Boston Scientific Corporation is an American medical device manufacturer. The company offers solutions for the following medical specialties: electrophysiology, gastroenterology, vascular surgery, gynecology, interventional cardiology, interventional radiology, female pelvic medicine, neurological surgery, orthopedic surgery, pulmology, pain medicine, structural heart, urology.
SECURITIES AND EXCHANGE COMMISSION Washington, D.C. 20549 ------------------- FORM 10-Q /x/ QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES ACT OF 1934 For the quarterly period ended: June 30, 1997 Commission file number: 1-11083 BOSTON SCIENTIFIC CORPORATION ------------------------------------------------------ (Exact name of registrant as specified in its charter) DELAWARE 04-2695240 --------------------------------- ------------------- (State or other jurisdiction (I.R.S. Employer of incorporation or organization) Identification No.) One Boston Scientific Place, Natick, Massachusetts 01760-1537 - -------------------------------------------------- ---------- (Address of principal executive offices) (Zip Code) Registrant's telephone number, including area code: (508) 650-8000 -------------- - ------------------------------------------------------------------------------- Former name, former address and former fiscal year, if changed since last report. Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes X No --- --- Indicate the number of shares outstanding of each of the issuer's classes of common stock, as of the last practicable date. Shares Outstanding Class as of June 30, 1997 ----- ------------------- Common Stock, $.01 Par Value 194,157,387 - ------------------------------------------------------------------------------- Part I Financial Information Item 1. Financial Statements BOSTON SCIENTIFIC CORPORATION AND SUBSIDIARIES Condensed Consolidated Balance Sheets (Unaudited) <TABLE> <CAPTION> June 30, December 31, In thousands, except share and per share data 1997 1996 - ------------------------------------------------------------------------------------------------ <S> <C> <C> Assets Current assets: Cash and cash equivalents $ 54,141 $ 72,175 Short-term investments 32,178 45,606 Trade accounts receivable, net 361,876 321,025 Inventories 306,558 236,670 Deferred income taxes 97,865 97,364 Prepaid expenses and other current assets 56,586 43,977 ------------------------- Total current assets 909,204 816,817 Property, plant, equipment and leaseholds 608,014 529,933 Less: accumulated depreciation and amortization 186,311 167,631 ------------------------- 421,703 362,302 Intangibles, net 320,104 319,762 Investments and other assets 91,041 86,164 ------------------------- $1,742,052 $1,585,045 ========================= Liabilities and Stockholders' Equity Current liabilities: Borrowings due within one year $ 350,265 $ 240,556 Accounts payable and accrued expenses 210,537 163,784 Income taxes payable 27,403 Accrual related to special charges 107,781 48,144 Other current liabilities 4,892 1,929 ------------------------- Total current liabilities 673,475 481,816 Accrual related to special charges 10,166 Deferred income taxes 59,975 59,975 Other long-term liabilities 48,829 48,139 Stockholders' equity: Preferred stock, $ .01 par value - authorized 25,000,000 shares, none issued and outstanding Common stock, $ .01 par value - authorized 300,000,000 shares, 195,611,491 shares issued at June 30, 1997 and at December 31, 1996 1,956 1,956 Additional paid-in capital 451,129 437,074 Contingent stock repurchase obligation 7,095 24,855 Retained earnings 622,591 574,051 Foreign currency translation adjustment (73,747) (37,964) Unrealized gain on available-for-sale securities, net 16,411 18,886 Treasury stock, at cost -1,454,104 shares at June 30, 1997 and 643,991 shares at December 31, 1996 (75,828) (23,743) ------------------------- Total stockholders' equity 949,607 995,115 ------------------------- $1,742,052 $1,585,045 ========================= </TABLE> See notes to unaudited condensed consolidated financial statements. BOSTON SCIENTIFIC CORPORATION AND SUBSIDIARIES Condensed Consolidated Statements of Operations (Unaudited) <TABLE> <CAPTION> Three months ended Six months ended June 30, June 30, In thousands, except per share data 1997 1996 1997 1996 - ------------------------------------------------------------------------------------------------- <S> <C> <C> <C> <C> Net sales $473,749 $379,237 $904,280 $722,790 Cost of products sold 131,455 101,386 252,512 193,341 --------------------------------------------- Gross profit 342,294 277,851 651,768 529,449 Selling, general and administrative expenses 157,031 124,102 308,994 234,321 Royalties 5,388 4,293 11,286 8,680 Research and development expenses 41,006 33,822 79,704 63,431 Special charges 157,841 73,666 157,841 142,341 --------------------------------------------- 361,266 235,883 557,825 448,773 --------------------------------------------- Operating income (loss) (18,972) 41,968 93,943 80,676 Other income (expense): Interest and dividend income 956 1,457 1,994 3,835 Interest expense (3,353) (3,213) (6,651) (4,794) Other, net (1,686) (1,148) 251 (3,223) --------------------------------------------- Income (loss) before income taxes (23,055) 39,064 89,537 76,494 Income taxes 3,841 25,975 40,997 61,215 --------------------------------------------- Net income (loss) $(26,896) $ 13,089 $ 48,540 $ 15,279 ============================================= Net income (loss) per common share $ (0.14) $ 0.07 $ 0.25 $ 0.08 ============================================= Primary weighted average number of common shares 194,702 199,490 197,694 199,373 ============================================= </TABLE> See notes to unaudited condensed consolidated financial statements. BOSTON SCIENTIFIC CORPORATION AND SUBSIDIARIES Condensed Consolidated Statement of Stockholder's Equity (Unaudited) <TABLE> <CAPTION> Six Months Ended June 30, 1997 ------------------------------------------------------------------------------------------------- Unrealized Gain on Contingent Foreign Available- Common Stock Additional Stock Currency for-Sale ----------------------- Paid-In Repurchase Retained Translation Securities, Treasury Shares Issued Par Value Capital Obligation Earnings Adjustment Net Stock Total ------------------------------------------------------------------------------------------------- (In thousands, except share data) <S> <C> <C> <C> <C> <C> <C> <C> <C> <C> Balance at December 31, 1996 195,611,491 $1,956 $437,074 $ 24,855 $574,051 $(37,964) $18,886 $(23,743) $995,115 Net income 48,540 48,540 Foreign currency translation adjustment (35,783) (35,783) Issuance of common stock under options, warrant and stock purchase plans (12,486) 29,373 16,887 Purchase of common stock for treasury (82,014) (82,014) Sale of stock repurchase obligation (7,095) 7,095 556 556 Expiration of stock repurchase obligation 24,855 (24,855) Tax benefit relating to stock option and employee stock purchase plans 8,781 8,781 Net change in equity investments (2,475) (2,475) ------------------------------------------------------------------------------------------------ Balance at June 30, 1997 195,611,491 $1,956 $451,129 $ 7,095 $622,591 $(73,747) $16,411 $(75,828) $949,607 ================================================================================================ </TABLE> See notes to unaudited condensed consolidated financial statements. BOSTON SCIENTIFIC CORPORATION AND SUBSIDIARIES Condensed Consolidated Statements of Cash Flows (Unaudited) <TABLE> <CAPTION> Six Months Ended June 30, In thousands 1997 1996 - --------------------------------------------------------------------------------------- <S> <C> <C> Cash provided by operating activities $ 67,863 $ 26,709 Investing activities: Purchases of property, plant, and equipment, net (109,583) (50,755) Acquisition of businesses, net of cash acquired (241,493) Net maturities of held-to-maturity short-term investments 18,232 18,400 Net purchases of available-for-sale securities (4,399) (4,424) Payments for acquisitions of and/or investments in certain technologies (23,700) (3,229) Other (13,119) (3,074) ---------------------- Cash used in investing activities (132,569) (284,575) Financing activities: Net increase in commercial paper 93,950 235,000 Net proceeds (payments) on notes payable and capital leases 12,020 (28,696) Proceeds from issuances of shares of common stock, net of tax benefits 25,668 36,823 Acquisition of treasury stock, net of proceeds from put options (81,458) (58,543) Other 25 737 ---------------------- Cash provided by financing activities 50,205 185,321 Effect of foreign exchange rates on cash (3,533) (1,118) ---------------------- Net decrease in cash and cash equivalents (18,034) (73,663) Cash and cash equivalents at beginning of period 72,175 134,831 ---------------------- Cash and cash equivalents at end of period $ 54,141 $ 61,168 ====================== </TABLE> See notes to unaudited condensed consolidated financial statements. Notes to Condensed Consolidated Financial Statements (Unaudited) June 30, 1997 Note A - Basis of Presentation The accompanying unaudited condensed consolidated financial statements have been prepared in accordance with generally accepted accounting principles for interim financial information and with the instructions to Form 10-Q and Article 10 of Regulation S-X. Accordingly, they do not include all of the information and footnotes required by generally accepted accounting principles for complete financial statements. In the opinion of management, all adjustments (consisting only of normal recurring accruals) considered necessary for a fair presentation have been included. Operating results for the three and six-month periods ended June 30, 1997 are not necessarily indicative of the results that may be expected for the year ending December 31, 1997. For further information, refer to the consolidated financial statements and footnotes thereto incorporated by reference in Boston Scientific Corporation's Annual Report on Form 10-K for the year ended December 31, 1996. Certain prior year's amounts have been reclassified to conform to the current year presentation. Note B - Acquisitions On April 8, 1997, the Company completed its merger with Target Therapeutics, Inc. (Target) in a tax-free stock-for-stock transaction accounted for as a pooling-of-interests. As a result, the unaudited condensed consolidated financial statements have been restated for all periods presented. In conjunction with this merger, Target's stockholders received 1.07 shares of the Company's common stock in exchange for each share of Target common stock. Approximately 16.5 million shares of common stock were issued in connection with the Target acquisition. Separate results of the combining entities for the six months ended June 30, 1996 are as follows: <TABLE> <CAPTION> Combined Boston Boston (In millions) Scientific Target Scientific - ---------------------------------------------------------------- <S> <C> <C> <C> Net sales $680 $ 43 $ 723 Net income (loss) 23 (8) 15 </TABLE> Target's net sales and net income for the three months ended March 31, 1997 were approximately $31 million and $2 million, respectively. Note C - Merger-Related Charges and Expenses In the second quarter of 1997, the Company recorded special charges of $158 million ($117 million, net-of-tax). Charges include $12 million for purchased research and development recorded in conjunction with accounting for the Company's additional investment in Medinol Ltd., $16 million in direct transaction costs and $96 million of estimated costs to be incurred in merging the separate operating businesses of Target with subsidiaries of the Company. Estimated costs include those typical in a merging of operations and relate to, among other things, rationalization of facilities, workforce reductions, unwinding of various contractual commitments, asset writedowns and other integration costs. The remaining amounts represent primarily adjustments to merger-related and special charges recorded in 1996 and 1995 based on actual costs incurred or changes in estimates (approximately $15 million) and writedowns of assets in connection with the Company's implementation of a global information system. The special charges are determined based on formal plans approved by the Company's management using the best information available to it at the time. The workforce-related initiatives have involved substantially all of the Company's employee groups. The amounts the Company may ultimately incur may change as the plans are executed. The activity impacting the accrual related to special charges during the first six months of 1997, net of reclassifications made by management in prior years based on available information, is summarized in the following table: <TABLE> <CAPTION> Balance at Charges to Charges Balance at (In millions) December 31, 1996 Operations Utilized June 30, 1997 - ---------------------------------------------------------------------------------------------- <S> <C> <C> <C> <C> Facilities $ 19 $ 6 $ 3 $ 22 Workforce reductions 26 14 14 26 Contractual commitments 8 53 9 52 Asset writedowns 6 24 12 18 Direct transaction and other costs 6 49 18 37 ------------------------------------------------ $ 65 $ 146 $ 56 $ 155 ================================================ </TABLE> Most of the plans are expected to be completed by the end of 1998. Cash outlays to complete the balance of the Company's initiative to integrate the businesses related to all business combinations consummated since 1994 are estimated to be approximately $118 million. The June 30, 1997 balance of the accrual for special charges is classified within the balance sheet as follows: <TABLE> <CAPTION> (In millions) - -------------------------------------------------------------- <S> <C> Accrual related to special charges - current $ 108 Property, plant, equipment and leaseholds, net 23 Accrual related to special charges - non-current 10 Inventories 13 Other 1 ----- $ 155 ===== </TABLE> Note D - Credit Arrangements At December 31, 1996, the Company had a $350 million revolving line of credit with a syndicate of U.S. and international banks. In June 1997, the Company increased its maximum worldwide borrowings provided under an amended and restated credit agreement to $500 million with a similar syndicate of banks (the Credit Agreement). Under the Credit Agreement, the Company has the option to borrow amounts at various interest rates, payable quarterly in arrears. The term of the borrowings extends through June 2002; use of the borrowings is unrestricted and the borrowings are unsecured. The Credit Agreement requires the Company to maintain a specific ratio of consolidated funded debt (as defined) to consolidated tangible net worth (as defined) plus consolidated funded debt. At June 30, 1997, the Company did not have any outstanding borrowings under the Credit Agreement. The Company maintains a commercial paper program which is supported by the Company's Credit Agreement; outstanding commercial paper reduces available borrowings under the Credit Agreement. At June 30, 1997, the Company had approximately $306 million in commercial paper outstanding with interest rates ranging from 5.82% to 5.98%. Note E - Inventories The components of inventory consist of the following: <TABLE> <CAPTION> June 30, December 31, (In millions) 1997 1996 - ------------------------------------------------------- <S> <C> <C> Finished goods $ 167 $ 129 Work-in-process 50 45 Raw materials 90 63 --------------------- $ 307 $ 237 ===================== </TABLE> Note F - Stockholders' Equity The Company is authorized to purchase on the open market up to approximately 20 million shares of the Company's common stock. Purchases will be made at prevailing prices as market conditions and cash availability warrant. Stock repurchased under the Company's systematic plan will be used to satisfy the Company's obligations pursuant to its employee benefit and incentive plans. During the second quarter of 1997, the Company repurchased approximately 1.6 million shares of its common stock under its systematic plan at a net cost of $81 million. As part of the stock repurchase program, the Company has been selling European equity put options to an independent broker-dealer. Each option, if exercised, obligates the Company to purchase from the broker-dealer a specified number of shares of the Company's common stock at a predetermined exercise price. The put options are exercisable only on the first anniversary of the date the options were sold. Proceeds are recorded as a reduction to the cost of the Company's treasury stock. During the second quarter of 1997, put options issued in 1996 for 600,000 shares expired. Additionally, the Company sold put options for 129,000 shares during the second quarter and received proceeds of approximately $556,000. The repurchase price relating to put options outstanding at June 30, 1997 is $55 per share. The Company's contingent obligation to repurchase shares upon exercise of the outstanding put options approximated $7 million at June 30, 1997. Note G - Accounting Pronouncement In February 1997, the Financial Accounting Standards Board issued Statement of Financial Accounting Standards No. 128, "Earnings Per Share", which establishes new methods to compute earnings per share. The Company is required to adopt this statement beginning in the fourth quarter of 1997. The adoption of this standard would not have a material impact on the Company's earnings per share. Note H - Commitments and Contingencies Schneider (Europe) AG and Schneider (USA) Inc., subsidiaries of Pfizer, Inc., have alleged that the Company's Synergy(TM) products infringe one of their patents. On May 13, 1994, the Company filed a lawsuit against them in the U.S. District Court for the District of Massachusetts seeking a declaratory judgment that this patent is invalid and that the Company's Synergy products do not infringe the patent. The Schneider companies filed counterclaims against the Company, alleging the Company's willful infringement of the patent and seeking monetary and injunctive relief. The parties have made cross motions for summary judgment on various aspects of the case. The Company ceased marketing its Synergy catheters in August 1996. On May 31, 1994, SCIMED Life Systems, Inc. (SCIMED) filed a suit for patent infringement against Advanced Cardiovascular Systems, Inc. (ACS), alleging willful infringement of two of SCIMED's U.S. patents by ACS's FLOWTRACK- 40(TM) and RX ELIPSE(TM) PTCA catheters. On November 17, 1995, SCIMED filed a suit for patent infringement against ACS, alleging willful infringement of three of SCIMED's U.S. patents by the ACS RX LIFESTREAM(TM) PTCA catheter. Both suits were filed in the U.S. District Court for the Northern District of California seeking monetary and injunctive relief. The cases were sent to consolidated arbitration for a threshold determination of one issue covered by the November 27, 1991 settlement agreement between the parties. On March 14, 1997, the arbitration panel reached a final determination in the consolidated arbitration. Pursuant to this determination, the Company is continuing its action as to the ELIPSE product and has dismissed the actions as to the FLOWTRACK and LIFESTREAM products. On October 10, 1995, ACS filed a suit for patent infringement against SCIMED, alleging willful infringement of four U.S. patents licensed to ACS by SCIMED'S EXPRESS PLUS(TM) and EXPRESS PLUS II(TM) PTCA catheters. Suit was filed in the U.S. District Court for the Northern District of California and seeks monetary and injunctive relief. SCIMED has answered, denying the allegations of the complaint. On March 12, 1996, ACS filed two suits for patent infringement against SCIMED, alleging in one case the willful infringement of a U.S. patent by SCIMED's EXPRESS PLUS, EXPRESS PLUS II and LEAP EXPRESS PLUS PTCA catheters, and in the other case the willful infringement of a U.S. patent by SCIMED's BANDIT(TM) PTCA catheter. The suits were filed in the U.S. District Court for the Northern District of California and seek monetary and injunctive relief. SCIMED has answered, denying the allegations of the complaint. On June 10, 1997, SCIMED filed in the U.S. District Court for the Northern District of California a suit for patent infringement against ACS alleging willful infringement of a SCIMED patent by ACS's COMET(TM) PTCA catheters. SCIMED is seeking monetary and injunctive relief. ACS has moved to dismiss, or in the alternative, to stay the action pending arbitration of a threshold determination covered by the November 27, 1991 settlement agreement between the parties. On December 15, 1995, the Company and SCIMED filed a suit for restraint of trade, unfair competition and conspiracy to monopolize against ACS and the Schneider companies, alleging certain violations of state and federal antitrust laws arising from the improper prosecution, enforcement and cross- licensing of U.S. patents relating to rapid exchange balloon dilatation angioplasty catheters. Suit was filed in the U.S. District Court for the District of Massachusetts and seeks monetary, declaratory and injunctive relief. The defendants have moved for dismissal. On November 9, 1994, Target Therapeutics, Inc. (Target) filed a lawsuit in the U.S. District Court for the Northern District of California alleging that SCIMED's VENTURE(R) and VENTURE II(TM) microcatheters and CORDIS Corporation's (Cordis) TRANSIT(R) and RAPIDTRANSIT(TM) microcatheters infringe a patent assigned to Target. On May 2, 1996, the District Court entered an order granting a preliminary injunction to Target prohibiting SCIMED and CORDIS from marketing or selling the accused products. On July 1, 1996, the Court of Appeals for the Federal Circuit stayed the preliminary injunction pending a decision on SCIMED's appeal of the District Court's order. Upon the recent merger between the Company and Target, the lawsuit has been dismissed as to the Company. Subsequently, the Court of Appeals vacated the preliminary injunction. The lawsuit against Cordis will proceed in the District Court. On October 3, 1995, Cordis Endovascular, Inc. and Cordis filed a suit alleging patent infringement against Target Therapeutics, Inc. (Target) alleging that Target's DASHER(R) guidewires, FASGUIDE(R) catheters and TRACKER(R) and FASTRACKER(R) guide microcatheters infringe three patents owned by Cordis. Target has answered, denying the allegations of the complaint. On April 5, 1995, C.R. Bard, Inc. (Bard) filed a lawsuit in the U.S. District Court for the District of Delaware alleging that certain Company products, including the Company's MaxForce TTS(TM) catheter, infringe a patent assigned to Bard. The lawsuit seeks a declaratory judgment that the Company has infringed the Bard patent, preliminary and permanent injunctions enjoining the manufacture, use or sale of the Max Force TTS catheter or any other infringing product, monetary damages and expenses. After a jury trial in June 1997, the jury returned a verdict finding that the Company infringed the Bard patent and awarded damages to Bard in the amount of $10.8 million. No judgment has been entered pending trial on the Company's claim that the patent was obtained by inequitable conduct. The Company intends to appeal any judgment entered on the jury verdict. On February 28, 1997, C.R. Bard, Inc. (Bard) filed a suit for patent infringement against SCIMED alleging that SCIMED's WAVE(TM) and SURPASS(TM) catheters are infringing a patent assigned to Bard. The suit was filed in the U.S. District Court for the District of New Jersey seeking monetary and injunctive relief. The Company has answered, denying the allegations of the complaint. Trial is scheduled for December 1997. On March 7, 1996, Cook Inc. filed suit in the Regional Court, Munich, Division for Patent Disputes, in Munich, Germany against MinTec, Inc. Minimally Invasive Technologies alleging that the Cragg EndoPro(TM) System I and Stentor(TM) endovascular device infringe a certain Cook patent. Since the purchase of the assets of the Endotech/MinTec companies by the Company, the Company has assumed control of the litigation. The defendant answered, denying the allegations. Hearings were held in January and July 1997. A decision is expected in September 1997. On March 25, 1996, Cordis, a subsidiary of Johnson & Johnson Company, filed a suit for patent infringement against SCIMED, alleging the infringement of five U.S. patents by SCIMED's LEAP(TM) balloon material, used in certain SCIMED catheter products, including SCIMED's BANDIT and EXPRESS PLUS catheters. The suit was filed in the U.S. District Court for the District of Minnesota and seeks monetary and injunctive relief. SCIMED has answered, denying the allegations of the complaint. Trial is scheduled for March 1998. On March 13, 1997, the Company (through its subsidiaries) filed suits in The Netherlands and the United Kingdom, and on March 17, 1997 filed suit in France, seeking a declaration of noninfringement for the Company's LEAP(TM) balloon in relation to a European patent owned by Cordis. On July 18, 1997, Cordis Corporation sued various subsidiaries of the Company in the Netherlands alleging that the Company's Leap (TM) balloon products infringed a different, newly-issued European patent of Cordis. Cordis has requested cross-border relief in the Netherlands, Germany, France, the United Kingdom and Italy. A hearing has been scheduled for November 1997. On March 27, 1997, SCIMED filed suit for patent infringement against Cordis alleging willful infringement of four of SCIMED's U.S. patents by Cordis' TRACKSTAR 14(TM), TRACKSTAR 18(TM), OLYMPIX(TM), POWERGRIP(TM), SLEEK(TM), THOR(TM), TITAN(TM) and VALOR(TM) catheters. The suit was filed in U.S. District Court for the District of Minnesota, Fourth District seeking monetary and injunctive relief. Cordis has answered, denying the allegations of the complaint. On December 13, 1996, the Superior Court of the State of Arizona granted the motion of Impra, Inc. (Impra), to add the Company as an additional defendant in Impra's case against Endomed, Inc. Impra (now a subsidiary of C.R. Bard, Inc.) alleges that Endomed, Inc. misappropriated certain Impra trade secrets and that the Company acted in concert with Endomed to utilize the technology. On the same date, Endomed and the Company were preliminarily enjoined, among other things, from any further use or disclosure of the technology. The Company has answered, denying the allegations of the complaint. On March 13, 1997, the Company (through its subsidiaries) filed suits against Johnson & Johnson (through its subsidiaries) in The Netherlands, United Kingdom and Belgium, and on March 17, 1997 filed suit in France, seeking a declaration of noninfringement for the NIR(TM) stent relative to two European patents licensed to Ethicon, Inc. (Ethicon), a Johnson & Johnson subsidiary, as well as a declaration of invalidity with respect to those patents. On March 18, 1997, the Company (through its subsidiary) filed a similar suit in Germany, but seeking only a declaration of noninfringement for the NIR stent relative to the two patents. On March 20, 21 and 22, 1997, the Company (through its subsidiaries) filed additional suits against Johnson & Johnson (through its subsidiaries) in Sweden, Italy and Spain, respectively, seeking a declaration of noninfringement for the NIR stent relative to one of the European patents licensed to Ethicon and a declaration of invalidity in relation to that patent (in Italy and Spain only). Ethicon and other Johnson & Johnson subsidiaries filed a cross-border suit in The Netherlands on March 17, 1997, alleging that the NIR stent infringes one of the European patents licensed to Ethicon. In this action, they requested relief covering Austria, Belgium, France, Greece, Italy, The Netherlands, Norway, Spain, Sweden, Switzerland and the United Kingdom. Johnson & Johnson has filed a similar cross-border proceeding in The Netherlands with respect to the second European patent licensed to Ethicon. A hearing on Johnson & Johnson's request for provisional cross-border relief on both patents is scheduled for September 1997. On March 13, 1997, the Company filed a Motion to Intervene in Johnson & Johnson Interventional Systems Co. et al. v. Cook, Incorporated et al., an action in the U.S. District Court for the Southern District of Indiana. The motion seeks intervention for the purpose of modifying the present protective order to direct the Clerk of Court to retain, and the parties and their counsel not to destroy, materials and testimony assembled in that action. In addition, the Company seeks access to such materials and testimony, and access to materials filed by the parties in that action under seal. On March 17, 1997, the court temporarily stayed the return of documents from the court to the parties and ordered the parties to retain documents relating to the proceeding. A final decision is expected later in 1997. On June 16, 1997, BSC and SCIMED filed a suit against Johnson & Johnson, Ethicon, Inc. and Johnson & Johnson International Systems Co. (Johnson & Johnson) in the U.S. District Court for the District of Massachusetts seeking a declaratory judgment of noninfringement for the NIR(TM) stent relative to two patents licensed to Johnson & Johnson and that the two patents are invalid and unenforceable. Johnson & Johnson has responded with a motion to dismiss the suit. The Company is involved in various other lawsuits from time to time. In management's opinion, the Company is not currently involved in any legal proceedings other than those specifically identified above which, individually or in the aggregate, could have a material effect on the financial condition, operations or cash flows of the Company. The Company believes that it has meritorious defenses against claims that it has infringed patents of others. However, there can be no assurance that the Company will prevail in any particular case. An adverse outcome in one or more cases in which the Company's products are accused of patent infringement could have a material adverse effect on the Company. Further, product liability claims may be asserted in the future relative to events not known to management at the present time. The Company has insurance coverage which management believes is adequate to protect against product liability losses as could otherwise materially affect the Company's financial position. Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations Results of Operations Net sales for the second quarter of 1997 increased 25% to $474 million as compared to $379 million in the second quarter of 1996. International revenues for the quarter were impacted by changes in foreign currency exchange rates. Without the impact of changes in exchange rates, net sales for the second quarter increased approximately 28%. The Company reported a net loss of $27 million, or $.14 per share, in the second quarter of 1997, inclusive of merger-related and special charges of $158 million ($117 million, net-of-tax). This compares to net income of $13 million, or $.07 per share, in the second quarter of 1996, inclusive of merger-related and special charges of $74 million ($61 million, net-of-tax). Net income, exclusive of merger-related and special charges, increased 22% to $90 million in the second quarter of 1997 from $74 million in the second quarter of 1996. Net sales for the six month period ended June 30, 1997 increased 25% to $904 million as compared to $723 million in the first half of 1996. International revenues for the six month period ended June 30, 1997 were impacted by changes in foreign currency exchange rates. Without the impact of changes in exchange rates, net sales for the first half of 1997 increased approximately 28%. The Company reported net income of $49 million for the six month period ended June 30, 1997, inclusive of merger-related and special charges of $158 million ($117 million, net-of-tax). This compares to net income of $15 million in the six month period ended June 30, 1996, inclusive of merger-related and special charges of $142 million ($128 million, net-of-tax). Net income, exclusive of merger-related and special charges, increased 16% to $166 million in the first half of 1997 from $143 million in the first half of 1996. During the second quarter, United States (U.S.) revenues increased approximately 18%, while international revenues, including export sales, increased approximately 35% compared to the same period in the prior year. International sales as a percentage of worldwide sales increased from 40% in the second quarter of 1996 to 43% in the second quarter of 1997. Revenues in the United States increased approximately 19% during the first six months of 1997 compared to the same period of the prior year. International revenues, including export sales, increased approximately 35% during the first six months of 1997 compared to the same period in the prior year. Gross profit as a percentage of net sales decreased from 73.3% in the second quarter of 1996 to 72.3% in the second quarter of 1997, and decreased from 73.3% in the six months ended June 30, 1996 to 72.1% in the six months ended June 30, 1997. The decrease in the Company's gross margin percentage is primarily due to a shift in the Company's product sales mix and a decline in average selling prices due to continuing pressure on healthcare costs and increased competition. In addition, since the second half of 1996, the Company's gross margins and inventory levels reflect the impact of increased inventory and reserves for inventory resulting principally from the opening of a new distribution center in Europe, new product launches, and transferring international manufacturing from several sites in Europe to Ireland. However, the negative impact of the above conditions was partially offset by the Company's U.S. cost containment programs and an increase in the percentage of international sales compared to U.S. sales. The Company's future gross margins may be impacted by its ability to effectively manage its inventory levels and mix. The Company has also initiated a number of cost savings programs which may offset, in part, other declines in gross margin. Uncertainty remains with regard to future changes within the healthcare industry. The trend towards managed care and economically motivated buyers in the U.S. may result in continued pressure on selling prices of certain products and resulting compression on gross margins. The U.S. marketplace is increasingly characterized by consolidation among healthcare providers and purchasers of medical devices who prefer to limit the number of suppliers from whom they purchase medical products. There can be no assurance that these entities will continue to purchase products from the Company. In addition, international markets are also being affected by economic pressure to contain healthcare costs. Although these factors will continue to impact the rate at which Boston Scientific can grow, the Company believes that it is well positioned to take advantage of opportunities for growth that exist in the markets it serves. Selling, general and administrative expenses increased 27% from $124 million in the second quarter of 1996 to $157 million in the second quarter of 1997 and remained 33% of sales. Selling, general and administrative expenses increased 32% from $234 million to $309 million from the first six months of 1996 to 1997, respectively. The increase reflects continued expansion of the Company's domestic and international sales organizations and related marketing support. Royalty expenses increased 26% from $4 million in the second quarter of 1996 to $5 million in the second quarter of 1997, and 30% from $9 million in the first six months of 1996 to $11 million in the first six months of 1997. Royalty expenses remained approximately 1% of net sales. The increase in overall expense dollars is due primarily to royalties due under several strategic alliances the Company initiated in the first half of 1997 and in prior years. Research and development expenses increased 21% from $34 million in the second quarter of 1996 to $41 million in the second quarter of 1997, and 26% from $63 million in the first six months of 1996 to $80 million in the first six months of 1997. Research and development expenses remained 9% of sales. The increase in dollars reflects increased spending in regulatory, clinical research and various other product development programs, and reflects the Company's continued commitment to refine existing products and procedures and to develop new technologies that provide simpler, less traumatic, less costly and more efficient diagnosis and treatment. The trend in countries around the world toward more stringent regulatory requirements for product clearance and more vigorous enforcement activities has generally caused or may cause medical device manufacturers to experience more uncertainty, greater risk and higher expenses. In addition, regulatory approval times for new products continue to be lengthy, a concern of medical device manufacturers generally. During 1996, the Company accelerated certain spending programs so as to be in a position to take advantage of the expanded market opportunities it expects in 1997 and beyond. The programs impacted the Company's manufacturing, selling, general and administrative costs. During the second quarter of 1997, the Company's operating income, excluding merger-related and special charges, increased 20% from the second quarter of 1996 compared to a 25% increase in sales. These results were in line with internal expectations and reflect an expense infrastructure that has not yet been absorbed by revenue growth. Management believes that it will take a number of quarters to earn off the elevated cost structure. The Company's ability to benefit from these accelerated spending programs may be limited by risks and uncertainties related to competitive offerings, timing and scope of regulatory approvals, infrastructure development, continued international expansion, rights to intellectual property, and the ability of the Company to implement its overall business strategy. Interest and dividend income was $1 million in both the second quarter of 1997 and the second quarter of 1996, and $2 million in the first six months of 1997 compared to $4 million in the first six months of 1996. The decrease is primarily attributable to a decrease in the Company's average cash and marketable securities balance resulting from the use of cash to finance several of the Company's recent acquisitions and alliances. Interest expense remained unchanged from $3 million in the second quarter of 1996 to the second quarter of 1997, and increased from $5 million in the first six months of 1996 to $7 million in the first six months of 1997. The increase in interest expense is primarily attributable to the Company's issuance of commercial paper. Other income (expense), net, increased from expense of $1 million in the second quarter of 1996 to expense of $2 million in the second quarter of 1997. Other income (expense), net, changed from expense of $3 million in the first six months of 1996 to income of $251 thousand in the first six months of 1997. The change is primarily attributable to a net gain of approximately $6 million recognized on sales of equity investments recorded in the first half of 1997. As the Company has expanded its international operations, its sales and expenses denominated in foreign currencies have expanded and that trend is expected to continue. Thus, certain sales and expenses have been, and are expected to be, subject to the effect of foreign currency fluctuations and these fluctuations may have an impact on margins. The Company enters into forward foreign exchange contracts to hedge foreign currency transactions on a continuing basis for periods consistent with commitments. The Company does not engage in speculation. The Company's foreign exchange contracts, which totaled approximately $86 million at June 30, 1997, should not subject the Company to material risk due to exchange rate movements because gains and losses on these contracts should offset losses and gains on the assets and liabilities being hedged. Although the Company engages in hedging transactions that may offset the effect of fluctuations in foreign currency exchange rates on foreign currency denominated assets and liabilities, financial exposure may nonetheless result, primarily from the timing of transactions and the movement of exchange rates. Further, any significant changes in the political, regulatory or economic environments where the Company conducts international operations may have a material impact on revenues and profits. The Company's effective tax rate, excluding the impact of merger-related and special charges, improved from approximately 34% in the second quarter of 1996 to 33% in the second quarter of 1997. The Company's effective tax rate, excluding the impact of merger-related and special charges, improved from approximately 35% in the first six months of 1996 to 33% in the first six months of 1997. The reduction in the Company's effective tax rate, excluding the impact of special charges, is primarily due to increased business in lower tax geographies and certain tax planning initiatives. Liquidity and Capital Resources Cash and marketable securities totaled $86 million at June 30, 1997 compared to $118 million at December 31, 1996. Working capital was reduced from $335 million at December 31, 1996 to $236 million at June 30, 1997. The decrease in cash and marketable securities is primarily attributable to cash used to repurchase the Company's common stock, capital expenditures incurred to expand the Company's manufacturing and distribution facilities, additional strategic investments, tax payments and payments of merger-related costs. Cash expenditures during the first half of 1997 were partially offset by proceeds from normal operating activities and additional borrowings under the Company's financing arrangements. The increase in accounts receivable from December 31, 1996 to June 30, 1997 is primarily due to an increase in international sales that tend to have longer payment periods than domestic sales. Refer to the future cash impact of special charges as referenced in the notes to the unaudited condensed consolidated financial statements. Since early 1995, the Company has entered into several transactions involving acquisitions and alliances, certain of which have involved equity investments. As the healthcare environment continues to undergo rapid change, management expects that it will continue focusing on strategic initiatives and/or make additional investments in existing relationships. In addition, the Company expects to incur capital expenditures of approximately $100 million to $150 million during the remainder of 1997, including construction of additional manufacturing and distribution space and development of a global information system. During July 1997, the Company borrowed an additional 6 billion yen (the equivalent of approximately $52 million) under a five-year fixed rate financing arrangement. The Company expects its cash and cash equivalents, short-term investments, cash flows from operating activities, and projected borrowing capacity will be sufficient to meet its projected operating cash needs, including integration costs, at least through the end of 1997. The Company is involved in various lawsuits, including product liability suits, from time to time in the normal course of business. In management's opinion, the Company is not currently involved in any legal proceeding other than those specifically identified in the notes to the unaudited condensed consolidated financial statements which, individually or in the aggregate, could have a material effect on the financial condition, operations and cash flows of the Company. The Company believes that it has meritorious defenses against claims that it has infringed patents of others. However, there can be no assurance that the Company will prevail in any particular case. An adverse outcome in one or more cases in which the Company's products are accused of patent infringement could have a material adverse effect on the Company. Further, product liability claims may be asserted in the future relative to events not known to management at the present time. The Company has insurance coverage which management believes is adequate to protect against such product liability losses as could otherwise materially affect the Company's financial position. Cautionary Statement for Purposes of the Safe Harbor Provisions of the Private Securities Litigation Reform Act of 1995 This report contains forward-looking statements. The Company desires to take advantage of the safe harbor provisions of the Private Securities Litigation Reform Act of 1995 and is including this statement for the express purpose of availing itself of the protections of the safe harbor with respect to all forward-looking statements. Forward-looking statements contained in this report include, but are not limited to, statements with respect to: a) the Company's ability to effectively manage its inventory levels and mix; b) the Company's ability to realize benefits from its cost savings programs; c) the potential impacts of continued consolidation among healthcare providers, trends towards managed care, and healthcare cost containment; d) the Company's belief that it is well positioned to take advantage of opportunities for growth that exist in the markets it serves; e) the Company's continued commitment to refine existing products and procedures and to develop new technologies that provide simpler, less traumatic, less costly and more efficient diagnosis and treatment; f) the Company's ability to absorb certain spending programs over a number of quarters and to take advantage of expanded market opportunities; g) the potential effect of foreign currency fluctuations on sales and expenses and on the Company's hedge transactions; h) the process and plans for the integration of businesses acquired by the Company; i) the Company's continuing focus on strategic initiatives and existing relationships; j) the Company's plans to continue to invest aggressively in its global information system and worldwide manufacturing and distribution capacity; and, k) the ability of the Company to meet its projected cash needs through the end of 1997. Therefore, the Company wishes to caution each reader of this report to consider carefully the specific factors discussed with each forward- looking statement in this report and other factors contained in the Company's filings with the Securities and Exchange Commission as such factors in some cases have affected, and in the future (together with other factors) could affect, the ability of the Company to implement its business strategy and may cause actual results to differ materially from those contemplated by the statements expressed herein. OTHER INFORMATION Item 1: Legal Proceedings Note H - Commitments and Contingencies to the Company's unaudited condensed consolidated financial statements contained elsewhere in this Quarterly Report is incorporated herein by reference. Item 4: Submissions of Matters to a Vote of Security Holders The Annual Meeting of Stockholders of the Company was held on May 6, 1997, to consider and vote upon proposals to elect three Class II Directors of the Company to hold office until the 2000 Annual Meeting of Stockholders of the Company, and until their respective successors are chosen and qualified or until their earlier resignation, death or removal. John E. Abele, Joel L. Fleishman and Lawrence L. Horsch were elected as Class II Directors of the Company by a vote of 152,729,971, 152,885,213, and 152,826,728 for, respectively, and 1,485,537, 1,330,295, and 1,338,780 withheld, respectively. Item 5. Other Events On April 8, 1997, Patriot Acquisition Corp., a wholly owned subsidiary of the Company, was merged (the "Merger") with and into Target Therapeutics, Inc. ("Target"). The Merger was approved by the shareholders of Target at a special meeting on April 8, 1997. As a result of the Merger, Target became a wholly owned subsidiary of the Company. The Merger is accounted for as a pooling of interests and qualifies as a tax free reorganization. Target's shareholders received 1.07 shares of the Company's common stock in exchange for each share of Target common stock. Approximately 16.5 million shares of the Company's common stock were issued in connection with the Merger. A copy of the Company's press release announcing the completion of the Merger is filed as an exhibit hereto and incorporated herein by reference. Item 6: Exhibits and Reports on Form 8-K (a) Exhibits Exhibit 10.1 - Form of Amended and Restated Credit Agreement dated June 10, 1997 among the Company, The Several Lenders and certain other parties. Exhibit 11 - Computation of Earnings Per Share Exhibit 27 - Financial Data Schedule Exhibit 99.1 - Press Release dated April 8, 1997 SIGNATURE --------- Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized on August 14, 1997. BOSTON SCIENTIFIC CORPORATION By: /s/ Lawrence C. Best ---------------------------------------- Name: Lawrence C. Best Title: Chief Financial Officer and Senior Vice President - Finance and Administration