Boston Scientific's (BSX) CEO Michael Mahoney on Q2 2014 Results - Earnings Call Transcript

Jul.24.14 | About: Boston Scientific (BSX)

Boston Scientific Corporation (NYSE:BSX)

Q2 2014 Results Earnings Conference Call

July 24, 2014 8:00 a.m. ET

Executives

Susan Lisa - Investor Relations

Michael Mahoney - President and Chief Executive Officer

Daniel Brennan - Executive Vice President and Chief Financial Officer

Keith Dawkins - Global Chief Medical Officer and Executive Vice President

Ken Stein - Senior Vice President and Associate Chief Medical Officer of Cardiac Rhythm Management

Analysts

Glenn Novarro - RBC Capital Markets

Mike Weinstein - JPMorgan

Rick Wise - Stifel Nicolaus

Bob Hopkins - Bank of America

David Lewis - Morgan Stanley

Bruce Nudell - Credit Suisse

David Brill - Wells Fargo Securities

Brooks West - Piper Jaffray

Operator

Ladies and gentlemen, thank you for standing by. Welcome to the Boston Scientific Q2 2014 Earnings Conference Call. At this time, all participants are in a listen-only mode. Later, we will conduct a question-and-answer session. Instructions will be given at that time. (Operator Instructions) As a reminder, this call is being recorded.

I would now like to turn the conference over to our host, Ms. Susan Lisa. Please go ahead.

Susan Lisa

Thank you, Linda. Good morning, everyone, and thanks for joining us. With me on today's call are Mike Mahoney, President and Chief Executive Officer; and Dan Brennan, Executive Vice President and Chief Financial Officer. I also have with us today our chief medical officers, Dr. Keith Dawkins and Dr. Ken Stein.

We issued a press release earlier this morning announcing our Q2 2014 results, which included reconciliations of the non-GAAP measures used in the release. We have posted a copy of that release as well as reconciliations of the non-GAAP measures used in today's call to the Investor Relations section of our Web site under the heading, Financial Information.

The duration of this morning's call will be approximately one hour. Mike will begin our prepared remarks with an update on our business progress and his perspectives on the quarter. Dan will then review our overall Q2 2014 financial results as well as guidance for full-year 2014 and the Q3 2014. During today's Q&A session, Mike and Dan will be joined by Dr. Dawkins and Dr. Stein.

Before we begin, I'd like to remind everyone that this call contains forward-looking statements within the meaning of federal securities laws, which may be identified by words like anticipate, expect, believe, estimate and other similar words. They include, among other things, statements about our growth and market share; new product approvals and launches; clinical trials; cost savings and growth opportunities; our cash flow and expected use; our financial performance, including sales, margins, earnings and other Q3 and full-year 2014 guidance; as well as our tax rates, R&D spend and other expenses.

Actual results may differ materially from those discussed in the forward-looking statements. Factors that may cause such differences include those described in the Risk Factors section of our most recent 10-K and subsequent 10-Qs and 8-Ks filed with the SEC. These statements speak only as of today's date and we disclaim any intention or obligation to update them.

At this point, I'll turn it over to Mike for his comments. Mike?

Michael Mahoney

Thank you, Susie. Good morning everyone. Boston Scientific achieved strong results in second quarter, posting 4% operational sales growth and 17% adjusted EPS growth over the prior year period.

This quarter's results increased our confidence in our outlook and we are raising our adjusted EPS guidance for the full year. We remain very confident and enthusiastic about our strategic plan as we execute on our growth initiatives and advance our pipeline. We believe that Boston Scientific is uniquely positioned to drive sustainable double-digit EPS growth, given our global momentum, pipeline and significant opportunity for margin improvement. We are excited about our future as we continue to build throughout the business.

We are in the very early innings of launching multiple new platforms that will strengthen the future of the company. These platforms target large disease states that impact patients globally. Such as coronary artery disease, heart failure, stroke, sudden cardiac arrest, vascular disease, pulmonary disorders, Parkinson's disease, severe pain and cancer.

Our differentiated pipeline that will be highlighted throughout the call represents a portfolio that delivers unique clinical benefits to patients and physicians while delivering economics savings to our customers.

I will now provide some key highlights in the quarter and thoughts on our outlook. Dan will review the financials and 2014 guidance and then we will take your questions. So please note that in my remarks all references to growth are on a year-over-year basis, constant currency unless otherwise specified.

So beyond the strong 4% operational sales growth and 17% adjusted EPS growth, I would like to go into some detail on four key highlights of the quarter. First, our diversified and balanced growth across the company. Second, our outperformance in cardiac rhythm management. Thirdly, our above market growth in interventional cardiology. And, fourth, our strong position in peripheral interventions.

So starting with a big picture for BSC in the second quarter. Our performance represents strong, balanced global growth across divisions and geographies delivering 4% total company operational sales growth. We continue to execute our strategy to strengthen and diversify the portfolio in key segments while expanding geographically.

MedSurg posted a solid growth of 5% with endoscopy just below that rate and continued above market growth in urology and women's health. We believe that our neuromodulation continues to grow faster than the market, however our growth slowed in the second quarter due to challenging year-over-year comparisons. These results plus solid cardiovascular sales and stronger rhythm management sales, all contributed to our overall 4% operational sales growth.

Furthermore, we are executing our strategies to drive global expansion. In second quarter, in Europe we are up 7% and sales in the BRIC countries grew 19%. We continued to see strong returns on our investments in emerging markets as total emerging market sales are up 14% and now average 10% of total company's sales, a great improvement.

Turning now to cardiac rhythm management. Sales grew a solid 4% on strong demand for our truly differentiated products. BSC offers a portfolio that now includes the world's only ICD that does not require leads in the heart, the world's smallest ICD, the most reliable leads and the world's longest lasting defibrillators. We are also encouraged by our 12-months operational sales trend in CRM with year-over-year sales growth of 2% for the trailing 12-months. So to provide further context, it was a very positive quarter for the S-ICD platform and other new product launches that will benefit our CRM business going forward.

We continue to rollout S-ICD globally and for the full year 2014 we remain very comfortable with our target for S-ICD revenue contribution north of $75 million. From a reimbursement standpoint, we are pleased this quarter to have commercial insurers such as Coventry and HCSC, the Blue Cross, Blue Shield affiliate with over 12 million members in the west and Midwest, to now provide S-ICD coverage joining Health Net and others.

In Electrophysiology, we began to launch the innovative Rhythmia Mapping and Navigation platform in the second half. And we expect to see improved performance in this business in fourth quarter and into the future with the Rhythmia launch, new catheter platforms and synergies from our broader cardiac rhythm management team.

The third point. Moving on to cardiovascular. Interventional cardiology is building momentum and posted its second consecutive quarter of revenue growth due to strong Promus PREMIER and SYNERGY DES performance, improved sales execution and multiple new product launches outside of stents. We have moved back into the clear number one market share position in interventional cardiology DES in the U.S. We believe that we gained another 150 basis points of U.S. DES share in the quarter, exiting the second quarter in the high 30s on the strength of Promus PREMIER's performance.

Globally in DES, we are pleased to expand our market leadership position in the U.S., return to growth in Europe, and also executing a successful premier launch in Japan. As a result, we estimate our worldwide DES share is up roughly 300 basis points from year-end 2013. And this is consistent with our prior guidance for BSC to be a net share gainer in global DES in 2014. Many of our interventional cardiology products and solutions are still on the very early phases of launch. Such as SYNERGY, our next generation bioabsorbable coated stent.

LOTUS, our percutaneous aortic value and our POLARIS Imaging System for IVUS that will soon enable us to provide an integrated FFR offering. Regarding SYNERGY, we are excited the second quarter with a sales increase in over 15% of our DES revenue in Europe and nearly 30% of our mix in countries where SYNERGY has launched. Positive three-year follow-up SYNERGY data were presented at EuroPCR in May, demonstrating zero incidence of stent thrombosis at three years and a low 1.1% rate of target lesion revascularization at three years. We expect the pivotal EVOLVE II data to be released at AHA this November.

In addition, our structural heart franchise continues to build momentum and strengthen internationally. We believe that six months post LOTUS TAVR launch, we are now the number three transfemoral aortic value company in Europe. Six months follow-up from our LOTUS REPRISE II CE Mark trial was presented at EuroPCR in May and demonstrated excellent results with 79.8% of patients demonstrating zero or trace para-valvular aortic regurgitation. To continue the momentum, we received CE Mark earlier this month for the 25 mm LOTUS value system which complements the previously available 23 mm and 27 mm sizes. We began the 1,000 patient response post-market registry in Europe in June and we look forward to initiating the REPRISE III U.S. IDE trial later this year in 2014.

Also within structural heart, a brief update on WATCHMAN. Our left atrial appendage closure device designed to reduce the risk of stroke of patients with on-valvular atrial fibrillation. The FDA recently confirmed to us the third circulatory system devices panel will be convened on October 8 to review the WATCHMAN clinical evidence. As per our June update, we estimate a U.S. approval in the first half of 2015. BSC looks forward to presenting the totality of the data supporting the safety and efficacy for WATCHMAN in appropriately selected patients consistent with our proposed labeling. We look forward to the opportunity to expand patient access to this innovative stroke prevention treatment.

Fourth, in our peripheral interventions business we took an important step to strengthen our global position and expand our capabilities with the May signing of a definitive agreement to acquire the interventional division of Bayer AG. Our internal R&D efforts also continue to deliver with the recent CE Mark and launch of the RANGER drug-coated balloon. The RANGER drug-coated balloon plus the future editions Bayer Interventional's thrombectomy and atherectomy platforms will enhance our ability to provide physicians and healthcare systems with a comprehensive portfolio of solutions to treat challenging vascular conditions.

Also in the PI, an update on resistant hypertension. We consistently receive feedback in international markets on the unique benefits and differentiation of Vessex. This is our second generation, bipolar, multipoint renal denervation platform. We spent the last several months gathering input on our clinical strategy from multiple experts in the scientific community. This input has helped shaped our view of the new landscape of renal denervation while providing us with critical insights as we consider the next steps in our clinical program. So based on the inputs from your advisors and from recent meetings with the regulators and thought leaders, it has become clear that pursuing a global pivotal trial as previously designed is not the best approach. We expect to engage regulatory agencies in the coming weeks and we will proposed a revised study protocol in which our goal would be to isolate the effects of renal denervation while minimizing the challenges encountered in other trials due to the unpredictable effects of changes in medication and patient compliance. This is an innovative approach that we believe is the appropriate strategy given both the significant opportunity and near-term challenges in the renal denervation market.

So moving to our operating margins. Our focus on margin improvement remains a critical imperative for the company in 2014 and throughout our strategic plan. In the second quarter despite higher plan spending to support various product launches and commercial programs, we held adjusted operating margin roughly flat sequentially and year-over-year and came in at the high-end of our second quarter adjusted operating margin guidance. Driving margin improvement remains an absolute top priority for our entire team. We also expect to continue to generate strong cash flow which will support an allocation of capital that is aligned with our strategic priorities while enabling us to maintain sufficient flexibility.

So in summary, Boston Scientific is building momentum. We delivered a strong second quarter and first half 2014. We delivered operational revenue growth of 4% in the second quarter and leveraged that to 17% adjusted EPS growth. We are on track to deliver our full year 2014 operational sales guidance of 3% to 5% and we expect to drive roughly 100 basis points of operating margin improvement and leverage our sales growth to drive double-digit EPS growth as we believe there is ample room for improved operating performance across many of our businesses and regions.

Furthermore, our strategic plan is compelling. It's achievable and we believe that it will deliver strong value to BSC shareholders. Finally and most importantly, I will like to thank our employees for their winning spirit, their performance in the first half, and their relentless commitment to Boston Scientific. Now let me turn the call over to Dan for a more detailed review of our financials and 2014 guidance.

Daniel Brennan

Thanks, Mike. I will start with some overall perspective on the quarter before diving into the details.

We generated adjusted EPS of $0.21 compared to $0.18 in Q2 of 2013 and exceeded our guidance range of $0.18 to $0.20. The improved performance in Q2 was driven by operational revenue growth, lower royalty expense and a lower than expected tax rate. In addition, this quarter saw a lower R&D spend which was down 130 basis points year-over-year due to the timing of some projects and a focus R&D efficiency. These improvements were partially offset by SG&A spend related to investments in our strategic growth initiatives and core product launches.

Despite a higher adjusted SG&A rate this quarter, we posted an adjusted operating margin of 19.8% which was at the high end of our Q2 guidance range of 19% to 20% and roughly flat both year-over-year and sequentially. We remain highly focused on reducing spend and believe we are on track to achieve our profitability goal of roughly of roughly 100 plus basis points of annual operating margin improvement, which will result in a adjusted operating margin approaching 20% for the full year 2014. Below the operating income line, a $4.1 million net gain on investments and a slightly lower than expected effective tax rate along with a 1% reduction in shares outstanding from a year ago also contributed to adjusted EPS of $0.21 or a 17% year-over-year adjusted earnings per share growth.

In addition, we generated adjusted free cash flow of $262 million and operating cash flow of $286 million in the quarter. We continue to execute against our goal of consistent revenue growth and believe we are uniquely positioned to leverage that growth to double-digit adjusted earnings growth.

Now I will provide a detailed review of our Q2 business performance and operating results. For the second quarter of 2014, consolidated revenue of $1.873 billion represented operational revenue growth of 4% compared to the prior year period which excludes the impact of foreign exchange and the divested neurovascular business. Revenue grew 4% year-over-year on an as reported basis as well. The acquisition of the C.R. Bard electrophysiology business contributed roughly 135 basis points of growth in the quarter. So operational revenue growth excluding the acquired Bard EP business was 3% year-over-year.

The foreign exchange impact on sales was a $5 million tailwind in the quarter compared to the prior year period in line with what we assumed in our guidance range.

I will now provide details on the revenue results for our seven divisions which roll up into our three business groups. I will start with MedSurg where total group sales of $580 million grew 5% year-over-year on a constant currency basis and group adjusted operating income remained stable at 30.2%. Urology and women's health worldwide sales grew 7% on a constant currency basis compared to the prior quarter. Physician training, product registrations and commercial investment in key international geographies fueled strong international performance. In addition to all international regions growing double-digits for the fourth consecutive quarter, the U.S. business returned to growth in Q2 and continues to have very attractive margin.

Endoscopy sales grew 4% worldwide year-over-year on a constant currency basis as five of our eight franchises in this division posted growth. Latin America was particularly strong growing 21% year-over-year on a constant currency basis offset by weakness in Japan. To close out the MedSurg results, our worldwide neuromodulation business grew 3% year-over-year on a constant currency basis. We signaled last quarter, changes to Medicare reimbursement for physician office trialing of spinal cord stimulation systems went into effect this year and has negatively impacted market growth in Q2. As physicians adjust their practice patterns, we believe the market may reset this year to reflect the new reimbursement environment.

In addition, Q2 marks the one-year anniversary of our Precision Spectra launch, creating tougher comparisons. After growing over 30% in the second half of last year, our neuromodulation business will face increasingly difficult comparisons for the remainder of 2014 but we believe this will still be a growing market and our goal is to grow faster than this market given the strength of our technology and our team.

Turning now to the cardiovascular group which consists of the interventional cardiology and peripheral interventions divisions. Global sales for the group totaled $739 million and grew 2% year-over-year on a constant currency basis for the second consecutive quarter. Cardiovascular group adjusted operating margins for the quarter of 26.1% represented 100 basis point improvement year-over-year. Within cardiovascular, worldwide interventional cardiology sales of $528 million grew 1% year-over-year on a constant currency basis.

On the strength of the Promus PREMIER DES launch, we believe we expanded DES market leadership in the U.S. with $128 million in sales and an estimated high 30s market share. Globally, DES sales grew 4% year-over-year on a constant currency basis. U.S. DES sales grew 10% while sales internationally grew 1% year-over-year on a constant currency basis. DES revenue in Europe grew 1% year-over-year on a constant currency basis but excluding Germany, European DES sales were 8% higher than last year. Recall that we still have one more quarter before we anniversary the temporary injunction in Germany that resulted in a missed cycle of tenders.

We continued to execute our three tier strategy and increase our mix of synergy in select markets. Asia's DES results were flat year-over-year on a constant currency basis, a reflection of share gains on the strength of the Promus PREMIER Japan launch and the April 1, biannual reimbursement cut.

Moving beyond DES I will now address our other IC performance. Within other IC, IVUS grew 7% and core IC grew 2%, both on a constant currency year-over-year basis. Total other IC declined 2% year-over-year on a constant currency basis largely due to weakness in bare-metal stents ahead of our REBEL bare-metal stent launch in the U.S. which we announced earlier this week. Overall, we believe our strategy to provide the interventional cardiologist with a broadest portfolio of technology to treat the most complex coronary cases is resonating with physicians and driving above market growth in worldwide interventional cardiology.

In structure heart, which includes our LOTUS percutaneous valve and WATCHMAN left atrial appendage closure device. LOTUS posted solid sequential growth on a constant currency basis off a small base and WATCHMAN continued its strong growth with revenue up 30% year-over-year on a constant currency basis. Peripheral interventions delivered revenue of 3% over the prior year period on a constant currency basis. U.S. growth of 6% year-over-year was led by strength in the interventional oncology franchise. Partially offsetting this weakness was Asia where we saw some procedural softness, particularly in Japan. We remain on track to close the Bayer interventional deal in the second half of the year.

Finally I will discuss our rhythm management group which consists of electrophysiology and cardiac rhythm management divisions. Worldwide, rhythm management sales in Q2 of $553 million grew 7% year-over-year on a constant currency basis. Rhythm management's adjusted operating margin for Q2 of 12.2% represents 130 basis point improvement year-over-year and continues to be an area of key focus. Worldwide electrophysiology revenue grew 54% year-over-year on a constant currency basis. Excluding the acquired Bard EP business, global EP revenue declined in the quarter.

Looking ahead, the launch of our Rhythmia mapping and navigation system and further integration of the Bard EP acquisition will significantly expand our product portfolio and commercial capabilities. For the cardiac rhythm management division, Q2 worldwide sales increased 4% on a constant currency basis year-over-year. Growth in CRM was broad base as the U.S. grew 3%, Europe grew 4% and Asia grew 5%, all year-over-year on a constant currency basis. As Mike detailed, we continue to see strong demand for the S-ICD and feel very comfortable with the goal of $75 million plus in revenue for the year for 2014.

On a worldwide basis, defib sales of $355 million were up 3% year-over-year on a constant currency basis. U.S. defib revenue posted solid growth of 5% driven by continued S-ICD momentum and the rollout of our MINI ICD and our X4 quad pulse generator, both of which launched in the U.S. in the second half of the quarter. Worldwide pacer sales were up 6% on a constant currency basis year-over-year totaling $142 million. We continue to see strong adoption of our INGENIO family of pacemakers which drove international year-over-year growth of 15% on a constant currency basis. We believe our o-U.S. pacer business continued to gain share in the quarter.

We were also very encouraged with our worldwide CRM results in Q2 and would like to reiterate our belief that CRM trends are best analyzed over multiple quarters. And as Mike highlighted on a rolling 12-month basis, our CRM business posted 2% constant currency growth which we believe outpaced the market.

Turning now to the P&L, adjusted gross profit margin for the second quarter was 70.3% or 50 basis points lower than the prior year quarter. Recall that Q2 2013 gross margin included a 90 basis point benefit from the final true-up related to our Promus profit share agreement. Excluding this onetime benefit, GM this quarter was 40 basis points higher than Q2 of last year. The increase was largely attributable to benefits from our value improvement programs as well as some benefit from the neurovascular divestiture, partially offset by price erosion.

We believe we are on track to deliver adjusted gross margin in our range of 70% to 71% for the full year. Once again the impact of foreign exchange upon gross margin was minimal as a result of our hedging program. Adjusted SG&A expenses were $715 million or 38.2% of sales in the quarter. This represents a 230 basis point increase in SG&A spending as a percentage of revenue compared to Q2 2013 due to higher spend to support product launches and commercial programs. However, we are not satisfied with the overall SG&A expend and are taking steps to reduce it.

Adjusted research and development expenses were $206 million in the second quarter or 11% of sales. As a percent of sales, this represents 130 basis point decline in year-over-year spending due to efficiency gains and the timing of projects. As an example of these efficiency gains, our recently CE Mark drug-coated balloons, RANGER for the peripheral market and AGENT for the coronary market, resulted from a very lean development process. We leverage capabilities across both our PI and IC divisions as well as the technological expertise of a partner who is a recognized leader in coating technology and brought these technologies to market for considerably less cost than in the past. While we continue to look for more of these types of opportunities, we expect to return to a more normalized rate of R&D spend in the second half of this year.

Royalty expense was $25 million in the quarter or 1.3% of sales, down 130 basis points year-over-year due to a more favorable than expected royalty structure. As we continue to focus on costs savings opportunities, we have a number of royalty arrangements and regularly look to renegotiate them. We expect our royalty rate in the second half of 2014 to be relatively flat to the second half of 2013. On an adjusted basis, pretax operating income was $371 million in the quarter or 19.8% of sales, roughly flat both sequentially and year-over-year.

GAAP operating loss which includes GAAP to adjusted items of $440 million, was $69 million in Q2 2014. I would like to add context to two of these items. First, a $110 million intangible asset impairment charge, the majority of which is related to our Vessex acquisition, resulting from our clinical strategy change that Mike outlined. There is also a portion related to WATCHMAN due to revised expectations and timing as a result of the upcoming third FDA advisory panel.

Second, $267 million in litigation related net charges are primarily related to increase in our transvaginal surgical mesh product liability reserves. As a reminder, our reserves cover both known and estimated future cases in claims asserted against us as well as cost of defense. Our total accrual for all legal matters of which mesh is included, was $825 million as of June 30, 2014.

Now I will move on to other income and expense which primarily consisted of interest expense. Net interest expense for the quarter was $52.6 million as compared to $61.7 million in Q2 last year, due primarily to the refinancing of our public debt in Q3 of 2013. Our average interest expense rate in the quarter was 4.8% or approximately 90 basis points lower than Q2 last year. Our tax rate for the second quarter was 103.7% on a reported basis due in part to the intangible asset impairments and litigation related charges that negatively impacted reported pretax income. Our tax rate was 9.7% on adjusted basis. This low rate continues to reflect the expected geographic mix of our profits. The difference between our reported and adjusted tax rates for the quarter is attributed to charges excluded in determining our non-GAAP results.

Finally, Q2 2014 adjusted EPS of $0.21 per share represents 17% year-over-year growth. As mentioned, included in the adjusted EPS calculation is an approximate $20 million lower royalty expense. On a reported GAAP basis, Q2 2014 EPS was breakeven and included net charges and amortization expense totaling $281 million. This decline compared to Q2 2013 GAAP earnings of $0.10 per share, largely reflects the aforementioned intangible asset impairment charges and litigation related charges, partially offset by benefits related to contingent consideration.

Moving on to the balance sheet. DSO of 63 days decreased one day compared to June of 2013, due primarily to strong collections in the U.S. and Europe. Days inventory on hand of 153 days was up 9 days compared to June of last year and up 5 days compared to December of 2013 due to higher inventory in advance of launches, primarily Promus PREMIER, the S-ICD, MINI and X4 and lower cost of goods sold driven primarily by standard cost improvements and a favorable product mix.

Adjusted free cash flow for the quarter was $262 million, compared to $388 million in Q2 2013. This decrease is primarily due to investments in inventory to support new product launches. We continue to expect our full year 2014 adjusted free cash flow to be approximately $1.2 billion with stronger free cash flow generation than second half. Capital expenditures were $64 million in the quarter compared to $51 million in the same quarter last year.

There were no share repurchases in the quarter as we issued a net cash payment of $65 million to acquire the remaining 72% of IoGyn and announce our intent to acquire the interventional division of Bayer AG for $415 million. We value returning cash to shareholders and any continuation of our share repurchase program in 2014 would be subject to business development opportunities, market conditions, our stock performance, regulatory trading windows and other factors.

I’d like to conclude with our guidance for Q3 and the full-year 2014. For the full-year 2014, we expect consolidated revenue to be in the range of $7.325 billion to $7.425 billion, which represents year-over-year growth of 3% to 5% operationally and 3% to 4% on a reported basis. We continue to expect foreign exchange to be a net neutral for the full year 2014. We now expect adjusted EPS for the full-year 2014 to be in a range of $0.79 to $0.83, and we encourage you to model to the midpoint of the range.

On a GAAP basis, we expect EPS to be in a range of $0.28 to $0.32. Although it will be necessary to make tradeoffs within the P&L in any given time period, we remain focused on achieving our goal of at least 100 basis points of annual adjusted operating margin improvement and reaching an overall 25% operating margin by 2017. We believe that our strategies and programs to improve profitability are succeeding and we remain on track to achieve our goal.

Now turning to Q3 2014. We expect consolidated revenues to be in a range of $1,790 million to $1,840 million. If current foreign exchange rates hold constant, the tailwind from FX should be approximately $10 million or 60 basis points relative to Q3 last year. On an operational basis, we expect consolidated Q3 sales to grow year-over-year in a range of plus 3% to plus 5%. For the third quarter, adjusted EPS is expected to be in a range of $0.18 to $0.20 per share and reported GAAP EPS is expected to be in a range of $0.08 to $0.10 per share. I encourage you to check our investor relations Web site for Q2 2014 financial and operational highlights which outlines Q2 results and 2014 guidance and will welcome your feedback.

So with that I will turn it back to Susie who will moderate the Q&A.

Susan Lisa

Thanks, Dan. Linda, let's open it up for questions for the next 30 minutes or so. Linda, please go ahead.

Question-and-Answer Session

Operator

(Operator Instructions) We do have a question from the line of Glenn Novarro with RBC Capital Markets. Please go ahead.

Glenn Novarro - RBC Capital Markets

Very, very strong ICD quarter. And I'm just wondering if you can provide a little bit more color with respect to the U.S.? Was the better than expected results driven by quad can and S-ICD? And then I had a follow-up on the revenue guidance for the year.

Michael Mahoney

Good morning, Glenn. Yes, we do expect a lot out of that business and we are really pleased with our performance broadly in CRM and in U.S. in particular. Also as Dan highlighted, we really do look at the business on an ongoing basis and the 12-month trend is a plus 2%. We got a lot of heat in the first quarter for a down quarter but over the 12 months it's up 2% and up 4% in the second quarter. You know some of the biggest contributors to that, you highlighted a few, one is a very strong S-ICD momentum. We have a lot of confidence that we will exceed the $75 million target that we gave for the year. And also just the richness of the pipeline that we are delivering in the U.S. with our MINI which is -- the device is about 20% smaller than competitive devices. A lot of uptake by physicians and patients with that product. It represents a significant part of our mix.

We are also gaining some nice benefit globally with our quad platform and in the U.S. with the recent approval of the X4 quad generator. So we have a lot of positive news with our pipeline. We offer physicians significant differentiation and our commercial teams are delivering.

Glenn Novarro - RBC Capital Markets

And what is early feedback on the quad can? Because I know in the quarter that was launched more in kind of later in the quarter in June. Are you seeing EPs gravitate towards the product? Our research tells us that docs do indeed mix and match a lot more than maybe what we historically know. And is this what's also helping to drive the, what drove the better than expected results in 2Q and going forward.

Michael Mahoney

Yes, it's certainly a part of the equation. You know in Europe we offer the full lead and generator for a quad solution which certainly strengthens our portfolio in Europe. And in the U.S. we do see physicians that are going to mix and match the generator with the leads and they have traditionally done that in other instances as well. And so physicians enjoy the longevity that we offer. Additional pacing vector that’s offered versus competitive systems. And we are seeing that as an opportunity to break into competitive accounts as well as to secure CRT-D business that we may have lost without this offering in the past. So it's certainly a part of the equation of our improved growth.

Glenn Novarro - RBC Capital Markets

Okay. And then just quickly, Dan, on the revenue guidance that you offered. Does that include the Bayer acquisition because by our map we thought that would, probably by the fourth quarter contribute $20 million-$30 million.

Daniel Brennan

Glenn, it does not. Since we haven't closed that deal, we have not included that in our guidance for the second half of 2014.

Glenn Novarro - RBC Capital Markets

Okay. But if we threw $20 million or $30 million into our model in the foreclosure, is that a reasonable range?

Daniel Brennan

It all depends when you assume a closure. I mean as we have said, it was $120 million business within Bayer. So $10 a month and whatever you assume from close date, that would seem reasonable.

Operator

We have a question from the line of Mike Weinstein with JPMorgan. Please go ahead.

Mike Weinstein - JPMorgan

Can I start with the SG&A line, because you ended up with obviously so much higher than you guided at the end of the first quarter? So if you could spend some more time on that?

Daniel Brennan

Sure, Mike, happy to. Some of that is expected because we do have a seasonality effect where we have heavier trade show activity as you would know in the second quarter. We do have launch spend. So the Promus PREMIER launch happened a little early then we expected in Japan and we had all the series of launches that Mike went through relative to CRM. Some of it's more unexpected. We do -- as our IRS case moves out further relative to ultimately resolution, we have more fees associated with that. And we do take opportunistic opportunities to look at investments in Europe and emerging markets to drive revenue. So all that, you know some expected and some unexpected. But I would agree, we look at it and not happy with the 38.2% and we would look for that to come down in the back half of '14 and into '15.

Mike Weinstein - JPMorgan

And the degree at which it looks like it's -- I'm just looking at it relative to your guidance. The degree to which it looks like it surprised you for the quarter? The tax expense [couldn’t] (ph) be part of that. Why do you think it was so much higher than what you guys thought it would be at the end of the first quarter?

Michael Mahoney

Yes, it's Mike. I wouldn’t say it surprised us. Dan talked about some legal matters we are working through. But we are very confident we will deliver on our full year guidance for SG&A in that 36.5% to 37.5% range. So we are very comfortable with that in the back half. And as we talked about before, with the sales growing, the guidance of 3% to 5%, the ability to drive the operating income margin improvement. And we believe this will be the high point of our SG&A in the second quarter. As we drive down to our guidance for the full year we will drive double-digit EPS growth. So I wouldn’t say it's a big surprise for us. It's well planned. We have a lot of important launches and you are going to see the SG&A rate to creep down in the second half of the year.

Mike Weinstein - JPMorgan

Okay. Let me step back from the quarter, Mike, and ask you strategically. Obviously there's been a lot of activity in the healthcare sector over the course of the last several months. Can you just share with us your updated thoughts on the bigger industry consolidation? It's not just consolidations but it's M&A activity, all designed to try and create shareholder value. Can you just talk about how you think M&A plays in Boston Scientific's strategy? And whether you think the healthcare, I wouldn't say competitive landscape, I'd say the healthcare landscape is shifting and whether your strategy alters at all, given some of the deals that have been announced?

Michael Mahoney

Absolutely. Good question. And I would say the recent highly publicized acquisitions that you have read are certainly interesting news. But I would say in general it certainly does not impact our outlook in '14 nor do we see it impacting our strategic plan and our initiatives in any significant way. I think what's important for investors and employees is that the company is delivering today. We are building momentum and we have a strategic plan that’s compelling. It's attainable. We are ahead of the investor day presentation that we provided 18 months ago. And I think more importantly, in our existing markets that we play in today, we play in very big markets well in excess of $30 billion, and we have ample opportunity to grow share in those businesses.

And when we think about how we compete, we want to be the preferred innovative, clinical leader in very large disease states. And we have seven of those businesses today. So we will continue to provide tuck-in acquisitions and the right innovation bets to be really clinically differentiated and have scale in those specific disease states. And I think you are seeing the benefit of that strategy with our second quarter performance and the guidance we are reinforcing for the year. So I think the news is interesting but I think the plan that we have in place is very differentiated in the medtech. The ability to grow at or faster than our peer group and the ability that we have we believe to drive margin improvements faster, given the low base that the margins are currently at, which will drive consistent sustainable double-digit EPS growth. So it's really newsworthy but we believe the strategy we have in place is very sound and compelling for investors.

Operator

We have a question from the line of Rick Wise with Stifel. Please go ahead.

Rick Wise - Stifel Nicolaus

Mike, you turned in a really healthy EU drug-eluting stent performance, up 8% excluding Germany. A couple of questions. Help us understand when those German tenders occur? And does this have positive implications you'd hope for '15? Does it help us in '14? Maybe a little color there. Number two, maybe you could update us on SYNERGY? I'm assuming in particular SYNERGY is doing well? You had some favorable comments. How do we think about the SYNERGY opportunity now with the U.S. trial enrollment? And maybe in particular we saw some commentary out of Europe with the GHOST-EU Registry that showed very high thrombosis rates for bioabsorbables and this meshes frankly with commentary we heard at PCR about high thrombosis rates. Help us think through the competitive environment for your business broadly and SYNERGY specifically? Thanks.

Michael Mahoney

Sure. I will make some comments on our DES performance and what's driving that and then I will have Dr. Dawkins come in on your second part on the clinical aspects of some of the competitive implications. So just overall, our cardiology team has put ourselves in a very strong position with our global portfolio. And we are seeing the benefit of that in Europe today with our three-tier offering that Dan outlined. SYNERGY, we are very careful with how we price SYNERGY. It's a highly differentiated platform. And so today that mix is growing. But it currently approaches about 30% of our mix where we have launched it. So we are very careful with the pricing on this, as I said. And we have excellent three-tiered portfolio in Europe and it's surrounded by other unique benefits that we have. We just received approval for a new platinum-chromium bare-metal stent for chronic total occlusion.

So a lot of investments in the cardiovascular field starting to pay off. So good progress in Europe. And in the U.S., we are really excited about what's happening in the U.S. We grew estimated 10% in the U.S. in DES in the quarter of the heals of Promus PREMIER. And also in Japan we are launching Promus PREMIER really as we speak here. So there is lot of good momentum and then as you look forward, we expect the pivotal SYNERGY data from EVOLVE II in our U.S. IDE trial will be released to AHA in November. So we look forward to the coming of SYNERGY in the U.S., probably late '15. So good work by the cardiovascular team and a pretty rich pipeline that we are kind of tearing out globally. So maybe Dr. Dawkins can comment on your other questions.

Keith Dawkins

Thanks, Rick. I will just say a few words on the first generation bioresorbable vascular scaffold. As you know in the last few months, the recent literature has been has been replete with BVS complications including sub-optimal performance, mal-absorption, fracture displacement, stent thrombosis restenosis, myocardial infarction, and death. And last week in EuroIntervention Online was published the GHOST-EU Registry of BVS, which is the largest European registry, more than 1100 patients. And what caught our attention was the 3.4% annualized death from probable stent thrombosis rate. To put that, that was a one year, and to put that in perspective, the SYNERGY stent thrombosis rate of three years is zero percent admittedly in a more simple patient population.

If we just dig down into these stent thrombosis, 87% of these patients were on dual antiplatelet therapy, 13% died and 55% suffered an acute myocardial infarction. So even the editor of that journal who as you know is a big BVS supported, cautioned in a short editorial that this may raise note of caution over the unselected use of BVS in an old comers population or as a workhorse stent. And as a clinician, I want to imply what is best for my patients. And frankly, the 3.4% one year stent thrombosis rate is just not acceptable. So we will obviously, as Mike said, look very carefully and we are very excited by the pivotal EVOLVE data of the SYNERGY stent which will be presented at AHA, more than 1,800 patients. And then that will be followed by a very large diabetic sub-study. So because of the very early strut coverage of SYNERGY and the fact the polymer in the drug disappear abluminaly within a few months, and we have seen already a PCR two-month OCT data showing strut coverage. We are very confident that we will do well in terms of stent thrombosis and obviously the acute performance is impressive.

In terms of BVS, we note a low single-digit EU market penetration and that’s the fact that CE Mark was achieved for the product three and half year ago. And I think that compares strikingly with what we are doing with SYNERGY.

Rick Wise - Stifel Nicolaus

A quick follow-up question. On LOTUS you've got the 25 mm approved. Mike, you have 23, 25, 27, the full size complement. How do we think about the LOTUS ramp from here? And will we see data with the 25 mm valve at some point that shows a lower pacer rate than we saw in the REPRISE II data in Paris? Thanks.

Michael Mahoney

Yes. So certainly that data will come out over time once the value has been launched. Maybe Keith you want to comment on the clinical implications?

Keith Dawkins

Yes. So, Rick the 25 is being incorporated in the RESPOND Post Market study. That’s the 1000 patient post market study which just started in Europe and is on track. And we know from the REPRISE II data that more than 50% of patients who needed pacing, there was significant overstretch. In other words, a 27 was put in when the 25 should have been put it but was not available, or a 23 was put in when a 21 should have been put in but was not available. So we are optimistic with the pacemaker rate. We will fall in the RESPONSE study with the addition of the 25 mm and we are working internally on a 21 and 29 mm. When comparing different devices as you know the range of sizes, the aortic, annually that you can cover with different devices is different but we think 29 back to 21 will cover the range.

Operator

And we have a question from the line of Bob Hopkins with Bank of America. Please go ahead.

Bob Hopkins - Bank of America

So two questions, one for Dan and then one for Mike. And Dan just to start out on the tax rate. Obviously that stuck out this quarter as quite low, and I'm just wondering for the rest of 2014 if you've upped your EPS guidance a little bit here. How much of that is due to the lower tax rate?

Daniel Brennan

Yes. I think with where we are through the middle of the year, I think we will be comfortable with a 12 to 14 range for this year rather than the 13 to 15 that we had. So we probably see 100 basis point improvement relative to what we had previously signaled on tax.

Bob Hopkins - Bank of America

And did that drive the EPS increase or are there one or two other things that are helping?

Daniel Brennan

It obviously helps but there are a lot of other things that help, most notably including a 3% to 5% growth rate in revenue in the third quarter and overall for the full year.

Bob Hopkins - Bank of America

Okay. And then, Mike, sort of a bigger picture question on revenue guidance relative to some of the long-term thoughts you put out there in 2013. You've had a couple of setbacks in left atrial appendage and hypertension and I'm just wondering if you're still confident in those long-term financial guidance that you provided last year relative to some of these challenges that you've seen? And then also more specifically 2014, is that 100 basis point guidance still stand relative to adjacencies or is that a little lower just because of the timing of WATCHMAN?

Michael Mahoney

Yes, good question. So we are proud that our team is delivering on the commitments we gave despite some of those you have mentioned with hypertension and also the delays in Atritech, which we are hopeful that product will be approved in the first half of '15. But we are still delivering on the commitments that we made and ahead of the commitments that we talked about at the investor day. So I think a couple of things that are really in our favor. Our quad business is really executing nicely. We continue to see a steady performance and a lot of upside in our MedSurg businesses growing above market and strong market positions. A lot of international growth. So we expect continued strong performance there.

And cardiovascular business, I won't go through every -- repeat the script here, but we have had a second quarter growth in drug-eluting stents and we are having increased momentum with TAVR. And our rhythm management business is strengthening despite the underperformance of our EP division. So we expect that to improve. So overall despite some of the slippage in the adjacencies -- and you are right, the impact to adjacencies will be less in '14 given the delays of WATCHMAN. But overall, the core business is executing stronger and our business globally is executing very well. Emerging markets growth is up over 15%, represent 10% of the company.

So we have a balanced growth across the company and we have a number of also additional tailwinds Dr. Dawkins talked about in the drug-eluting market, as well as some other exciting launches and the uptake of S-ICD.

Operator

We have a question from the line of David Lewis with Morgan Stanley. Please go ahead.

David Lewis - Morgan Stanley

Mike, just to think about, or for Dan, the revenue guidance for the year obviously moved around a little bit, perhaps $20 million-$25 million at the midpoint. Just operationally as you think about the year, maybe sort of talk through maybe what drove some of those changes. And then also secondarily, on the endo business, obviously we're accustomed to that seeing much stronger results for the company over the last two to three years. Any specific things you talk about here in the particular quarter as it relates to endo and traction you're expecting for the remainder of the year in that business?

Daniel Brennan

Thanks, David. I think as you look at the growth -- and it's part of what Mike had just answered. So we have taken WATCHMAN out for the back half of the year as we anticipate approval for the first half of '15. So obviously absorb that but still delivering on the 3% to 5% for the full year. So it's really just tweaking around the edges to tighten the range as we go through the rest of the year. But still feel like that 3% to 5%, that zone we went in for the first half of this year, pulled through for the back half of the year as well for a lot of the reasons that Mike just outlined in the answer to the last question.

Michael Mahoney

And just in terms of the endoscopy business, it's not a concern for us. That business is very healthy. We did have a slow, little bit of a slowdown in the second quarter. We had some key product launches that will likely shift to late third quarter, fourth quarter. But overall, we don’t see on a year-over-year basis, any anticipated slowdown with our endoscopy performance.

David Lewis - Morgan Stanley

Okay. And then Dan maybe just to follow up quickly on SG&A. One thing we saw in the fourth quarter last year was sort of the reinvestment to take advantage of some of this tax potentially. Is that sort of what we're seeing again here in the second quarter? Just you are being a little opportunistic given you have a little more flexibility, or is this really just one-time spending here and there that you expect to resolve and maintain your guidance for the year?

Daniel Brennan

Yes. No, and that’s a good question. I think first just to clarify relative to the overall. The 38.2% that I mentioned, that’s the adjusted SG&A rate, which is the rate for the quarter. As you look at being opportunistic, we will always be opportunistic within a given quarter if we see opportunity but as Mike mentioned earlier, we are still laser focused on delivering on the operating profit targets that we have. So we will make tradeoffs between gross margin, SG&A and R&D, but still very focused on the operating margin targets and the double-digit EPS growth.

Operator

We have a question from the line of Bruce Nudell with Credit Suisse. Please go ahead.

Bruce Nudell - Credit Suisse

Mike, just looking at the two quarters back-to-back, 1Q and 2Q, for the S-ICD or for the ICD franchise. I mean, should we be -- and I know there are puts and takes. There's the replacement headwind, there's the quad situation. Should we be thinking about this year as kind of having a masking effect on the progress you're really making and maybe 50 to 100 basis points in worldwide share? And that the real full impact of the transformation in CRM or the ICD franchise really not being evident fully till something like 2016, where you have your own CRT-D product, full system product in the market?

Michael Mahoney

Yes, I think that’s a fair way to characterize it. I think we are very comfortable in stating that we are gaining share in de novo ICD. So physicians are choosing our platform portfolio more often. And as you said that success has been hampered by not having a full launch of a quad system which we now have in Europe but we don’t have that quite yet in the U.S. And the replacement headwind -- you know quite frankly due to some of the battery longevity benefits that we deliver. So we think that replacement headwind will taper and right itself in 2016. So we are facing those two headwinds and that’s being offset with positive growth due to the strong de novo ICD momentum and patient momentum that we have.

So in the future, once neutralized for that replacement headwind and the full launch of quad, would better show the strength of the portfolio that we are delivering. I think if you look to Europe, we do have the portfolio today. We have the full quad capabilities, the S-ICD. We are battling the replacement headwind, at least the overall position is stronger in Europe given that trend.

Bruce Nudell - Credit Suisse

And I guess a follow-up for my good friend, Keith. Just looking at the PREVAIL results and the body of evidence, really doesn't look like there's any smoking gun in LAA and everybody's very confused by the need for a third panel. And the only thing that really strikes me is that the great utility of this technology would be in patients who are both at high stroke and bleeding risk. And that trial has never been done where people who are truly contraindicated for anticoagulants are tested, but they're having registries that speak to that. I mean are we on the right track in thinking that it's really an indication question that the FDA may have and that the compendium of evidence really speaks to safety even in anticoagulant intolerant patients?

Keith Dawkins

Thanks, Bruce. I think I should pass that comment to my colleague, Ken Stein, who is CMO of the CRM division. Because WATCHMAN lodges in that division and Ken has been spending a few minutes on the forthcoming panel.

Ken Stein

Yes, thanks. Thanks a lot Keith and thanks for the question, Bruce. We are really not able to get into any public details about our ongoing negotiations with FDA or speak for them in terms of what their concerns are that led to us go to this unprecedented third panel. I can tell you again, our belief is that the data as it exists today is still supportive of and consistent with the data that we presented to the panel last December. And that got us the overwhelmingly positive 13 to 1 votes in favor of safety, efficacy and positive benefit risk for the populations that have been studied in the large randomized trial. I think the only other thing I might want to clarify just in terms of your question, you know it's our belief that if you look into the populations that were studied in, PREVAIL and PROTECT and our two registries, CAP and CAP 2. Those are populations at high risk of stroke and those are population with high bleeding risk based on their CHADS VASc scores and their HAS-BLED scores. So we think that the populations that we studied and the indications that we are seeking really are the appropriate populations for this device.

Operator

We have a question from the line of Larry Biegelsen with Wells Fargo. Please go ahead.

David Brill - Wells Fargo Securities

This is David Brill for Larry. So first, second half 2014 EPS guidance, looked like it was $0.38 to $0.42. You know why would second half be lower than $0.41 in the first half?

Daniel Brennan

The biggest piece of that is seasonality. Q3, particularly in Europe is the slowest sales quarter of the year. So you lose a little bit of sales, the industry loses sales in the third quarter. So that’s the primary driven as to why the second half is lower.

David Brill - Wells Fargo Securities

Great. And second, you talked about some of the headwinds in neuromodulation. Can you give us a little bit of color about how we should think about the neuromodulation in the U.S. going forward?

Michael Mahoney

Sure. So in neuromodulation the business continues to do well. We did have -- we highlighted in the call, a slowdown in the second quarter and we anticipate a slowdown in the second half, given the annual comps. You the comparables in the second half of the year will be against a 30% growth comp. So that will be a challenge for us in the second half of the year but we still delivered positive growth in the second quarter despite some of those reimbursement changes. So as we look forward in the future, we do expect this to be a continued strong mid to high single digit growth market and we have a lot of innovation that we are launching out. The Spectra platform and more things in the pipeline that we will outline at investor day in the first quarter in '15.

So our growth will slow down in the second half given those comparables. But as we anniversary those comps in '15 and strengthen the pipeline in a market that we believe that will settle into the kind of mid-single digit to high-single digit growth rate, we expect to outperform the market.

Susan Lisa

Linda, there is time for one more please.

Operator

Okay. Thank you. We do have a question from the line of Brooks West with Piper Jaffray. Please go ahead.

Brooks West - Piper Jaffray

Thanks for fitting me in. One on CRM. Can you update us on where you are with the NAVIGATE X-4 trial and kind of how we should think about that impacting your ICD results? And then I had a follow-up on cardiology.

Michael Mahoney

Dr. Stein, you want to take that question?

Ken Stein

Yes. I mean I don’t -- the NAVIGATE trial is on pace, we are still projecting U.S. approval of our quad pole leads in 2016. I don’t think that the fact that the trial is running has any material effect on the financial results that we have reported for the year.

Brooks West - Piper Jaffray

Okay. But, Ken, you do get revenue from the trial, correct?

Ken Stein

I am going to have to refer it to Dan on how that actually gets booked into the P&L.

Daniel Brennan

Yes, Brooks. Yes, but nothing that’s materially going to move the needle. So I wouldn’t factor it into your model.

Brooks West - Piper Jaffray

Okay. Great. And I guess my follow-up is on some of the other cardiology products. You know you have got IVUS FFR, you have now got a coronary drug-eluting balloon. You still got I think good momentum in the CTO device. Can you talk about the ability of those devices or maybe quantify a little bit the ability of that other bucket of stuff to impact the cardiology franchise going forward?

Daniel Brennan

Sure, I can take that Brooks. The other IC, and again it's almost a shame to call it the other IC because there is so many good products in that category. But the products that we have in that to treat the complex PCI have significantly contributed to the overall IC franchise and actually to the company. Because if you recall, that’s a franchise that was going backwards in prior years. And now that that has forward momentum and it's not just one product. It's IVUS, you just saw we announced the new bare-metal stent launch in CTO devices, Rotablator. There is a list of products in there that are all rejuvenated from a product portfolio perspective and contributing to growth in that franchise as well as IC. I don’t know, Keith, if you have might any other comment as well.

Keith Dawkins

You know I think, Brooks, also these are areas that have been neglected somewhat but Boston Scientific. So we haven't produced a bare metal stent for ten years and we have rarely refurbished the IVUS business, obviously new catheter, new software and then anticipate that we can integrate FFI next year on a very competitive wire. So we have focused a lot on the core IC business which previously perhaps just escaped our attention.

Susan Lisa

With that, we’d like to conclude the call. Thanks for joining us today. We appreciate your interest in Boston Scientific. And before you disconnect, Linda, will give you all the pertinent details for the replay. Thank you.

Operator

Thank you. Ladies and gentlemen, this conference will be available for replay after 10:30 AM Eastern time today until August 7 at midnight. You may access the AT&T Executive Playback Service at any time by dialing 1-800-475-6701 and entering the access code 329481. International participants may dial 1- 320-365-3844. Again those numbers are 1-800-475-6701 or 1- 320-365-3844. Access code, 329481. That does conclude our conference for today. Thank you for your participation and using AT&T Executive Teleconference Service. You may now disconnect.

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