® Express ² ™ paclitaxel-eluting coronary stent system, has become the worldwide leader in the drug-eluting coronary stent market. In 2006, approximately 30 percent of our net sales were derived from sales of our TAXUS stent system.

 

We are continuing to enhance our product offerings in the coronary drug-eluting stent market. We recently launched our next-generation coronary stent, the TAXUS® Liberté™ paclitaxel-eluting coronary stent system, in our Europe and Inter-Continental markets, and we expect to launch the product in the U.S., subject to regulatory approval. The Liberté™ coronary stent is designed to further enhance deliverability and conformability, particularly in challenging lesions. Also, prior to our acquisition of Guidant, Abbott Laboratories acquired Guidant’s vascular intervention and endovascular solutions businesses and shares the drug-eluting technology it acquired from Guidant with us. This arrangement gives us access to a second drug-eluting stent program which complements our existing TAXUS coronary stent program. In the fourth quarter of 2006, we launched our PROMUS™ everolimus-eluting stent system in certain European countries and expect to launch the PROMUS stent system in certain other European markets in the first quarter of 2007, certain Inter-Continental markets in the second quarter of 2007 and in the U.S. in 2008, subject to regulatory approval.

 

Our U.S. TAXUS stent system sales decreased in 2006 relative to 2005, due in part to a decline in the U.S. market size due to recent uncertainty regarding the risk of late stent thrombosis following the use of drug-eluting stents. Late stent thrombosis is the formation of a clot, or thrombus, within the stented area one year or more after implantation of the stent. In the fourth quarter of 2006, the FDA held a special advisory panel meeting to discuss drug-eluting stents. Members of the panel concluded that drug-eluting stents remain safe and effective when used as indicated, and that the benefits outweigh the risks.

 

As a result of our acquisition of Guidant in April 2006, we now develop, manufacture and market products that focus on the treatment of cardiac arrhythmias and heart failure. Natural electrical impulses stimulate the heart’s chambers to pump blood. In healthy individuals, the electrical current causes the heart to beat at an appropriate rate and in synchrony. We make a variety of implantable devices that can monitor the heart and deliver electricity to treat cardiac abnormalities, including:

·	Implantable defibrillator systems used to detect and treat abnormally fast heart rhythms (tachycardia) that could result in sudden cardiac death, including implantable cardiac resynchronization therapy defibrillator systems used to treat heart failure; and

·	Implantable pacemaker systems used to manage slow or irregular heart rhythms (bradycardia), including implantable cardiac resynchronization therapy pacemaker systems used to treat heart failure.

 

Tachycardia (abnormally fast or chaotic heart rhythms) can prevent the heart from pumping blood efficiently and can lead to sudden cardiac death. Implantable cardioverter defibrillator systems (defibrillators, leads, programmers, our LATITUDE® Patient Management System and accessories) monitor the heart and can deliver electrical energy, restoring a normal rhythm. Our defibrillators can deliver tiered therapy—a staged progression from lower intensity pacing pulses designed to correct the abnormal rhythm to more aggressive shocks to restore a heartbeat.

Heart failure (the heart’s inability to pump effectively) is a debilitating, progressive condition, with symptoms including shortness of breath and extreme fatigue. After a person is diagnosed with heart failure, the one-year mortality rate is high, with one in five people dying. Moreover, once diagnosed, sudden cardiac death occurs at six to nine times the rate of the general population. The condition is pervasive, with approximately five million people in the U.S. affected.

Bradycardia (slow or irregular heart rhythms) often results in a heart rate insufficient to provide adequate blood flow throughout the body, creating symptoms such as fatigue, dizziness and fainting. Cardiac pacemaker systems (pulse generators, leads, programmers and accessories) deliver electrical energy to stimulate the heart to beat more frequently and regularly. Pacemakers range from conventional single-chamber devices to more sophisticated adaptive-rate, dual-chamber devices.

 

Our remote monitoring system, the LATITUDE® Patient Management System, can be placed in a patient’s home (at their bedside) and reads implantable device information at times specified by the patient’s physician. The communicator can then transmit the data to a secure Internet server where the physician (or other third party) can access this medical information anytime, anywhere. In addition to automatic device data uploads, the communicator enables a daily confirmation of the patient’s device status, providing assurance the device is operating properly. Available as an optional component to the system is the LATITUDE Weight Scale and Blood Pressure Monitor. Weight and blood pressure data is captured by the communicator and sent to the secure server for review by the patient’s physician (or other technician). In addition, this weight and blood information is immediately available to patients in their home to assist their compliance with the day-to-day and home-based heart failure instructions prescribed by their physician.

 

Business Strategy

 

Our mission is to improve the quality of patient care and the productivity of healthcare delivery through the development and advocacy of less-invasive medical devices and procedures. We believe that the pursuit of this mission will likewise enhance shareholder value.

 

We intend to accomplish our mission through the continuing refinement of existing products and procedures and the investigation and development of new technologies that can reduce risk, trauma, cost, procedure time and the need for aftercare. Our approach to innovation combines internally developed products and technologies with those we obtained externally through strategic acquisitions and alliances. Building relationships with development-stage companies and inventors allows us to deepen our current franchises as well as expand into complementary businesses.

 

Key elements of our overall business strategy include the following:

 

Product Quality

 

Our commitment to quality and the success of our quality objectives are designed to build customer trust and loyalty. This commitment to provide quality products to our customers runs throughout our organization and is one of our most critical business objectives. During 2005, in order to strengthen our quality controls, we established Project Horizon, a cross-functional initiative to further improve and harmonize our overall quality processes and systems. Under Project Horizon, we have made an overarching effort to elevate quality thinking in all that we do. To that end, in 2006, we have made significant improvements to our quality systems, including in the areas of field action decision-making, corrective and preventative actions, management controls, process validations and complaint management systems. In 2006, our Board of Directors created a Compliance and Quality Committee to monitor our compliance and quality initiatives. Our quality policy, applicable to all employees, is “I improve the quality of patient care and all things Boston Scientific.”

 

Innovation

 

We are committed to harnessing technological innovation through a mixture of tactical and strategic initiatives that are designed to offer sustainable growth in the near and long term. Combining internally developed products and technologies with those obtained through acquisitions and alliances allows us to focus on and deliver products currently in our own research and development pipeline as well as to strengthen our technology portfolio by accessing third-party technologies.

 

Clinical Excellence

 

Our commitment to innovation is further demonstrated by our clinical capabilities. Our clinical groups focus on driving innovative therapies that can transform the practice of medicine. Our clinical teams are organized by therapeutic specialty to better support our research and development pipeline and marketing and sales efforts. During 2006, our clinical organizations planned, initiated and conducted an expanding series of focused clinical trials that support regulatory and reimbursement requirements and demonstrate the safe and effective clinical performance of critical products and technologies. In October, we announced positive results from our TAXUS OLYMPIA registry, supporting the safety and efficacy of our TAXUS Liberté stent system in real-world patient subsets considered high risk for bare-metal stenting, including diabetics, small vessels and long lesions. We are currently enrolling patients in our SYNTAX clinical trial, which will compare the performance of drug-eluting stents with cardiac surgery in the most complex subsets: those with coronary artery disease in all three coronary arteries, in the left main coronary artery, or both.

 

Product Diversity

 

We offer products in numerous product categories, which are used by physicians throughout the world in a broad range of diagnostic and therapeutic procedures. The

 

breadth and diversity of our product lines permit medical specialists and purchasing organizations to satisfy many of their less-invasive medical device requirements from a single source.

 

Operational Excellence

 

We are focused on continuously improving our supply chain effectiveness, strengthening our manufacturing processes and optimizing our plant network in order to increase operational efficiencies within our organization. By shifting global manufacturing along product lines, we are able to leverage our existing resources and concentrate on new product development, including the enhancement of existing products and their commercial launch. We are committing additional resources to support our growth and implementing new systems designed to provide improved quality and reliability, service, greater efficiency and lower supply chain costs. We have substantially increased our focus on process controls and validations, supplier controls, distribution controls and providing our operations teams with the training and tools necessary to drive continuous improvement in product quality. In 2007, we are also focused on examining our operations and general business activities to identify cost-improvement opportunities in order to enhance our operational effectiveness.

 

Focused Marketing

 

We consistently strive to understand and exceed the expectations of our customers. Each of our business groups maintains dedicated sales forces and marketing teams focusing on physicians who specialize in the diagnosis and treatment of different medical conditions. We believe that this focused disease state management enables us to develop highly knowledgeable and dedicated sales representatives and to foster close professional relationships with physicians. In recent years, we have expanded our direct sales presence worldwide so as to be in a position to take advantage of expanding market opportunities.

 

Active Participation in the Medical Community

 

We believe that we have excellent working relationships with physicians and others in the medical industry, which enable us to gain a detailed understanding of new therapeutic and diagnostic alternatives and to respond quickly to the changing needs of physicians and patients. Active participation in the medical community contributes to physician understanding and adoption of less-invasive techniques and the expansion of these techniques into new therapeutic and diagnostic areas.

 

Corporate Culture

 

We believe that success and leadership evolve from a motivating corporate culture that rewards achievement, respects and values individual employees and customers, and focuses on quality, patient care, integrity, technology and service. This high performance culture has embraced an intense increase in quality focus, and now places quality at the top of its priorities. We believe that our success is attributable in large part to the high caliber of our employees and our commitment to respecting the values on which our success has been based.

 

Research and Development

 

Our investment in research and development is critical to drive our future growth. We have directed our development efforts toward regulatory compliance and innovative technologies designed to expand current markets or enter new markets. Enhancements to existing products that are typically originated and developed within our research and development, manufacturing and marketing operations contribute to each year’s sales growth. We believe that streamlining,

 

prioritizing and coordinating our technology pipeline and new product development activities are essential to our ability to stimulate growth and maintain leadership positions in our markets. Our approach to new product design and development is through focused, cross-functional teams. We believe that our formal process for technology and product development aids in our ability to offer innovative and manufacturable products in a consistent and timely manner. Involvement of the research and development, clinical, quality, regulatory, manufacturing and marketing teams early in the process is the cornerstone of our product development cycle. This collaboration allows these teams to concentrate resources on the most viable and game-changing new products and technologies and get them to market in a timely manner. In addition to internal development, we work with hundreds of leading research institutions, universities and clinicians around the world to develop, evaluate and clinically test our products.

 

We believe our future success will depend upon the strength of these development efforts. In 2006, we expended over $1.0 billion on research and development, representing approximately 13 percent of our 2006 net sales. Our investment in research and development reflects:

 

·	spending on new product development programs;

 

·	regulatory compliance and clinical research, particularly relating to our next-generation stent and CRM platforms and other development programs acquired in connection with our business combinations; and

 

·	sustaining engineering efforts which factor customer (or “post market”) feedback into continuous improvement efforts for currently marketed products.

 

Strategic Initiatives

 

Since 1995, we have undertaken a strategic acquisition program to assemble the lines of business necessary to achieve the critical mass that allows us to continue to be a leader in the medical device industry. In 2006, in addition to our acquisition of Guidant, we invested approximately $500   million in approximately 25 new and existing strategic alliances and acquisitions. These initiatives are intended to further expand our product offerings by adding new or complementary technologies to our already diverse technology portfolio.

 

Many of our alliances involve complex arrangements with third parties and include, in many instances, the option to purchase these companies at pre-established future dates, generally upon the attainment of performance, regulatory and/or revenue milestones. These arrangements allow us to evaluate new technologies prior to acquiring them.

 

We expect that we will continue to focus selectively on strategic acquisitions and alliances in order to provide new products and technology platforms to our customers, including making additional investments in several of our existing strategic relationships.

 

Products

 

Our products are principally offered for sale by three dedicated business groups—Cardiovascular (which includes our interventional cardiology, cardiac rhythm management and cardiovascular divisions), Endosurgery (which includes our oncology, endoscopy and urology/gynecology divisions) and Neuromodulation (which includes our cochlear and pain management divisions). Our Cardiovascular organization focuses on products and technologies for use in interventional cardiology, cardiac rhythm management, peripheral interventions, cardiac surgery, vascular surgery, electrophysiology and neurovascular procedures. Our Endosurgery organization focuses

 

on products and technologies for use in oncology, endoscopy, urology and gynecology procedures. Our Neuromodulation organization currently focuses on the treatment of auditory disorders and chronic pain. During 2006, approximately 80 percent of our net sales were derived from our Cardiovascular business groups, approximately 17 percent from our Endosurgery business groups and approximately 3 percent from our Neuromodulation business group.

 

The following section describes some of our Cardiovascular, Endosurgery and Neuromodulation offerings:

 

Cardiovascular

 

Coronary Stent Business

 

Drug-Eluting Stents

 

We market our TAXUS Express ² paclitaxel-eluting coronary stent system principally in the U.S., and we expect to launch the TAXUS Express ² stent system in Japan during the second half of 2007, subject to regulatory approval. In January 2007, the FDA approved extending the shelf life of our TAXUS coronary stent system in the U.S. from 12 to 18 months. We also market our second-generation coronary stent, the TAXUS® Liberté™ coronary stent system, in our European and Inter-Continental markets. We also expect to launch the TAXUS Liberté coronary stent system in the U.S., subject to regulatory approval.

 

During the fourth quarter of 2006, we launched our PROMUS ™ everolimus-eluting coronary stent system in certain European countries, expanding our drug-eluting stent portfolio to include two distinct drug platforms. We expect to launch the PROMUS stent system in certain Inter-Continental countries during the second quarter of 2007 and in the U.S. in 2008, subject to regulatory approval. We also expect to launch an internally manufactured next-generation everolimus-based stent system in Europe in 2010 and in the U.S. in 2011. In addition, we have commenced regulatory filings to begin clinical trials for our next-generation paclitaxel-eluting stent beyond TAXUS Liberté stent system, the TAXUS® Element™ coronary stent system, which we expect to launch in Europe in 2009 and in the U.S. in 2010, subject to regulatory approval.

 

Bare-Metal Stents

 

We offer our Liberté coronary stent system globally. The Liberté coronary stent system serves as the platform for our second-generation paclitaxel-eluting stent system, the TAXUS Liberté coronary stent system. The Liberté bare-metal coronary stent is designed to enhance deliverability and conformability, particularly in challenging lesions.

 

Cardiac Surgery

 

Our acquisition of Guidant also enabled us to enter the cardiac surgery business. Cardiac surgery devices are used to perform endoscopic vessel harvesting, cardiac surgical ablation and less-invasive coronary artery by-pass surgery.

 

Coronary Revascularization

 

We market a broad line of products used to treat patients with atherosclerosis. Atherosclerosis, a principal cause of coronary artery obstructive disease, is characterized by a thickening of the walls of the coronary arteries and a narrowing of arterial lumens (openings) caused by the progressive development of deposits of plaque. The majority of our products in this market are used in percutaneous transluminal coronary angioplasty (PTCA) and include bare-metal and drug-

 

eluting stents, such as the TAXUS® paclitaxel-eluting coronary stent systems, PTCA balloon catheters, such as the Maverick® balloon catheter, the Cutting Balloon® microsurgical dilatation device, rotational atherectomy systems, guide wires, guide catheters and diagnostic catheters. We also market a broad line of fluid delivery sets, pressure monitoring systems, custom kits and accessories that enable the injection of contrast and saline or otherwise facilitate cardiovascular procedures.

 

Intraluminal Ultrasound Imaging

 

We market a family of intraluminal catheter-directed ultrasound imaging catheters and systems for use in coronary arteries and heart chambers as well as certain peripheral systems. In July 2006, we launched the new iLab ™ Ultrasound Imaging System in the U.S. This new system enhances the diagnosis and treatment of blocked vessels and heart disorders.

 

Embolic Protection

 

Our FilterWire EZ™ Embolic Protection System is a low profile filter designed to capture embolic material that may become dislodged during a procedure, which could otherwise travel into th e microvasculature where it could cause a heart attack or stroke. It is commercially available in the U.S., Europe and other international markets for multiple indications, including the treatment of disease in peripheral, coronary and carotid vessels. It is also available in the U.S. for the treatment of saphenous vein grafts (SVGs) and carotid artery stenting procedures.

 

Peripheral Interventions

 

We also sell various products designed to treat patients with peripheral disease (disease which appears in blood vessels other than in the heart and in biliary strictures), including a broad line of medical devices used in percutaneous transluminal angioplasty and peripheral vascular stenting. Our peripheral product line includes vascular access products, balloon catheters, stents and peripheral vascular catheters, wires and accessories. We also market the PolarCath ™ peripheral dilatation system used in CryoPlasty ® Therapy®, an innovative approach to the treatment of peripheral artery disease in the lower extremities. We launched in June 2006 the Sterling™ Balloon dilatation catheter, a dilatation catheter with several differentiating features, including the only pre- and post-stent dilatation indication for carotid artery stenting.

 

In January 2007, we completed the acquisition of EndoTex Interventional Systems, Inc., a development stage medical device company, and now market the NexStent® Carotid Stent System, a laser-cut, nitinol stent with a rolled sheet design that enables one stent size to adapt to multiple diameters in tapered or non-tapered vessel configurations.

 

Neurovascular Intervention

 

We market a line of coils (coated and uncoated), micro-delivery stents, micro-guidewires, micro-catheters, guiding catheters and embolics to neuroradiologists and neurosurgeons to treat diseases of the neurovascular system. We market the GDC® Coils (Guglielmi Detachable Coil) and Matrix® systems to treat brain aneurysms. We also offer the Wingspan™ Stent System with Gateway™ PTA Balloon Catheter under a Humanitarian Device Exemption (HDE) approval granted by the FDA. The Wingspan Stent System is designed to treat atherosclerotic lesions or accumulated plaque in brain arteries. Designed for the brain’s fragile vessels, the Wingspan Stent System is a self-expanding, nitinol stent sheathed in a delivery system that enables it to

 

reach and open narrowed arteries in the brain. The Wingspan Stent System is currently the only device available in the U.S. for the treatment of intracranial atherosclerotic disease (ICAD) and is indicated for improving cerebral artery lumen diameter in patients with ICAD who are unresponsive to medical therapy.

 

Vascular Surgery

 

We design abdominal, thoracic and peripheral vascular grafts for the treatment of aortic aneurysms and dissections, peripheral vascular occlusive diseases and dialysis access. Our grafts and fabrics are used for peripheral vascular and cardiovascular indications.

 

Electrophysiology

 

We offer medical devices for the diagnosis and treatment of cardiac conditions called arrhythmias (abnormal heartbeats). Included in our product offerings are RF generators, mapping systems, intracardiac ultrasound and steerable ablation catheters, as well as a line of diagnostic catheters and associated accessories. We also market the Chilli II™ cooled ablation catheter, the first bidirectional cooled-tip catheter available in the U.S. In 2006, we launched our next-generation line of RF generators, the MAESTRO 3000 ® Cardiac Ablation System.

 

Cardiac Rhythm Management

 

Through our acquisition of Guidant, we now offer a variety of implantable devices that can monitor the heart and deliver electricity to treat cardiac rhythm abnormalities, including tachycardia (abnormally fast or chaotic heart rhythms), heart failure and bradycardia (slow or irregular heart rhythms).

 

Our product offerings include:

 

·	the VITALITY® family of defibrillators which provide a broad range of atrial (upper chambers of the heart) and ventricular (lower chambers) therapies to serve patients’ various needs;

 

·	cardiac resynchronization therapy devices, like those in our CONTAK RENEWAL® family of devices, which can help reduce mortality and hospitalization;

 

·	the INSIGNIA® family of pacemakers which offer proprietary blended sensor technology designed to measure patient workload through respiration and motion, providing rate response based on the patient’s activity; and

 

·	the LATITUDE® Patient Management System, comprised of the LATITUDE Communicator, LATITUDE Website, CONTAK RENEWAL 3RF CRT-D and ZOOM® LATITUDE Programmer, which enables a physician or technician to monitor a patient’s device status and health data from home.

 

In October 2006, the FDA approved our LATITUDE® Patient Management System to be used for remote monitoring in certain existing ICD systems and cardiac resynchronization defibrillators. We are in the process of making this technology available to many of our current CRM patients.

 

The Frontier ™ CRM technology is our next-generation CRM pulse generator platform that will incorporate new components and software and will be leveraged across all CRM product lines to

 

treat electrical dysfunction in the heart. We expect to launch various products based on the Frontier ™  CRM technology in the U.S. over the next 36 months, subject to regulatory approval.

 

Endosurgery

 

Esophageal, Gastric and Duodenal (Small Intestine) Intervention

 

We market a broad range of products to diagnose, treat and palliate a variety of gastrointestinal diseases and conditions, including those affecting the esophagus, stomach and colon. Common disease states include esophagitis, portal hypertension, peptic ulcers and esophageal cancer. Our products in this area include disposable single and multiple biopsy forceps, balloon dilatation catheters, hemostasis catheters and enteral feeding devices. We also market a family of esophageal stents designed to offer improved dilatation force and greater resistance to tumor in-growth. We launched the Radial Jaw® 4 Single-Use Biopsy Forceps, the newest version of our Radial Jaw Single-Use Biopsy Forceps, in July 2006. The Radial Jaw 4 biopsy forceps are designed to enable collection of large high-quality tissue specimens without the need to use large channel therapeutic endoscopes.

 

Colorectal Intervention

 

We market a line of hemostatic catheters, polypectomy snares, biopsy forceps, enteral stents and dilatation catheters for the diagnosis and treatment of polyps, inflammatory bowel disease, diverticulitis and colon cancer.

 

Pancreatico-Biliary Intervention

 

We sell a variety of products to diagnose, treat and palliate benign and malignant strictures of the pancreatico-biliary system (the gall bladder, common bile duct, hepatic duct, pancreatic duct and the pancreas) and to remove stones found in the common bile duct. Our products include diagnostic catheters used with contrast media, balloon dilatation catheters and sphincterotomes. We also market self-expanding metal and temporary biliary stents for palliation and drainage of the common bile duct.   In 2006, we introduced the Spyglass™ Direct Visualization System for direct imaging of the bile duct system.  This is the first single operator cholangioscopy device that offers clinicians a direct visualization of the bile duct system and includes supporting devices for tissue acquisition, stone retrieval and lithotripsy.

 

Pulmonary Intervention

 

We market devices to diagnose, treat and palliate diseases of the pulmonary system. The major devices include pulmonary biopsy forceps, transbronchial aspiration needles, cytology brushes and tracheobronchial stents used to dilate strictures or for tumor management.

 

Urinary Tract Intervention and Bladder Disease

 

We sell a variety of products designed primarily to treat patients with urinary stone disease, including ureteral dilatation balloons used to dilate strictures or openings for scope access; stone baskets used to manipulate or remove the stone; intracorporeal shock wave lithotripsy devices and holmium laser systems used to disintegrate stones; ureteral stents implanted temporarily in the urinary tract to provide short-term or long-term drainage; and a wide variety of guidewires used to gain access to a specific site. We have also developed other devices to diagnose and treat bladder cancer and bladder obstruction.

 

Prostate Intervention

 

For the treatment of Benign Prostatic Hyperplasia (BPH), we currently market electro-surgical resection devices designed to resect large diseased tissue sites. We also market disposable needle biopsy devices, designed to take core prostate biopsy samples. In addition, we distribute and market the Prolieve thermodilatation system, a transurethral microwave thermotherapy system, and the DuoTome™ SideLite™ holmium laser treatment system for treatment of symptoms associated with BPH.

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Marketing and Sales

 

Dedicated sales forces of approximately 2,400 individuals in approximately 45 countries internationally and over 3,400 individuals in the U.S. marketed our products worldwide as of December 31, 2006. Sales in countries where we have direct sales organizations accounted for approximately 94 percent of our net sales during 2006. A network of distributors and dealers who offer our products in more than 50 countries worldwide accounts for our remaining sales. We also have a dedicated corporate sales organization in the U.S. focused principally on selling to major buying groups and integrated healthcare networks.

 

In 2006, we sold our products to over 10,000 hospitals, clinics, out-patient facilities and medical offices. We are not dependent on any single institution and no single institution accounted for more than 10 percent of our net sales in 2006. Large group purchasing organizations, hospital networks and other buying groups have, however, become increasingly important to our business and represent a substantial portion of our U.S. net sales.

 

We also distribute certain products for third parties, including an introducer sheath and certain guidewires, as well as BPH devices, various graft materials, and pneumatic and laser lithotripters for use in connection with urology and gynecology procedures. Our agreement to distribute certain guidewire and sheath products expired during the first quarter of 2006. While we have identified replacements for these products, the sales level associated with the replacement products has been, as expected, less than that of our previously distributed products. Together, these distributed products represented less than two percent of our 2006 net sales. Leveraging our sales and marketing strength, we expect to continue to seek new opportunities for distributing complementary products as well as new technologies.

 

International Operations

 

Internationally, through 2006, we operated through three business units divided among the geographic regions of Europe, Japan and Inter-Continental. Maintaining and expanding our international presence is an important component of our long-term growth plan. Through our international presence, we seek to increase net sales and market share, leverage relationships with leading physicians and their clinical research programs, accelerate the time to bring new products to market and gain access to worldwide technological developments that may be implemented across our product lines. After our acquisition of Guidant, we integrated Guidant’s international sales operations into our geographic regions. Consistent with our geographic focus, the Guidant CRM business became a business unit within each country organization across Europe, Japan and Inter-Continental. In the first quarter of 2007, we began operating through four international business units: Europe, Asia Pacific/Japan, Inter-Continental and Distributor Management.

 

International sales accounted for approximately 38 percent of our net sales in 2006. Net sales and operating income attributable to significant geographic areas are presented in Note N—Segment Reporting to our 2006 consolidated financial statements included in Item 8 of this Form 10-K.

 

In recent years, we have expanded our direct sales presence worldwide so as to be in a position to take advantage of expanding market opportunities. As of December 31, 2006, we had direct marketing and sales operations in approximately 45 countries internationally. We believe that we will continue to leverage our infrastructure in markets where commercially appropriate and to use third parties in those markets where it is not economical or strategic to establish a direct presence.

 

We have five international manufacturing facilities in Ireland, one in Costa Rica and one in Puerto Rico. Presently, approximately 33 percent of our products sold worldwide are manufactured at these facilities. We also maintain an international research and development

 

facility in Ireland, a training facility in Tokyo, Japan, and a training and research and development center in Miyazaki, Japan. We currently share a training facility in Brussels, Belgium with Abbott.

 

Manufacturing and Raw Materials

 

We design and manufacture the majority of our products in technology centers around the world. Many components used in the manufacture of our products are readily fabricated from commonly available raw materials or off-the-shelf items available from multiple supply sources. Certain items are custom made for us to meet our specifications. We believe that in most cases, redundant capacity exists at our suppliers and that alternative sources of supply are available or could be developed within a reasonable period of time. We also have an ongoing program to identify single-source components and to develop alternative back-up supplies. However, in certain cases, we may not be able to quickly establish additional or replacement suppliers for specific components or materials, largely due to the regulatory approval system and the complex nature of the manufacturing processes employed by us and many suppliers. A reduction or interruption in supply, an inability to develop and validate alternative sources if required, or a significant increase in the price of raw materials or components could adversely affect our operations and financial condition, particularly materials or components related to our TAXUS® and PROMUS™ drug-eluting coronary stent systems and our CRM products.

 

Quality Assurance

 

On January 26, 2006, legacy Boston Scientific received a corporate warning letter from the FDA notifying us of serious regulatory problems at three of our facilities and advising us that our corporate-wide corrective action plan relating to three site-specific warning letters issued to us in 2005 was inadequate. As stated in this FDA warning letter, the FDA may not grant our requests for exportation certificates to foreign governments or approve pre-market approval (PMA) applications for class III devices to which the quality control or current good manufacturing practices deficiencies described in the letter are reasonably related until the deficiencies have been corrected. During 2005, in order to strengthen our corporate-wide quality controls, we established Project Horizon a corporate-wide cross-functional initiative to improve and harmonize our overall quality processes and systems. As part of Project Horizon, we have made modifications to our process validation and complaint management systems. Project Horizon resulted in the reallocation of significant internal engineering and management resources to quality initiatives, as well as incremental spending, which has resulted in adjustments to product launch schedules of certain products and the decision to discontinue certain other product lines over time.

In 2006, our Board of Directors created a Compliance and Quality Committee to monitor our compliance and quality initiatives. We believe we have identified solutions to the quality issues cited by the FDA, and we continue to make progress in transitioning our organization to implement those solutions. We communicate frequently and meet regularly with the FDA to apprise them of our progress. The FDA has communicated the need for us to complete substantially our remediation efforts before they will re-inspect our facilities. We have engaged a third party to audit our enhanced quality systems in order to assess our Company-wide compliance prior to re-inspection by the FDA. We believe we will be ready for third-party audit in the second quarter of 2007.

On December 23, 2005, Guidant received an FDA warning letter citing certain deficiencies with respect to its manufacturing quality systems and record keeping procedures in its CRM facility in St. Paul, Minnesota. This FDA warning letter followed an inspection by the FDA that was completed on September 1, 2005 and cited a number of observations. Guidant received a follow-up letter from the FDA dated January 5, 2006. As stated in this follow-up letter, until we have corrected the

 

identified deficiencies, the FDA may not grant requests for exportation certificates to foreign governments or approve PMA applications for class III devices to which the deficiencies described are reasonably related. The FDA conducted a further inspection of the CRM facility between December 15, 2005 and February 9, 2006 and made one additional inspectional observation.  The FDA has concluded its reinspection of our CRM facilities. While we believe this reinspection went well, we may be required to take additional actions in order to comply with any FDA observations that we may receive.

 

We are committed to providing high quality products to our customers. To meet this commitment, we are implementing updated quality systems and concepts throughout our organization. Our quality system starts with the initial product specification and continues through the design of the product, component specification process and the manufacturing, sales and servicing of the product. Our quality system is designed to build in quality and process control and to utilize continuous improvement concepts throughout the product life. These systems are designed to enable us to satisfy the quality system regulations of the FDA with respect to products sold in the U.S. Many of our operations are certified under ISO 9001, ISO 9002, ISO 13485, ISO 13488, EN 46001 and EN 46002 international quality system standards. ISO 9002 requires, among other items, an implemented quality system that applies to component quality, supplier control and manufacturing operations. In addition, ISO 9001 and EN 46001 require an implemented quality system that applies to product design. These certifications can be obtained only after a complete audit of a company’s quality system by an independent outside auditor. Maintenance of these certifications requires that these facilities undergo periodic re-examination.

 

We maintain an ongoing initiative to seek ISO 14001 certification at our plants around the world. ISO 14001, the environmental management system standard in the ISO 14000 series, provides a voluntary framework to identify key environmental aspects associated with our businesses. We engage in continuous environmental performance improvement around these aspects. At present, nine of our manufacturing and distribution facilities have attained ISO 14001 certification. This initiative is expected to continue until each of our manufacturing facilities, including those we acquire, becomes certified.

 

Competition

 

We encounter significant competition across our product lines and in each market in which our products are sold from various companies, some of which may have greater financial and marketing resources than we do. Our primary competitors have historically included Johnson & Johnson (including its subsidiary, Cordis Corporation) and Medtronic, Inc. (including its subsidiary, Medtronic AVE, Inc.), as well as a wide range of companies which sell a single or limited number of competitive products or participate only in a specific market segment. Since we acquired Guidant, Abbott Laboratories has become a competitor of ours in the interventional cardiology market and St. Jude Medical, Inc. has become a competitor of ours in the CRM market, in addition to the Neuromodulation market. We also face competition from non-medical device companies, such as pharmaceutical companies, which may offer alternative therapies for disease states intended to be treated using our products.

 

We believe that our products compete primarily on the basis of their ability to safely and effectively perform diagnostic and therapeutic procedures in a less-invasive manner, including ease of use, reliability and physician familiarity. In the current environment of managed care, economically motivated buyers, consolidation among healthcare providers, increased competition and declining reimbursement rates, we have also increasingly been required to compete on the basis of price, value, reliability and efficiency. We believe that our continued competitive success will depend upon our ability to create or acquire scientifically advanced technology, apply our

 

technology cost-effectively and with superior quality across product lines and markets, develop or acquire proprietary products, attract and retain skilled development personnel, obtain patent or other protection for our products, obtain required regulatory and reimbursement approvals, continually enhance our quality systems, manufacture and successfully market our products either directly or through outside parties and supply sufficient inventory to meet customer demand.

 

Regulation

 

The medical devices that we manufacture and market are subject to regulation by numerous regulatory bodies, including the FDA and comparable international regulatory agencies. These agencies require manufacturers of medical devices to comply with applicable laws and regulations governing the development, testing, manufacturing, labeling, marketing and distribution of medical devices. Devices are generally subject to varying levels of regulatory control, the most comprehensive of which requires that a clinical evaluation program be conducted before a device receives approval for commercial distribution.

 

In the U.S., permission to distribute a new device generally can be met in one of two ways. The first process requires that a pre-market notification (a 510(k) Submission) be made to the FDA to demonstrate that the device is as safe and effective as, or substantially equivalent to, a legally marketed device that is not subject to pre-market approval (PMA) (i.e., the “predicate” device). An appropriate predicate device for a pre-market notification is one that (i) was legally marketed prior to May 28, 1976, (ii) was approved under a PMA but then subsequently reclassified from class III to class II or I, or (iii) has been found to be substantially equivalent and cleared for commercial distribution under a 510(k) Submission. Applicants must submit descriptive data and, when necessary, performance data to establish that the device is substantially equivalent to a predicate device. In some instances, data from human clinical trials must also be submitted in support of a 510(k) Submission. If so, these data must be collected in a manner that conforms to the applicable Investigational Device Exemption (IDE) regulations. The FDA must issue an order finding substantial equivalence before commercial distribution can occur. Changes to existing devices covered by a 510(k) Submission which do not raise new questions of safety or effectiveness can generally be made by us without additional 510(k) Submissions. More significant changes, such as new designs or materials, may require a separate 510(k) with data to support that the modified device remains substantially equivalent.

 

The second process requires that an application for PMA be made to the FDA to demonstrate that the device is safe and effective for its intended use as manufactured. This approval process applies to certain class III devices. In this case, two steps of FDA approval are generally required before marketing in the U.S. can begin. First, we must comply with the applicable IDE regulations in connection with any human clinical investigation of the device in the U.S. Second, the FDA must review our PMA application which contains, among other things, clinical information acquired under the IDE. The FDA will approve the PMA application if it finds that there is a reasonable assurance that the device is safe and effective for its intended purpose.

 

The FDA can ban certain medical devices; detain or seize adulterated or misbranded medical devices; order repair, replacement or refund of these devices; and require notification of health professionals and others with regard to medical devices that present unreasonable risks of substantial harm to the public health. The FDA may also enjoin and restrain certain violations of the Food, Drug and Cosmetic Act and the Safe Medical Devices Act pertaining to medical devices, or initiate action for criminal prosecution of such violations. International sales of medical devices manufactured in the U.S. that are not approved by the FDA for use in the U.S., or are banned or deviate from lawful performance standards, are subject to FDA export

 

requirements. Exported devices are subject to the regulatory requirements of each country to which the device is exported. Some countries do not have medical device regulations, but in most foreign countries medical devices are regulated. Frequently, regulatory approval may first be obtained in a foreign country prior to application in the U.S. to take advantage of differing regulatory requirements. Most countries outside of the United States require that product approvals be recertified on a regular basis, generally every five years. The recertification process requires that we evaluate any device changes and any new regulations or standards relevant to the device and conduct appropriate testing to document continued compliance. Where recertification applications are required, they must be approved in order to continue to sell our products in those countries.

 

In the European Union, we are required to comply with the Medical Devices Directive and obtain CE Mark certification in order to market medical devices. The CE Mark certification, granted following approval from an independent Notified Body, is an international symbol of adherence to quality assurance standards and compliance with applicable European Medical Devices Directives. We also comply with all other foreign regulations such as the requirement that we obtain Ministry of Health, Labor and Welfare approval before we can launch new products in Japan, including our TAXUS® Express ² coronary stent system. The time required to obtain these foreign approvals to market our products may be longer or shorter than that required in the U.S., and requirements for such approval may differ from those required by the FDA.

 

We are also subject to various environmental laws, directives and regulations both in the U.S. and abroad. Our operations, like those of other medical device companies, involve the use of substances regulated under environmental laws, primarily in manufacturing and sterilization processes. We believe that compliance with environmental laws will not have a material impact on our capital expenditures, earnings or competitive position. Given the scope and nature of these laws, however, there can be no assurance that environmental laws will not have a material impact on our results of operations. We assess potential environmental contingent liabilities on a quarterly basis. At present, we are not aware of any such liabilities which would have a material impact on our business. We are also certified with respect to the enhanced environmental FTSE4Good criteria and are a constituent member of the London Stock Exchange ’ s FTSE4Good Index, which recognizes companies that meet certain corporate responsibility standards.

 

Third-Party Coverage and Reimbursement

 

Our products are purchased by hospitals, doctors and other healthcare providers who are reimbursed by third-party payors, such as governmental programs (e.g., Medicare and Medicaid), private insurance plans and managed care programs, for the healthcare services provided to their patients. Third-party payors may provide or deny coverage for certain technologies and associated procedures based on assessment criteria as determined by the third-party payor. Reimbursement by third-party payors for these services is based on a wide range of methodologies that may reflect the services’ assessed resource costs, clinical outcomes and economic value. These reimbursement methodologies confer different, and often conflicting, levels of financial risk and incentives to healthcare providers and patients, and these methodologies are subject to frequent refinements. Third-party payors are also increasingly adjusting reimbursement rates and challenging the prices charged for medical products and services. There can be no assurance that our products will be automatically covered by third-party payors, that reimbursement will be available or, if available, that the third-party payors’ coverage policies will not adversely affect our ability to sell our products profitably.

 

Initiatives to limit the growth of healthcare costs, including price regulation, are also underway in many countries in which we do business. Implementation of cost containment initiatives and healthcare reforms in significant markets such as Japan, Europe and other international markets may limit the

 

price of, or the level at which reimbursement is provided for, our products and may influence a physician’s selection of products used to treat patients.

 

Proprietary Rights and Patent Litigation

 

We rely on a combination of patents, trademarks, trade secrets and non-disclosure agreements to protect our intellectual property. We generally file patent applications in the U.S. and foreign countries where patent protection for our technology is appropriate and available. We hold approximately 6,000 U.S. patents (many of which have foreign counterparts) and have more than 8,600 patent applications pending worldwide that cover various aspects of our technology. In addition, we hold exclusive and non-exclusive licenses to a variety of third-party technologies covered by patents and patent applications. There can be no assurance that pending patent applications will result in issued patents, that patents issued to or licensed by us will not be challenged or circumvented by competitors, or that such patents will be found to be valid or sufficiently broad to protect our technology or to provide us with a competitive advantage.

 

We rely on non-disclosure and non-competition agreements with employees, consultants and other parties to protect, in part, trade secrets and other proprietary technology. There can be no assurance that these agreements will not be breached, that we will have adequate remedies for any breach, that others will not independently develop equivalent proprietary information or that third parties will not otherwise gain access to our trade secrets and proprietary knowledge.

 

There has been substantial litigation regarding patent and other intellectual property rights in the medical device industry, particularly in the areas in which we compete. We have defended, and will continue to defend, ourself against claims and legal actions alleging infringement of the patent rights of others. Adverse determinations in any patent litigation could subject us to significant liabilities to third parties, require us to seek licenses from third parties, and, if licenses are not available, prevent us from manufacturing, selling or using certain of our products, which could have a material adverse effect on us.

 

Additionally, we may find it necessary to initiate litigation to enforce our patent rights, to protect our trade secrets or know-how and to determine the scope and validity of the proprietary rights of others. Patent litigation can be costly and time-consuming, and there can be no assurance that our litigation expenses will not be significant in the future or that the outcome of litigation will be favorable to us. Accordingly, we may seek to settle some or all of our pending litigation. Settlement may include cross-licensing of the patents which are the subject of the litigation as well as our other intellectual property and may involve monetary payments to or from third parties.

 

See Item 3. Legal Proceedings below and Note J—Commitments and Contingencies to our 2006 consolidated financial statements included in Item 8 of this Form 10-K for a further discussion of patent and other litigation and proceedings in which we are involved. In management’s opinion, we are not currently involved in any legal proceeding other than those specifically identified in Note J to our consolidated financial statements, which, individually or in the aggregate, could have a material effect on our financial condition, operations or cash flows.

 

Risk Management

 

The testing, marketing and sale of human healthcare products entails an inherent risk of product liability claims. We are involved in various lawsuits arising in the normal course of business from product liability and securities claims. We are substantially self-insured with respect to general, product liability and securities claims. As a result of the economic factors currently impacting the insurance industry, meaningful liability insurance coverage became unavailable due to its economically prohibitive cost.

In connection with our acquisition of Guidant, the number of product liability claims and other legal proceedings filed against us, including private securities litigation and shareholder derivative suits, significantly increased. Product liability and securities claims against us may be asserted in the future related to unknown events at the present time. The absence of significant third-party insurance coverage increases our potential exposure to unanticipated claims or adverse decisions. Product liability claims, product recalls, securities litigation and other litigation in the future, regardless of their outcome, could have a material adverse effect on our business. We believe that our risk management practices, including limited insurance coverage, are reasonably adequate to protect against anticipated general, product liability and securities litigation losses. However, unanticipated catastrophic losses could have a material adverse impact on our financial position, results of operations and liquidity.

 

Employees

 

As of December 31, 2006, we had approximately 28,600 employees, including approximately 14,300 in operations, 2,000 in administration, 4,600 in clinical, regulatory and research and development and 7,700 in selling, marketing, distribution and related administrative support. Of these employees, approximately 14,500 were employed outside the U.S., approximately 6,200 of which are included in the Operations function. We believe that the continued success of our business will depend, in part, on our ability to attract and retain qualified personnel.

 

Seasonality

 

Our worldwide sales do not reflect any significant degree of seasonality; however, customer purchases have been lighter in the third quarter of prior years than in other quarters. This reflects, among other factors, lower demand during summer months, particularly in European countries.

 

Available Information

 

Copies of our annual report on Form 10-K, quarterly reports on Form 10-Q, current reports on Form 8-K and amendments to those reports filed or furnished pursuant to Section 13(a) or 15(d) of the Securities Exchange Act of 1934 are available free of charge on our website (www.bostonscientific.com) as soon as reasonably practicable after we electronically file the material with or furnish it to the SEC. Our Corporate Governance Guidelines and Code of Conduct, which applies to all of our directors, officers and employees, including our Board of Directors, Chief Executive Officer, Chief Financial Officer and Corporate Controller, are also available on our website (along with any amendments to those documents). Any amendments to or waivers for executive officers or directors of our Code of Conduct will be disclosed on our website promptly after the date of any such amendment or waiver. Printed copies of these posted materials are also available free of charge to shareholders who request them in writing from Investor Relations, One Boston Scientific Place, Natick, MA 01760-1537. Information on our website or connected to our website is not incorporated by reference into this Form 10-K.

 

Cautionary Statement for Purposes of the Safe Harbor Provisions of the Private Securities Litigation Reform Act of 1995

 

Certain statements that we may make from time to time, including statements contained in this report and information incorporated by reference into this report, constitute “forward-looking statements.” Forward-looking statements may be identified by words like “anticipate,” “expect,” “project,” “believe,” “plan,” “estimate,” “intend” and similar words used in connection with, among other things, discussions of our financial performance, growth strategy, regulatory

 

approvals, product development or new product launches, market position, sales efforts, intellectual property matters or acquisitions and divestitures. These forward-looking statements are based on our beliefs, assumptions and estimates using information available to us at the time and are not intended to be guarantees of future events or performance. If our underlying assumptions turn out to be incorrect, or if certain risks or uncertainties materialize, actual results could vary materially from the expectations and projections expressed or implied by our forward-looking statements. As a result, investors are cautioned not to place undue reliance on any of our forward-looking statements.

 

We do not intend to update the forward-looking statements below or the risk factors described in Item 1A under the heading “Risk Factors” even if new information becomes available or other events occur in the future. We have identified these forward-looking statements below and the risk factors described in Item 1A under the heading “Risk Factors” in order to take advantage of the safe harbor provisions of the Private Securities Litigation Reform Act of 1995. Certain factors that could cause actual results to differ materially from those expressed in forward-looking statements are contained below and in the risk factors described in Item 1A under the heading “Risk Factors.”

 

CRM Business

 

·	The recovery of the CRM market to historical growth rates and our ability to regain CRM market share and increase CRM net sales;

 

·	The overall performance of and referring physician, implanting physician and patient confidence in our and other CRM products and technologies, including our LATITUDE® Patient Management System and Frontier ™ CRM technology;

 

·	The results of CRM clinical trials undertaken by us, our competitors or other third parties;

 

·	Our ability to launch various products utilizing the Frontier CRM technology, our next generation CRM pulse generator platform, in the U.S. over the next 36 months and to expand our CRM market position through reinvestment in our CRM products and technologies;

 

·	Our ability to retain our CRM sales force and other key personnel;

 

·	Competitive offerings in the CRM market and the timing of receipt of regulatory approvals to market existing and anticipated CRM products and technologies; and

 

·	Our ability to avoid disruption in the supply of certain components or materials or to quickly secure additional or replacement components or materials on a timely basis.

 

Coronary Stent Business

 

·

Volatility in the coronary stent market, competitive offerings and the timing of receipt of regulatory approvals to market existing and anticipated drug-eluting stent technology and other coronary and peripheral stent platforms;

·

Our ability to launch our TAXUS® Express 2 ™ coronary stent system in Japan during the second half of 2007, and to launch our next-generation drug-eluting stent system, the TAXUS® Liberté™ coronary stent system, in the U.S., subject to regulatory approval, and to maintain or expand our worldwide market leadership positions through reinvestment in our drug-eluting stent program;

·

The continued availability of our TAXUS stent system in sufficient quantities and mix, our ability to prevent disruptions to our TAXUS stent system manufacturing processes and to maintain or replenish inventory levels consistent with forecasted demand around the world as we transition to next-generation stent products;

·

The impact of concerns relating to late stent thrombosis on the size of the coronary stent market, distribution of share within the coronary stent market in the U.S. and around the world, the average number of stents used per procedure and average selling prices;

·

The overall performance of and continued physician confidence in our and other drug-eluting stents, our ability to adequately address concerns regarding the risk of late stent thrombosis, and the results of drug-eluting stent clinical trials undertaken by us, our competitors or other third parties;

·

Our ability to sustain or increase the penetration rate of drug-eluting stent technology in the U.S. and our European and Inter-Continental markets;

·	Our ability to take advantage of our position as one of two early entrants in the U.S. drug-eluting stent market, to anticipate competitor products as they enter the market and to respond to the challenges presented as additional competitors enter the U.S. drug-eluting stent market;

·

Our ability to manage inventory levels, accounts receivable, gross margins and operating expenses relating to our drug-eluting stent systems and other product franchises and to react effectively to worldwide economic and political conditions;

·	Our ability to manage the launch of our PROMUS™ everolimus-eluting stent system and the supply of this stent system in sufficient quantities and mix; and

·	Our ability to manage the mix of our PROMUS stent system revenue relative to our total drug-eluting stent revenue and maintain our overall profitability as a percentage of revenue.

 

Litigation and Regulatory Compliance

 

·

Any conditions imposed in resolving, or any inability to resolve, our outstanding warning letters or other FDA matters, as well as risks generally associated with our regulatory compliance quality systems and complaint handling;

·	The effect of our litigation, risk management practices, including self-insurance, and compliance activities on our loss contingency, legal provision and cash flow;

·

The impact of our stockholder derivative and class action, patent, product liability, contract and other litigation and other legal proceedings;

·

The ongoing, inherent risk of potential physician communications or field actions related to medical devices;

·	Costs associated with our incremental compliance and quality initiatives, including Project Horizon; and

·	The availability and rate of third-party reimbursement for our products and procedures.

 

Innovation

 

·

Our ability to complete planned clinical trials successfully, to obtain regulatory approvals and to develop and launch products on a timely basis within cost estimates, including the successful completion of in-process projects from purchased research and development;

·

Our ability to manage research and development and other operating expenses consistent with our expected revenue growth;

·

Our ability to fund and achieve benefits from our focus on internal research and development and external alliances as well as our ability to capitalize on opportunities across our businesses;

·

Our ability to develop products and technologies successfully in addition to our drug-eluting stent and cardiac rhythm management technologies;

·

Our failure to succeed at, or our decision to discontinue, any of our growth initiatives;

·

Our ability to integrate the acquisitions and other strategic alliances we have consummated, including Guidant;

·

Our decision to exercise, or not to exercise, options to purchase certain companies party to our strategic alliances and our ability to fund with cash or common stock these and other acquisitions, or to fund contingent payments associated with these alliances;

·

The timing, size and nature of strategic initiatives, market opportunities and research and development platforms available to us and the ultimate cost and success of these initiatives; and

·

Our ability to successfully identify, develop and market new products or the ability of others to develop products or technologies that render our products or technologies noncompetitive or obsolete.

 

International Markets

 

·

Dependency on international net sales to achieve growth;

·

Risks associated with international operations, including compliance with local legal and regulatory requirements as well as reimbursement practices and policies; and

 

·

The potential effect of foreign currency fluctuations and interest rate fluctuations on our net sales, expenses and resulting margins.

 

Liquidity

 

·

Our ability to generate sufficient cash flow to fund operations and capital expenditures, as well as our strategic investments over the next twelve months and to maintain borrowing flexibility beyond the next twelve months;

·

Our ability to access the public capital markets and to issue debt or equity securities on terms reasonably acceptable to us;

·

Our ability to achieve a 21 percent effective tax rate, excluding certain charges, during 2007 and to recover substantially all of our deferred tax assets;

·	Our ability to maintain investment-grade credit ratings and satisfy our financial covenants;

·	Our ability to generate sufficient cash flow to effectively manage our debt levels and minimize the impact of interest rate fluctuations on our floating-rate debt; and

·

Our ability to better align expenses with future expected revenue levels and reallocate resources to support our future growth.

 

Other

 

·

Risks associated with significant changes made or to be made to our organizational structure or to the membership of our executive committee; and

·

Risks associated with our acquisition of Guidant Corporation, including, among other things, the indebtedness we have incurred and the integration costs and challenges we will continue to face.

 

Several important factors, in addition to the specific factors discussed in connection with each forward-looking statement individually and the risk factors described in Item 1A under the heading “Risk Factors,” could affect our future results and growth rates and could cause those results and rates to differ materially from those expressed in the forward-looking statements and the risk factors contained in this report. These additional factors include, among other things, future economic, competitive, reimbursement and regulatory conditions, new product introductions, demographic trends, intellectual property, financial market conditions and future business decisions made by us and our competitors, all of which are difficult or impossible to predict accurately and many of which are beyond our control. Therefore, we wish to caution each reader of this report to consider carefully these factors as well as the specific factors discussed with each forward-looking statement and risk factor in this report and as disclosed in our filings with the SEC. These factors, in some cases, have affected and in the future (together with other factors) could affect our ability to implement our business strategy and may cause actual results to differ materially from those contemplated by the statements expressed in this report.

 

ITEM 1A. RISK FACTORS

 

In addition to the other information contained in this Form 10-K and the exhibits hereto, the following risk factors should be considered carefully in evaluating our business. Our business, financial condition or results of operations could be materially adversely affected by any of these risks. This section contains forward-looking statements. You should refer to the explanation of the qualifications and limitations on forward-looking statements set forth at the end of Item 1 of this Form 10-K. Additional risks not presently known to us or that we currently deem immaterial may also adversely affect our business, financial condition or results of operations.

 

Drug-eluting coronary stent revenues represented approximately 30 percent of our consolidated net sales during the fiscal year ended December 31, 2006. Our U.S. TAXUS sales declined in 2006 relative to 2005, due in part to a decline in the U.S. market size attributable to recent uncertainty regarding the risk of late stent thrombosis following the use of drug-eluting stents. Late stent thrombosis is the formation of a clot, or thrombus, within the stented area one year or more after implantation of the stent. In the fourth quarter of 2006, the FDA held a special ad visory panel meeting to discuss drug-eluting stents. If concerns about the risk of late stent thrombosis persist, there can be no assurance that the market will return to previous levels.  

In addition, lower device utilization per procedure and a decline in the overall percutaneous coronary intervention market contributed to the decline in our TAXUS stent system sales in 2006. There can be no assurance that these concerns will be alleviated in the near term or that drug-eluting stent penetration rates will return to previous levels. Our TAXUS® coronary stent system and Johnson & Johnson’s CYPHER® drug-eluting stent system are currently the only two drug-eluting stents available in the U.S. market. We expect our share of the drug-eluting stent market, as well as unit prices, to continue to be adversely affected as additional significant competitors enter the drug-eluting stent market, which began during the third quarter of 2005 internationally and is expected to continue to occur as early as the second half of 2007 in the U.S. In July 2005, Medtronic, Inc. received approval from European regulators to begin commercial sales of its Endeavor® drug-eluting stent system in the European market. As a result of Abbott’s acquisition of Guidant’s drug-eluting stent portfolio, Abbott sells its XIENCE™ V everolimus-eluting stent system in competition with us in certain international markets. In addition, Conor Medsystems, Inc., which was recently acquired by Johnson & Johnson, sells its CoStar® paclitaxel-eluting stent system in competition with us in certain international markets.

 

The manufacture of our TAXUS® coronary stent system involves the integration of multiple technologies, critical components, raw materials and complex processes. Significant favorable or unfavorable changes in forecasted demand, as well as disruptions associated with our TAXUS® stent manufacturing process, may impact our inventory levels. Variability in expected demand or the timing of the launch of next-generation products may result in excess or expired inventory positions and future inventory charges, which may adversely impact our results from operations. We share with Abbott rights to Guidant’s XIENCE™ V everolimus-eluting stent program. As a result, delays in receipt of regulatory approvals for the XIENCE™ V everolimus-eluting stent system, receipt of insufficient quantities of the PROMUS everolimus-eluting stent from Abbott or material nonacceptance of these stents in the marketplace could adversely affect our results from operations, as well as our ability to effectively differentiate ourselves from our competitors in the drug-eluting stent market as the leading company with two drug-eluting stent programs.

 

The worldwide CRM market growth rates declined during 2006 and if the CRM market does not recover, our results of operation and financial condition may be adversely impacted.

 

During 2005 and 2006, the operating and financial performance of our CRM business has been adversely impacted by various implantable defibrillator and pacemaker system field actions in the industry and a corresponding reduction in CRM market growth rates. We believe that field actions in the industry contributed to our CRM division having a lower market share for implantable defibrillator and pacemaker systems for 2006 as compared to 2005. The worldwide CRM market growth rate, including the U.S. defibrillator market growth rate, declined during the first three quarters of 2006; these growth levels are below those experienced in recent years. The U.S. defibrillator market represents approximately half of the worldwide CRM market. There can be no assurance that the CRM market will return to its historical growth rate

 

or that we will be able to regain CRM market share or increase net sales in a timely manner, if at all.

 

 

We may be unable to resolve issues related to our warning letters in a timely manner, which could delay the production and sale of our products and have an adverse impact on our business, financial condition and results of operation.

 

We are currently taking remedial action in response to certain deficiencies of our quality systems as cited by the FDA in its warning letters to us. For example, on January 26, 2006, we received a corporate warning letter from the FDA notifying us of serious regulatory problems at three of our facilities and advising us that our corrective action plan relating to three site-specific warning letters issued to us in 2005 was inadequate. As stated in this FDA warning letter, the FDA may not grant our requests for exportation certificates to foreign governments or approve pre-market approval (PMA) applications for our class III devices to which the quality control or current good manufacturing practices deficiencies described in the letter are reasonably related until the deficiencies have been corrected. If we are unable to resolve the issues raised by the FDA in its warning letters to the satisfaction of the FDA on a timely basis, we may not be able to launch our new class III devices as planned, including our Taxus® Liberté™ drug-eluting stent system in the United States, which may weaken our competitive position in the markets in which we participate.

 

In addition, in December 2005, Guidant received an FDA warning letter citing certain deficiencies with respect to its manufacturing quality systems and record keeping procedures in its CRM facility in St. Paul, Minnesota. This FDA warning letter followed an inspection by the FDA that was completed on September 1, 2005 and cited a number of observations. Guidant received a follow-up letter from the FDA dated January 5, 2006. As stated in this follow-up letter, until the identified deficiencies have been corrected, the FDA may not grant requests for exportation certificates to foreign governments or approve PMA applications for class III devices to which the deficiencies described are reasonably related. The FDA conducted a further inspection of the CRM facility between December 15, 2005 and February 9, 2006 and made one additional inspectional observation. The FDA has concluded its reinspection of our CRM facilities. We may be required to take additional actions in order to comply with any FDA observations that we may receive.

 

We may face enforcement actions in connection with these FDA warning letters, including injunctive relief, consent decrees or civil fines. While we are working with the FDA to resolve these issues, this work has required and will continue to require the dedication of significant incremental internal and external resources and has resulted in adjustments to the product launch schedules of certain products and the decision to discontinue certain other product lines over time. There can be no assurances regarding the length of time or cost it will take us to resolve these issues to the satisfaction of the FDA. In addition, if our remedial actions are not satisfactory to the FDA, we may have to devote additional financial and human resources to our efforts and the FDA may take further regulatory actions against us including, but not limited to, seizing our product inventory, obtaining a court injunction against further marketing of our products, assessing civil monetary penalties or imposing a consent decree on us, which could result in further regulatory constraints, including the governance of our quality system by a third party. If we or our manufacturers fail to adhere to QSR or ISO requirements, this could delay production of our products and lead to fines, difficulties in obtaining regulatory clearances, recalls or other consequences, which could in turn have a material adverse effect on our financial condition or results of operations.

 

We are subject to extensive medical device regulation which may impede or hinder the approval process for our products and, in some cases, may not ultimately result in approval or may result in the recall or seizure of previously approved products.

 

Our products, development activities and manufacturing processes are subject to extensive and rigorous regulation by the FDA pursuant to the federal Food, Drug, and Cosmetic Act (the FDC Act), by comparable agencies in foreign countries, and by other regulatory agencies and governing bodies. Under the FDC Act, medical devices must receive FDA clearance or approval before they can be commercially marketed in the U.S. In addition, most major markets for medical devices outside the U.S. require clearance, approval or compliance with certain standards before a product can be commercially marketed. The process of obtaining marketing approval or clearance from the FDA for new products, or with respect to enhancements or modifications to existing products, could:

 

• take a significant period of time;

• require the expenditure of substantial resources;

• involve rigorous pre-clinical and clinical testing;

• require changes to the products; and

• result in limitations on the indicated uses of the products.

Countries around the world have recently adopted more stringent regulatory requirements that are expected to add to the delays and uncertainties associated with new product releases, as well as the clinical and regulatory costs of supporting those releases. Even after products have received marketing approval or clearance, product approvals and clearances by the FDA can be withdrawn due to failure to comply with regulatory standards or the occurrence of unforeseen problems following initial approval. There can be no assurance that we will receive the required clearances from the FDA for new products or modifications to existing products on a timely basis or that any FDA approval will not be subsequently withdrawn.

In addition, regulations regarding the development, manufacture and sale of medical devices are subject to future change. We cannot predict what impact, if any, those changes might have on our business. Failure to comply with regulatory requirements could have a material adverse effect on our business, financial condition and results of operations. Later discovery of previously unknown problems with a product or manufacturer could result in fines, delays or suspensions of regulatory clearances, seizures or recalls of products, operating restrictions and/or criminal prosecution. The failure to receive product approval clearance on a timely basis, suspensions of regulatory clearances, seizures or recalls of products or the withdrawal of product approval by the FDA could have a material adverse effect on our business, financial condition or results of operations.

 

We may not meet regulatory quality standards applicable to our manufacturing and quality processes, which could have an adverse effect on our business, financial condition or results of operations.

 

As a device manufacturer, we are required to register with the FDA and are subject to periodic inspection by the FDA for compliance with the FDA’s Quality System Regulation (QSR) requirements, which require manufacturers of medical devices to adhere to certain regulations, including testing, quality control and documentation procedures. In addition, the federal Medical Device Reporting regulations require us to provide information to the FDA whenever there is evidence that reasonably suggests that a device may have caused or contributed to a death or serious injury or, if a malfunction were to occur, could cause or contribute to a death or serious injury. Compliance with applicable regulatory requirements is subject to continual review and is

 

rigorously monitored through periodic inspections by the FDA. In the European Community, we are required to maintain certain ISO certifications in order to sell our products and must undergo periodic inspections by notified bodies to obtain and maintain these certifications.

 

Pending and future intellectual property litigation could be costly and disruptive to us.

 

We operate in an industry that is susceptible to significant intellectual property litigation and, in recent years, it has been common for companies in the medical device field to aggressively challenge the patent rights of other companies in order to prevent the marketing of new devices. We are currently the subject of various patent litigation proceedings and other proceedings described in more detail under Item 3. Legal Proceedings. Intellectual property litigation is expensive, complex and lengthy and its outcome is difficult to predict. Pending or future patent litigation may result in significant royalty or other payments or injunctions that can prevent the sale of products and may significantly divert the attention of our technical and management personnel. In the event that our right to market any of our products is successfully challenged, and if we fail to obtain a required license or are unable to design around a patent, our business, financial condition or results of operations could be materially adversely affected.

 

We may not effectively be able to protect our intellectual property rights which could have an adverse effect on our business, financial condition or results of operations.

 

The medical device market in which we primarily participate is in large part technology driven. Physician customers, particularly in interventional cardiology, move quickly to new products and new technologies. As a result, intellectual property rights, particularly patents and trade secrets, play a significant role in product development and differentiation. However, intellectual property litigation to defend or create market advantage is inherently complex and unpredictable. Furthermore, appellate courts frequently overturn lower court patent decisions.

 

In addition, competing parties frequently file multiple suits to leverage patent portfolios across product lines, technologies and geographies and to balance risk and exposure between the parties. In some cases, several competitors are parties in the same proceeding, or in a series of related proceedings, or litigate multiple features of a single class of devices. These forces frequently drive settlement not only of individual cases, but also of a series of pending and potentially related and unrelated cases. In addition, although monetary and injunctive relief is typically sought, remedies and restitution are generally not determined until the conclusion of the proceedings and are frequently modified on appeal. Accordingly, the outcomes of individual cases are difficult to time, predict or quantify and are often dependent upon the outcomes of other cases in other geographies.

 

Several third parties have asserted that our current and former stent systems or other products infringe patents owned or licensed by them. Adverse outcomes in one or more of these proceedings against us could limit our ability to sell certain stent products in certain jurisdictions, or reduce our operating margin on the sale of these products. In addition, damage awards related to historical sales could be material. We have similarly asserted that stent systems or other products sold by these companies infringe patents owned or licensed by us.

 

Patents and other proprietary rights are and will be essential to our business, and our ability to compete effectively with other companies will be dependent upon the proprietary nature of our technologies. We rely upon trade secrets, know-how, continuing technological innovations, strategic alliances and licensing opportunities to develop, maintain and strengthen our competitive position. We pursue a policy of generally obtaining patent protection in both the U.S. and abroad for patentable subject matter in our proprietary devices and also attempt to review

 

third-party patents and patent applications to the extent publicly available to develop an effective patent strategy, avoid infringement of third-party patents, identify licensing opportunities and monitor the patent claims of others. We currently own numerous U.S. and foreign patents and have numerous patent applications pending. We also are party to various license agreements pursuant to which patent rights have been obtained or granted in consideration for cash, cross-licensing rights or royalty payments. No assurance can be made that any pending or future patent applications will result in issued patents, that any current or future patents issued to, or licensed by, us will not be challenged or circumvented by our competitors, or that our patents will not be found invalid.

 

In addition, we may have to take legal action in the future to protect our patents, trade secrets or know-how or to assert them against claimed infringement by others. Any legal action of that type could be costly and time consuming to us and no assurances can be made that any lawsuit will be successful. We are generally involved as both a plaintiff and a defendant in a number of patent infringement and other intellectual property-related actions. We are involved in numerous patent-related claims with our competitors, including Johnson & Johnson.

 

The invalidation of key patents or proprietary rights that we own, or an unsuccessful outcome in lawsuits to protect our intellectual property, could have a material adverse effect on our business, financial position or results of operations.

 

Pending and future product liability claims and other litigation, including private securities litigation, shareholder derivative suits and contract litigation, may adversely affect our business, reputation and ability to attract and retain customers.

 

The design, manufacture and marketing of medical devices of the types that we produce entail an inherent risk of product liability claims. Many of the medical devices that we manufacture and sell are designed to be implanted in the human body for long periods of time or indefinitely. A number of factors could result in an unsafe condition or injury to, or death of, a patient with respect to these or other products that we manufacture or sell, including component failures, manufacturing flaws, design defects or inadequate disclosure of product-related risks or product-related information. These factors could result in product liability claims, a recall of one or more of our products or a safety alert relating to one or more of our products. Product liability claims may be brought by individuals or by groups seeking to represent a class.

 

We are currently the subject of numerous product liability claims and other litigation, including private securities litigation and shareholder derivative suits including, but not limited to, the claims and litigation described under Item 3. Legal Proceedings . In connection with our acquisition of Guidant, the number of product liability claims and other legal proceedings filed against us, including private securities litigation and shareholder derivative suits, significantly increased. We are currently involved in litigation involving a contract dispute with certain former shareholders of Advanced Bionics Corporation, one of our subsidiaries. The outcome of this litigation could prevent us from operating the Advanced Bionics business in the manner that we expected at the time of acquisition.

 

The outcome of litigation, particularly class action lawsuits, is difficult to assess or quantify. Plaintiffs in these types of lawsuits often seek recovery of very large or indeterminate amounts, including not only actual damages, but also punitive damages. The magnitude of the potential loss relating to these lawsuits may remain unknown for substantial periods of time. In addition, the cost to defend against any future litigation may be significant. Further, we are substantially self-insured with respect to general, product liability claims and securities litigation. As a result of economic factors currently impacting the insurance industry, meaningful product liability and

 

securities litigation insurance coverage has become unavailable due to its economically prohibitive cost. The absence of significant third-party insurance coverage increases our potential exposure to unanticipated claims and adverse decisions. Product liability claims, product recalls, securities litigation and other litigation in the future, regardless of their outcome, could have a material adverse effect on our financial position, results of operations or liquidity.

 

We may not be successful in our strategic acquisitions of, investments in or alliances with, other companies and businesses, which have been a significant source of historical growth for us.

 

Our strategic acquisitions, investments and alliances are intended to further expand our ability to offer customers effective, high quality medical devices that satisfy their interventional needs. Many of these alliances involve equity investments and often give us the option to acquire the other company or assets of the other company in the future. If we are unsuccessful in our acquisitions, investments and alliances, we may be unable to continue to grow our business significantly or may record asset impairment charges in the future. These acquisitions, investments and alliances have been significant sources of growth for us. The success of any acquisition, investment or alliance that we may undertake will depend on a number of factors, including:

 

•   our ability to identify suitable opportunities for acquisition, investment or alliance, if at all;

•   our ability to finance any future acquisition, investment or alliance on terms acceptable to us, if at all;

•   whether we are able to establish an acquisition, investment or alliance on terms that are satisfactory to us, if at all;

•   the strength of the other companies’ underlying technology and ability to execute;

•    intellectual property and litigation related to these technologies; and

•   our ability to successfully integrate the acquired company or business with our existing business, including the ability to adequately fund acquired in-process research and development projects.

 

If we are unsuccessful in our acquisitions, investments and alliances, we may be unable to continue to grow our business significantly or may record asset impairment charges in the future.

 

We incurred substantial indebtedness in connection with our acquisition of Guidant and if we are unable to manage our debt levels and maintain our investment-grade credit ratings, it could have an adverse effect on our financial condition or results of operations.

 

We had outstanding borrowings of $8.9 billion at December 31, 2006, attributable in large part to our acquisition of Guidant. We will be required to use a significant portion of our operating cash flow to reduce our outstanding debt obligations over the next several years. We are examining all of our operations in order to identify cost improvement measures that will better align operating expenses with expected revenue levels and cash flow, and may decide to sell certain non-strategic assets or implement other strategic initiatives to generate proceeds that would be available for debt repayment. Certain of our debt agreements contain financial covenants that require us to maintain specified financial ratios. If we are unable to maintain these ratios, we may be required to obtain waivers from our lenders and no assurance can be made that our lenders

 

would grant such waivers on favorable terms or at all. While our credit ratings are currently investment grade, our Moody’s and S&P ratings outlooks are currently negative. Our inability to maintain our investment grade credit ratings could make it more expensive for us to borrow funds or issue debt securities in the public capital markets on terms reasonably acceptable to us.

 

Our future growth is dependent upon the development of new products, which requires significant research and development, clinical trials and regulatory approvals, all of which are very expensive and time-consuming and may not result in a commercially viable product.

 

In order to develop new products and improve current product offerings, we focus our research and development programs largely on the development of next-generation and novel technology offerings across multiple programs and divisions, particularly in our drug-eluting stent and CRM programs. We expect to launch our TAXUS® Liberté™ coronary stent system in the U.S., subject to regulatory approval. In addition, we expect to continue to invest in our CRM technologies, including our LATITUDE® Patient Management System and the Frontier ™ CRM technology. If we are unable to develop and launch these and other products as anticipated, our ability to maintain or expand our market position in the drug-eluting stent and CRM markets may be adversely impacted.

 

Further, we expect to invest selectively in areas outside of drug-eluting stent and CRM technologies. There can be no assurance that these or other technologies will achieve technological feasibility, obtain regulatory approval or gain market acceptance. A delay in the development or approval of these technologies or our decision to reduce funding of these projects may adversely impact the contribution of these technologies to our future growth.

 

As a part of the regulatory process of obtaining marketing clearance from the FDA for new products, we conduct and participate in numerous clinical trials with a variety of study designs, patient populations and trial endpoints. Unfavorable or inconsistent clinical data from existing or future clinical trials conducted by us, by our competitors or by third parties, or the market’s perception of this clinical data, may adversely impact our ability to obtain product approvals from the FDA, our position in, and share of, the markets in which we participate and our business, financial condition, results of operations or future prospects.

 

We face intense competition and may not be able to keep pace with the rapid technological changes in the medical devices industry, which could have an adverse effect on our business, financial condition or results of operations.

 

The medical device market is highly competitive. We encounter significant competition across our product lines and in each market in which our products are sold from various medical device companies, some of which may have greater financial and marketing resources than we do. Our primary competitors have historically included Johnson & Johnson (including its subsidiary, Cordis Corporation) and Medtronic, Inc. (including its subsidiary, Medtronic AVE, Inc.). Through our acquisition of Guidant, Abbott has become a primary competitor of ours in the interventional cardiology market and St. Jude Medical, Inc. has become a competitor of ours in the CRM market and in the Neuromodulation market. In addition, we face competition from a wide range of companies that sell a single or a limited number of competitive products or which participate only in a specific market segment, as well as from non-medical device companies, including pharmaceutical companies, which may offer alternative therapies for disease states intended to be treated using our products.

 

Additionally, the medical device market is characterized by extensive research and development, and rapid technological change. Developments by other companies of new or improved products,

 

processes or technologies, in particular in the drug-eluting stent and CRM markets, may make our products or proposed products obsolete or less competitive and may negatively impact our revenues. We are required to devote continued efforts and financial resources to develop or acquire scientifically advanced technologies and products, apply our technologies cost-effectively across product lines and markets, attract and retain skilled development personnel, obtain patent and other protection for our technologies and products, obtain required regulatory and reimbursement approvals and successfully manufacture and market our products consistent with our quality standards. If we fail to develop new products or enhance existing products, it could have a material adverse effect on our business, financial condition or results of operations.

 

Because we derive a significant amount of our revenues from international operations and a significant percentage of our future growth is expected to come from international operations, changes in international economic or regulatory conditions could have a material impact on our business, financial condition or results of operations.

 

Sales outside the U.S. accounted for approximately 38 percent of our net sales in 2006. Additionally, a significant percentage of our future growth is expected to come from international operations. As a result, our sales growth and profitability from our international operations may be limited by risks and uncertainties related to economic conditions in these regions, foreign currency fluctuations, exchange rate fluctuations, regulatory and reimbursement approvals, competitive offerings, infrastructure development, rights to intellectual property and our ability to implement our overall business strategy. Further, international markets are also being affected by economic pressure to contain reimbursement levels and healthcare costs. The trend in countries around the world, including Japan, toward more stringent regulatory requirements for product clearance, changing reimbursement models and more rigorous inspection and enforcement activities has generally caused or may cause medical device manufacturers to experience more uncertainty, delay, risk and expense. In addition, we are required to renew regulatory approvals and obtain exportation certificates to foreign governments in order to market our products in certain international jurisdictions, which may require additional testing and documentation. These approvals and certificates have been impacted by the FDA warning letters we have received. If sufficient resources are not available to renew these approvals or these approvals are not timely renewed, our ability to market our full line of existing products within these jurisdictions may be limited. Any significant changes in the competitive, political, legal, regulatory, reimbursement or economic environment where we conduct international operations may have a material impact on our business, financial condition or results of operations.

 

Healthcare cost containment pressures and legislative or administrative reforms resulting in restrictive reimbursement practices of third-party payors or preferences for alternate therapies could decrease the demand for our products, the prices which customers are willing to pay for those products and the number of procedures performed using our devices, which could have an adverse effect on our business, financial condition or results of operations.

 

Our products are purchased principally by hospitals or physicians, which typically bill various third-party payors, including governmental programs (e.g., Medicare and Medicaid), private insurance plans and managed care plans, for the healthcare services provided to their patients. The ability of customers to obtain appropriate reimbursement for their products and services from private and governmental third-party payors is critical to the success of medical technology companies. The availability of reimbursement affects which products customers purchase and the prices they are willing to pay. Reimbursement varies from country to country and can significantly impact the acceptance of new products and services. After we develop a promising new product, we may find limited demand for the product unless reimbursement approval is obtained from private and governmental third-party payors. Further legislative or administrative

 

reforms to the U.S. or international reimbursement systems in a manner that significantly reduces reimbursement for procedures using our medical devices or denies coverage for those procedures could have a material adverse effect on our business, financial condition or results of operations.

 

Major third-party payors for hospital services in the U.S. and abroad continue to work to contain healthcare costs. The introduction of cost containment incentives, combined with closer scrutiny of healthcare expenditures by both private health insurers and employers, has resulted in increased discounts and contractual adjustments to hospital charges for services performed and has shifted services between inpatient and outpatient settings. Initiatives to limit the increase of healthcare costs, including price regulation, are also underway in several countries in which we do business. Hospitals or physicians may respond to these cost-containment pressures by substituting lower cost products or other therapies for our products. In light of the Guidant product recalls, third-party payors may seek claims and further recourse against us for the recalled defibrillator and pacemaker systems for which Guidant had previously received reimbursement.

 

Consolidation in the healthcare industry could lead to demands for price concessions or the exclusion of some suppliers from certain of our significant market segments, which could have an adverse effect on our business, financial condition or results of operations.

 

The cost of healthcare has risen significantly over the past decade and numerous initiatives and reforms initiated by legislators, regulators and third-party payors to curb these costs have resulted in a consolidation trend in the healthcare industry, including hospitals. This in turn has resulted in greater pricing pressures and the exclusion of certain suppliers from important market segments as group purchasing organizations, independent delivery networks and large single accounts continue to consolidate purchasing decisions for some of our hospital customers. We expect that market demand, government regulation, third-party reimbursement policies and societal pressures will continue to change the worldwide healthcare industry, resulting in further business consolidations and alliances among our customers and competitors, which may reduce competition, exert further downward pressure on the prices of our products and may adversely impact our business, financial condition or results of operations.

 

We rely on external manufacturers to supply us with materials and components used in our products and any disruption of such sources of supply could adversely impact our production efforts.

 

We vertically integrate operations where integration provides significant cost, supply or quality benefits. However, we purchase many of the materials and components used in manufacturing our products, some of which are custom made. Certain supplies are purchased from single-sources due to quality considerations, costs or constraints resulting from regulatory requirements. We may not be able to establish additional or replacement suppliers for certain components or materials in a timely manner largely due to the complex nature of our and many of our suppliers’ manufacturing processes. Production issues, including capacity constraint; quality issues affecting us or our suppliers; an inability to develop and validate alternative sources if required; or a significant increase in the price of materials or components could adversely affect our operations and financial condition.

 

ITEM 1B. UNRESOLVED STAFF COMMENTS

 

There are no material unresolved written comments that were received from the SEC staff 180 days or more before the end of our fiscal year relating to our periodic or current reports under the Securities Exchange Act of 1934.