Boston Scientific Management Discusses Q2 2012 Results - Earnings Call Transcript

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Boston Scientific (NYSE:BSX)

Q2 2012 Earnings Call

July 26, 2012 8:00 am ET


Sean Wirtjes

William H. Kucheman - Chief Executive Officer, Director and Member of Finance Committee

Jeffrey D. Capello - Chief Financial Officer and Executive Vice President

Michael F. Mahoney - President


Glenn J. Novarro - RBC Capital Markets, LLC, Research Division

James Francescone - Morgan Stanley, Research Division

Michael N. Weinstein - JP Morgan Chase & Co, Research Division

Bruce M. Nudell - Crédit Suisse AG, Research Division

Kristen M. Stewart - Deutsche Bank AG, Research Division

Daniel Sollof - Barclays Capital, Research Division

Kevin Strange - Wells Fargo Securities, LLC, Research Division


Ladies and gentlemen, thank you for standing by. Welcome to the Boston Scientific Q2 Earnings Conference Call. [Operator Instructions] As a reminder, this call is being recorded. I would now like to turn the conference over to our host, Mr. Sean Wirtjes. Please go ahead.

Sean Wirtjes

Thank you, Linda. Good morning, everyone, and thanks for joining us. With me on today's call are Hank Kucheman, Chief Executive Officer; and Jeff Capello, Executive Vice President and Chief Financial Officer.

We issued a press release earlier this morning announcing our Q2 2012 results, which included key financials and reconciliations of the non-GAAP financial measures used in the release. We posted a copy of that press release, as well as reconciliations of the non-GAAP financial measures used in today's conference call to the comparable GAAP measures and other supporting schedules to the Investor Relations section of our website under the heading Financial Information.

The duration of this morning's call will be approximately 1 hour. Hank will begin our prepared remarks with an update on our business progress and his perspectives on the quarter. Jeff will then review our Q2 financial results and business performance, as well as Q3 and updated full year 2012 guidance. We'll then open up the call up to questions.

During today's Q&A session, Hank and Jeff will be joined by our President, Mike Mahoney; as well our Chief Medical Officers 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, project, believe, plan, estimate, intend, should and similar words. These forward-looking statements include, among other things, statements regarding our growth; market share; our products and the markets for them; product pipeline; new product approval, launches and performance; procedural volumes and pricing trends; clinical trials; cost savings and growth opportunities; investments in emerging markets and business development opportunities; the timing and volume of share repurchases; free cash flow and its uses; the impact of foreign exchange rates; our future financial performance, including sales, margins, earnings and losses and other guidance for the third quarter and full year 2012; impairments of our goodwill and other assets; and future tax rates, R&D spending and other expenses.

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

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

William H. Kucheman

Thank you, Sean. And good morning, everyone, and thanks for joining us. Let me begin today with some comments on our second quarter performance.

Our second quarter revenue of $1.828 billion was down 7% on a reported basis and down 4% on constant currency and excluding the Neurovascular divestiture. There's no doubt that this was a tough quarter from a top line perspective. A challenging economic and competitive environment, coupled with disciplined results in our largest businesses, as well as a larger-than-expected headwind from foreign currency, led us to come in below the end of our 2Q sales guidance range.

Despite this result, we remain focused on returning to top line growth in the near term and building on that over time. I'll outline the reasons for why we believe that could be our case here in a minute.

On an adjusted basis, our earnings performance was a positive in the quarter, as we delivered adjusted EPS of $0.17, driven primarily by continued gross margin improvement and cost control. This was above Street consensus and at the high end of our guidance range of $0.14 to $0.17 despite the revenue shortfall in the quarter.

During the quarter, we recorded an estimated $3.4 billion goodwill impairment charge relating to our EMEA reporting unit. This charge was primarily driven by the slightly lower projected long-term growth rates due to macroeconomic factors and our performance in the European market. To be clear, we still believe our revenues in EMEA will grow in the future, just at a slightly lower rate than we had previously projected. Jeff will cover this event in more detail later in his comments.

Operating cash flow was very strong at $407 million. We used a portion of our cash flow to make the upfront payment for the Cameron acquisition and a portion to the buy back another 18 million shares of stock in the quarter. We believe our stock price is undervalued, and we expect to continue repurchasing shares as part of our balanced capital allocation strategy in coming quarters.

From a business standpoint -- from a performance standpoint, another significant positive in 2Q was a continued, and in some cases, increased, constant currency growth we saw in several of our businesses. Our PI, Endoscopy and Urology businesses delivered mid- to high-single digit growth in the quarter. Even more impressive was the performance of our Neuromod business, which grew 10% compared to 2Q last year. And in the emerging markets of China and India, we also grew at above-market rates, with an increase of over 40% on a combined basis.

In total, 7 of our 12 businesses grew greater than market. We expect to see continued above-market growth from these businesses in regions in the future, which is a key element of our expected path back to top line growth for the company.

Let me start off with our IC business, where we faced challenging conditions in 2Q, but believe there is a number of reasons why we expect to see some stabilization beginning in the second half of the year. In the U.S. DES , we experienced some share loss, largely due to trialing of competitive new products. The greatest impact came in the month of April. However, we saw steady recovery in May and further recovery in June.

We believe we have a clear line of sight to stabilizing market share back in the low-40s in the second half of the year. This was based on a combination of factors, including the abatement of competitive product trialing; the June launch of the PROMUS Element Plus long length, which we expect provide access into previously locked-out accounts; and the strong clinical results of the platinum landmark 2-year data, which demonstrated superior performance for PROMUS Element over XIENCE, the first time that any statin has been shown to be superior to XIENCE in a randomized trial; coupled with improved clinical differentiated selling. In Japan, the launch PROMUS Element has gone very well. But we expect to see a similar dynamic play out there in the second half of '12 as customers trial competitive new products and we obtain approval for the long length.

From a U.S. pricing perspective, year-over-year pricing trends continue to be somewhat improved. We are focused on pricing discipline and have continued to walk away from some business when pricing did not make economic sense for us. We continue to see U.S. PCI volumes down in the low-single digits, offset by robust growth internationally, particularly in the emerging markets. We believe the U.S. weakness in PCIs is largely being driven by continued physician alignment with hospitals and the macroeconomic environment.

In the emerging markets of China and India, our biggest opportunity is in DES. We expect increasing productivity to continue to drive strong sales growth following significant investments we have made since 2011. In addition, we recently strengthened our leadership team by hiring a new and experienced leader for China, who has already sharpened our business focus and execution.

In terms of our IC pipeline, we continue to be excited about our next-generation Synergy stent and its potential to improve healing, reduce dual antiplatelet therapy duration for patients and thus, lower overall health care system cost. Compelling linear data were presented at EuroPCR, and we expect CE Mark before the end of the year.

Following European approval, we plan to commence an initial limited market release focused on building a broad array of clinical evidence to support a full European commercial launch, which we expect in early 2014. The overall goal here is to develop a fact base to support the Synergy premium technology and unique value proposition with robust clinical evidence and meaningful indications.

On the structural heart front, we are very encouraged by the REPRISE I experience and the data presented at PCR by our principal investigator, Dr. Ian Meredith. Feedback we've received implanting physicians supports our belief that the Lotus valve offers a true second-generation set of features, including the valve being preloaded on the delivery system; valve function very early in the deployment process, which makes precise placement a less stressful proposition; and the ability to fully recapture and reposition the device, if needed.

We're also encouraged by the low post-implant trans-value gradiant [ph]the high aortic valve area and the promise of reduced paravalvular leakage due to our unique Adaptive Seal. We expect to begin the REPRISE II trial later this year and complete patient enrollment in the first half of next year, and we expect to use the data from that trial to support CE Mark approval and European launch of the Lotus valve in the second half of 2013. Although we now expect the cost to bring the Lotus valve to market to be higher than previously estimated, due in part to changes in the regulatory environment, we continue to believe that it represents a significant future growth opportunity for us.

For the rest of the IC business, we are following the model that we successfully used to rejuvenate our PI business, which I'll speak to here in a minute, by investing in a renewed pipeline to bring a series of new products to the market. We have just begun to see some of the new products start to contribute, with the European launch of a Emerge PTCA balloon catheter in the second quarter. Emerge is getting rave reviews from our customers, all around performance in a product category in which BSC has led for decades. During the third quarter, we expect to launch Emerge in the U.S. as well as introduce our new Convey guide catheter and IVUS software upgrade.

We believe that Emerge will enable us to expand our overall market share position in Plain Old Balloon Angioplasty or POBA. We expect the combination of this new product pipeline and additional external opportunities, such as the recently announced collaboration with Philips Healthcare to sell Boston Scientific's imaging products, to drive the non-stent IC business back towards growth.

In Peripheral Interventions, we expect to grow above market in the U.S. as we execute the full launch of the Epic self-expanding vascular stent and with the introduction of more new products in the next few quarters. Internationally, we relaunched the INNOVA self-expanding SFA stent in Europe in 2Q and are enrolling patients in a trial to gain approval in the U.S. and Japan. We saw growth in every region of the world in this business in 2Q, with the emerging markets, including China and India, showing the strongest growth.

In Endoscopy, we continue to expect the recent product launches to bolster our already strong endoscopy above-market growth profile. During the quarter, we experienced broad growth across several of our key product franchises: our biopsy business; our Billary device franchise, driven by continued growth in our Expect UES needles and access products; our metal stent franchise, led by our industry-leading WallFlex product family; and our hemostasis franchise on the continued adoption and utilization of a resolution clip for GI bleeding.

On June 11, we held our first analyst meeting, primarily focused on the Endoscopy business and the bronchial thermoplasty or BT opportunity. We were very pleased to showcase the Endoscopy business and provide a deeper view into why we expect BT to be a $1 billion worldwide market and a contributor of meaningful sales growth commencing next year. So what's new here is that all of the 7 largest U.S. private payors have now covered the BT procedure for individual patients. We believe this is a significant change from even 6 months ago and is an important precursor to broader coverage of reimbursement. We also just signed up our 150th U.S. treating center and are ahead of schedule to reach our year-end goal of 200 centers.

In Urology and Women's Health, we expanded the commercial launch our BackStop gel, which is designed to prevent stone migration during stone management procedures. We continue to believe this business has considerable above-market growth potential and are planning to introduce several new and differentiated technologies in both our [indiscernible] and urology franchises later this year to help realize that potential. In Women's Health, we also expect comps to get easier in the second half of the year due to the negative impact of last year's FDA public health notice update on mesh.

In Neuromodulation, we continue to expect very healthy growth on the back of our product portfolio that clearly differentiates us from our competition. Looking ahead, we expect to introduce several clinically relevant innovations to provide physicians and their patients greater flexibility for the management of chronic pain. As an example, this type of meaningful innovation is our recently launched Infinion lead, the industries first and only 16-contact percutaneous lead, which has been received enthusiastically by the physician community. And looking forward, we believe our DBS program remains on track to be a growth contributor beginning in 2014.

Now let me move to CRM, where we continue to see a sluggish global market. In the U.S., we estimate the defib market decline around 5% in the second quarter. From a share perspective, we estimate that our total overall U.S. defib share was down approximately 100 basis points compared to 2Q last year, with modest de novo share gains and higher defib lead sales more than offset by continued replacement headwinds.

On the U.S. pacer front, we believe we began to take share in 2Q as we ramped the launch of INGENIO in June. Consistent with one of our competitor's recent comments, we believe that the worldwide CRM market will continue to be sluggish in 2012, declining approximately 3% to 5% for the full year on a constant currency basis.

While we expect year-over-year comparisons will improve in the second half, we have not concluded that we've seen the bottom of the CRM market at this point. We have worked hard to position our CRM business to succeed and grow in the future and have built a unique and competitive portfolio of arrhythmia management products, which we believe will enable us to take share over time in both defib and brady. In the near term, we also expect to benefit from easing comps due to midterm -- mid-teens decline we experienced in U.S. defib market in the second half of 2011.

In the U.S., the launch of our INCEPTA, ENERGEN and PUNCTUA ICDs and CRT-Ds continues to go well, with positive customer feedback and ASP uplift in line with our expectations. On the pacing side, we began a new era, with the initial launches of the INGENIO family of pacemakers and CRTPs in both Europe and U.S. in the latter part of the second quarter. We're very pleased with the roll out based on the positive feedback we received from customers, having a wireless RPM-enabled device, along with significant new features like right rate and respiratory rate trend, has upgraded our pacer offering significantly.

In the U.S., we have been particularly pleased with our ability to get customers on contract nearly 3x faster than we anticipated, along with strong ASP performance. INGENIO is our first new brady platform in many years, and we continue to believe that its potential to drive share gains in the worldwide pacer market is underappreciated.

More recently, we gained European approval for our first brady remote patient monitoring system, Latitude NXT, N-X-T. We also expect the first implants of our new brady MRI-safe system to take place in Europe very soon. In the U.S., we expect to start a brady MRI trial later this year.

In addition to the recent progress in our traditional CRM business, we're very happy to have closed the Cameron transaction and have welcomed the Cameron team to Boston Scientific. We believe that this acquisition is strategically important to our CRM business and that the S-ICD technology provides us with the opportunity to take both share in existing ICD market, but also expand the market over time for 3 key reasons: first, the S-ICD. We will establish the first new category of CRM devices since the introduction of CRT. The S-ICD is the world's largest and only commercially available completely subcu ICD that leaves the heart and vascular untouched. This new subcu category provides physicians and their patients with a new alternative that only BSC can offer.

Second, we expect the S-ICD to capture de novo share in the ICD market. In clinical trials and commercial experience, the S-ICD has gained broad utilization in primary and secondary prevention populations and across a wide range of patient conditions and ages. In addition to de novo share, we also expect to take share in complex ICD replacements. A meaningful percentage of S-ICD implants in clinical trials and commercial experience were among patients with prior transvenous systems.

And finally, we believe the S-ICD will gain preference among referring cardiologists who have indicated, through our research, that they would preferentially refer patients for the S-ICD. Furthermore, the referring cardiologists also indicated they would actually increase the number of ICD referrals they make as a result of the S-ICD, which could help expand the market.

Physician feedback at HRS and other recent congresses and our Medical Advisory Board suggests that the S-ICD has potential to be the major "what's next" in this market as a truly differentiated technology, and we agree. We and our colleagues from Cameron are focused on securing FDA approval for the S-ICD in the first half of next year, although we are hopeful that it could come sooner.

In addition, we continue to advance the WATCHMAN Device, both commercially and clinically. In May, the HF registry data that was presented at HRS showing a 77% reduction in stroke risk in patients with AFib and eligible for both [ph] therapy. We also completed enrollment in the confirmatory PREVAIL U.S. trial on schedule earlier this month, and we continue expect our FDA PMA submission around year-end, with approval expected by the end of 2013.

Finally, in our EP business, we continue to leverage our expertise in catheter and ablation technology as we execute our global AFib strategy and progress on our internal AFib-focused projects. We recently received conditional approval on our IDE with the FDA for our AFib clinical trial of Zero-AF, utilizing Blazer, open irrigated catheter. Enrollment is slated to begin in the fall.

To conclude, we were clearly disappointed by our 2Q performance in our largest businesses, particularly IC. However, we also grew above market in 7 of our 12 business units. We continue to believe there is a clear path back to near-term sales growth and achieving our second half objectives through share gains from new and recently introduced products and improved sales execution, as well as increased penetration in emerging markets and easing second half comps in defib and Women's Health in the U.S.

At the same time, we continue to achieve key milestones relating to our cost-reduction opportunities to drive earnings growth and to generate strong cash flow. We expect this will allow us to maintain the flexibility to balance investments in emerging markets and grow technologies, along with returning capital to shareholders through share repurchases.

That's it for my comments. So now let me turn the call over to Jeff. Jeff?

Jeffrey D. Capello

Thanks, Hank. Let me begin by providing some overall perspective on the quarter before getting into the details. Despite challenging global economic and end-market conditions and disappointing results in certain businesses that adversely impacted revenue, we generated adjusted earnings per share of $0.17, which was at the high end of our guidance range of $0.14 to $0.17 and above Street consensus of $0.16.

This solid profitability was driven by higher gross margins due largely to the continued rollout of PROMUS Element in the United States and Japan and continued strong attention to cost control. In addition to our strong adjusted earnings performance, we also generated $407 million in operating cash flow and repurchased another 18 million shares in the quarter.

During the quarter, we recorded a $3.4 billion impairment charge to write down goodwill associated with our EMEA reporting unit, reducing the goodwill from $4 billion to $600 million. This goodwill largely relates to our purchase of Guidant in 2006. Accounting rules require us to test our goodwill balances each year for impairment. As a result of our analysis performed in conjunction with this year's annual goodwill impairment test, we slightly lowered our revenue growth projections for EMEA reporting unit due to recent macroeconomic factors affecting the European market and our recent performance in that market.

This reduction in revenue growth assumptions for the EMEA reporting unit resulted in the estimated goodwill impairment charge in the quarter. It is important to note, given the size of our goodwill balance in this region, even small changes to expectations can have an impact on these carrying amounts. We still believe Europe represents a future growth opportunity for the company given our new products and future technology offerings, coupled with the aging population and under penetration of our therapies in that region.

The amount of goodwill impairment charge is subject to finalization and is expected to be within a range of $3.1 billion to $3.7 billion when finalized. As a reminder, this is a noncash charge with minimal tax consequences and has no impact on our expected cash flows or our bank covenant ratios. We will continue to monitor all of our goodwill balances for potential impairments as required.

Consolidated revenue for the second quarter of $1,828,000,000 represents a decrease of 7% on a reported basis and 4% on an operational basis, excluding the impact of foreign exchange and the divested Neurovascular business. The actual headwind from foreign exchange on sales was $50 million compared to the $40 million headwind assumed in our second quarter guidance range. And the divested Neurovascular business contributed $11 million less in sales in the second quarter compared to the same quarter last year.

Now I'll move to the detailed review of our business performance and operating results in the quarter. Starting with DES, worldwide revenues came in at $318 million in the second quarter, representing a constant currency decrease of 18% compared to the second quarter of 2011. U.S. DES revenues were $140 million in the quarter, representing a decline of 33% compared to the second quarter last year. This decrease was primarily due to a strong comparison to the prior year quarter driven by the launch of ION in the second quarter of 2011, lower share due to recent competitive product launches, lower ASPs and continued softness in PCI volumes.

We've completed our conversion from PROMUS and returned to fully stent manufactured DES margins in the U.S. late in the quarter. We also began the launch of PROMUS Element long length in early June, which has already began contributing to share recapture. We estimate that our U.S. DES share was down approximately 700 basis points from Q1 mainly due to the launch of competitive products and not having PROMUS Element Plus long length for most of the quarter.

Trialing of the competitor's product lasted longer than anticipated, with April being our low watermark. However, we have been recovering shares since April, with sequential improvements in May and June, and we exited the quarter with an estimated share in the low-40s. We expect to further stabilize our share position in the second half as we complete the introduction of PROMUS Element Plus long length and benefit from recent contacting wins that we expect to contribute significant incremental revenue.

International DES sales of $178 million represented a decrease of 2% in constant currency compared to Q2 of last year. In Japan, the launch of PROMUS Element has been very well received, and we estimate we have grown our share there more than 300 basis points over the prior year. We are also continuing to build momentum with our Element platform in the emerging markets, including India, Brazil and China, and expect this to accelerate through this year.

Moving to CRM. Worldwide CRM revenue was $488 million in the second quarter, representing a constant currency decrease of 8% compared to Q2 last year. In the U.S., CRM revenue of $284 million represented a 10% decrease from the second quarter of 2011. International CRM sales of $204 million were down 5% in constant currency compared to the prior year.

On a worldwide basis, defib sales were $355 million in Q2, which was down 7% in constant currency from the second quarter of 2011. In the U.S., defib sales were $220 million. This was down 10% compared to Q2 last year due primarily to the market declines experienced in the second half of last year, the placement headwinds in our business and a lower level of bulk sales.

However, these factors were partially offset by continued and significant increase in sales of our highly reliable RELIANCE defib lead platform within the quarter. We continue to launch our new line of defibrillators in the U.S. This innovative new tiered product offering continues to be very well received in the marketplace, and we plan to continue promoting their differentiated features as we continue to launch.

Looking at the broader U.S. market, de novo defib implant volumes look like they continue to be relatively stable sequentially based on the data we have so far for the second quarter. If this proves out, it would make 3 straight quarters of relatively stable de novo volumes. However, we do want to see how the rest of the market reports and plan to continue to monitor the market conditions carefully before calling a bottom on implant rates.

International defib sales of $135 million represented a 3% decrease in constant currency from the second quarter of last year. We are launching new products in many countries outside the U.S. and expect improved performance during the second half of this year. Finally, in pacer, the launches of our INGENIO pacemaker family in both the U.S. in Europe are going very well, and we have received positive feedback from customers.

Moving on to our peripheral interventions business. PI delivered a strong, growth again, this quarter, with double-digit increases in Asia Pacific and Canada and 7% in the U.S. Worldwide revenue within this business was up 7% in constant currency in the second quarter. Once again, we drove higher growth from new product launches in stents, balloons and CTO devices, and we expect this growth to continue.

Average selling prices were favorable, benefiting from a favorable mix shift to higher ASP products. Looking forward, we have several other key product launches planned that we expect to help drive continued revenue growth throughout 2012 in this $700 million-plus business.

Worldwide non-stent Interventional Cardiology was down 4% constant currency. While revenue declined in the U.S. compared to the second quarter of last year, we were very encouraged that our international business turned positive for the first time in quite a while. We expect to launch new products in vascular access, balloons and IVUS later in the quarter and expect to see improvement in this business as a result. Worldwide Electrophysiology was flat in constant currency during the quarter as some softness in both the small chip and large chip U.S. businesses was offset by growth in other segments.

Our Endoscopy business had another solid quarter, with worldwide sales up 7% in constant currency, led by 8% growth in the U.S. This performance was a result of broad growth across several of our key product franchises. In addition, our bronchial thermoplasty business continued to build momentum, with revenues of $3 million in the quarter, which was nearly as much as we generated in all of 2011. We expect bronchial thermoplasty to be a meaningful contributor to revenue growth in 2013.

In constant currency, our worldwide Urology and Women's Health business was flat versus second quarter of last year, but was up 10% internationally. Urology business maintained its leadership position and delivered 6% worldwide constant currency growth, driven by strong international growth of 11%.

Our Women's Health business declined 13% on a worldwide constant currency basis, primarily due to continued pressure on elective procedures and concerns around the use of surgical mesh for pelvic organ prolapse. Outside of the U.S., our international Women's Health business experienced excellent growth and was up 16% in constant currency, driven by new product introductions, increased sales investments and the penetration of new therapies.

In Neuromodulation, we maintained the momentum that we built in the first quarter of the year and grew a very healthy 8% in the U.S. market and 32% internationally. Our strong growth was driven by a combination of effective commercial execution strategies and a broad product portfolio that leverages our unique Smooth Wave technology platform.

Moving on from sales. Adjusted gross profit margin for the second quarter was 68.5% or a 280 basis point improvement over the second quarter of last year. The increase was largely attributable to the continued mix shift towards self-manufactured product in DES as a result of the launches PROMUS Element in the U.S. and Japan, as well as expected benefits from our plants network optimization plan and continued value improvement programs.

Looking forward, we expect adjusted gross margins to be between 68% and 69% for the second half of this year. Adjusted SG&A expense was $641 million or 35.1% of sales in the second quarter compared to $639 million or 32.4% of sales in the second quarter of last year. During the second quarter of this year, benefits from cost saving initiatives were largely offset by weaker sales than expected and a charge related to the termination of a program. Looking ahead, we expect adjusted SG&A to be between 33% and 34% as a percentage of sales in the second half of the year.

Research and development expenses were $213 million for the second quarter or 11.6% of sales. This compares to $223 million in the second quarter of 2011. We expect R&D spending to be somewhat higher in the second half of the year, largely due to the acquisition of Cameron Health. Royalty expense was $48 million or 2.6% of sales compared to $52 million in the second quarter of last year. Consistent with the prior year, we expect royalty expense to step down in the second half as we reach lower per unit royalty rate tiers under our annual volume-based arrangements.

On an adjusted basis, pretax operating income was $351 million or 19.2% of sales, down 20 basis points from the second quarter of last year. The decrease in adjusted operating margins was primarily due to the impact of lower sales, which was largely offset by higher adjusted gross margins. GAAP operating loss, which includes GAAP to adjusted items that had a negative impact of $3.643 billion on a pretax basis, was $3.404 billion in the second quarter. The primary GAAP to adjusted items in the quarter were: the estimated pretax goodwill impairment charge of $3.4 billion that I discussed earlier, a pretax intangible asset impairment charge of $129 million and pretax net litigation-related charges of $69 million.

The intangible asset impairment charge relates to a write-down of in-process research and development recorded in connection with the acquisition of Sadra Medical. Due in part to changes in the regulatory environment, we revised our expectations of the required effort, time and cost involved in completing the in-process projects and bringing related products to market. These changes result in intangible asset impairment charge in the quarter. Despite the charge, we continue to believe that the unique technology required through the Sadra acquisition represents a significant opportunity for us in the structural heart market.

Now I'll move on to the other income expense. Interest expense was $64 million in the second quarter, which was $9 million lower than the second quarter of last year, primarily due to our prepaying $1.25 billion of debt in the first half of last year. Our average interest expense rate in the second quarter was 5.4% or about 20 basis points higher than the second quarter of last year.

Our tax rate for the second quarter was approximately 1.1% on a reported GAAP basis and 15% on an adjusted basis. Our adjusted tax rate in the second quarter remain consistent with the expected full year operational tax rate of 16%. We expect our adjusted tax rate to be slightly higher than 16% over the remainder of 2012 as the Q1 and Q2 timing items reverse.

Moving on to the balance sheet. DSO of 62 days was up 1 day compared to the second quarter of 2011 due to continued weakness in certain areas of Europe, partially offset by solid progress in collecting overdue Spanish receivables and strong U.S. collections. Despite lower inventory levels, days inventory on hand of 141 days were up 18 days compared to the second quarter of last year, primarily due to the lower cost of goods sold due to the PROMUS Element transition.

On a reported GAAP basis, operating cash flow was $407 million compared to $390 million in the second quarter of last year. During the second quarter, we received approximately $60 million of receipts from the Spanish government, representing a majority of outstanding invoices that were overdue in 2011.

Q2 2012 GAAP operating cash flow included $31 million of restructuring payments compared to $38 million in the second quarter of last year. Excluding the restructuring payments, Q2 2012 operating cash flow was $438 million compared to $428 million in the second quarter of the prior year. Capital expenditures were $52 million in the second quarter of this year compared to $82 million in the second quarter of last year.

Given the favorability in Q2, we now expect our adjusted free cash flow to be closer to $1.1 billion than our previous estimate of $1 billion. Reported free cash flow was $355 million in the second quarter of this year compared to $308 million in the second quarter of last year.

Turning to share repurchases. We repurchased 18 million shares for approximately $112 million in the second quarter. During the past 4 quarters, we have repurchased 122 million or approximately 8% of our outstanding shares. At our current stock price, we estimate that we have almost $500 million of remaining capacity under our authorized share repurchase programs. We continue to believe that our stock price is undervalued and now expect to utilize approximately 1/2 of our full year adjusted free cash flow of $1.1 billion for share repurchases in 2012, subject to business development opportunities, market conditions, our stock price, regulatory trading windows and other factors.

Let me now briefly provide some perspective on our outlook and walk you through our guidance for the third quarter, as well as updated guidance for the full year. Looking ahead over the rest of the year, we expect to continue to face a challenging competitive environment and dynamic market conditions. We believe the risks of increasing macroeconomic weakness, particularly in Europe, and softening procedure volumes are real. As a result, we are carefully monitoring conditions and have applied what we believe is a reasonable level of conservatism in our guidance to account for these factors.

However, despite these uncertainties, we believe there's reason to be positive. We have recently launched key new products in most of our businesses and are seeing mid-single digit or better sales growth in several of them. We have an opportunity to turn improved execution into market share gains and to improve in our defib and Women's Health businesses in the U.S. as we anniversary significant prior year market declines. As a result, we remain focused on returning to top line growth in the near term. At the same time, we also believe we have significant incremental opportunities to enhance profitability and expect to continue to generate a very strong cash flow.

With that background, we expect consolidated third quarter sales to be in the range of $1,725,000,000 to $1,825,000,000. If current foreign exchange rates hold constant, we estimate that the headwind from foreign exchange will be approximately $50 million or around 270 basis points relative to the third quarter of last year.

On an operational basis, we expect consolidated Q3 sales to be in the range of up 1% to down 5% compared to the third quarter of last year. On a worldwide basis, we expect DES revenue to be the range of $295 million to $325 million and CRM revenue to be in the range of $445 million to $475 million in the third quarter. We expect third quarter adjusted EPS to be in the range of $0.14 to $0.17 per share and reported GAAP EPS to be in the range of $0.06 to $0.09 per share.

Moving to the full year. We now estimate that consolidated 2012 sales will be between $7.2 billion and $7.4 billion. Assuming that current foreign exchange rates hold constant, we expect the full year headwinds from foreign exchange to be approximately $150 million and the Neurovascular divestiture to be $40 million.

On an operational basis, consolidated 2012 sales should be in the range of flat to down 3%, with year-over-year growth rates improving sequentially in the second half as we benefit from new product launches, share recovery in the U.S. DES market, increasing contributions from emerging markets and easier comparables in our U.S. defib and Women's Health businesses as we anniversary the significant declines we experienced last year.

From an earnings standpoint, we now expect adjusted EPS for the full year 2012 to be in the range of $0.62 and $0.68 and would, again, encourage you to model the midpoint of that range. This guidance now includes $0.01 of dilution from the acquisition of Cameron Health, which we closed in the second quarter. On a reported GAAP basis, we expect net loss for the year to be in the range of $2.09 to $2.16 per share. That's it for guidance.

Before we move to Q&A, we'd like to announce that Sean Wirtjes will be transitioning to be our Controller of Asia Pacific and will be replaced by Michael Campbell, the current controller of Asia Pacific. Sean has done a very good job heading up the Investor Relations function here at Boston Scientific, and we wish him well in his next assignment.

We'd also like to welcome Michael Campbell, our next Vice President of Investor Relations. Michael has been with the company for over 15 years and brings a wealth of both company and financial experience. Sean and Michael will move into their new roles full time next month, following a short transition period.

With that I'll turn it back to Sean, who will moderate the Q&A. Sean?

Sean Wirtjes

Thanks, Jeff. Linda, let's open it up to questions for the next 20 minutes or so. [Operator Instructions] Please go ahead, Linda.

Question-and-Answer Session


[Operator Instructions] We do have a question from the line of Glenn Novarro with RBC Capital Markets.

Glenn J. Novarro - RBC Capital Markets, LLC, Research Division

I wonder if you can drill down a little bit more on what's happening in the ICD business, specifically for Boston Scientific. And I'm wondering if you can drill down between single, dual and tri-chamber share. I'm guessing that in the tri-chamber market, you're losing share to St. Jude's Quadpole. But I'm wondering how you're holding up in the single and dual chamber segment of the market. And then I had a follow-up.

Michael F. Mahoney

It's Mike Mahoney. I'd just like to comment on that. For the quarter overall, we continue to see nice sustainable share and slight uptick in our de novo implants based on the heels of our INCEPTA, ENERGEN and INGENIO lines. As mentioned on the call, we continue to see some headwinds in the replacement market. And overall to your question on CRT-D, we see a stable to slightly declining share position in CRT-D offset by a slight increase in de novo overall ICD share.

Glenn J. Novarro - RBC Capital Markets, LLC, Research Division

And then just as a follow-up, we would have expected you to do a little bit better in terms of U.S. ICD number, just given the issues that St. Jude is having. And I know you called out the RELIANT (sic) [RELIANCE] doing very well. Are you surprised that you're not able to pick up more generator sale?

Michael F. Mahoney

Good question. We're really optimistic about the trend. We're seeing continued lead percentages increase quarter -- actually month-over-month. So we continue to see an uptick in our leads based on the high performance, and that is an encouraging trend for the future. Clearly, we'd like to convert that to can sales as well, per your comment. So we're not satisfied with that can conversion yet, but we continue to have momentum on the lead side. And we believe over time, with the RELIANCE lead and our platform -- as it continues to roll out across the U.S. with our pin platform, our battery platform and the sustainability of our lead performers will be a positive trend for our business.

Glenn J. Novarro - RBC Capital Markets, LLC, Research Division

Is there any feedback you're getting from your sales force as to why you're not picking up the generator sale? And that's my last question. I'll get back into queue.

William H. Kucheman

As you know, traditionally, this has been a market where share is difficult to move. And absent large onetime events, share has moved slowly. The good news is our portfolio position really has never been stronger at Boston Scientific, and I think if you look at our current platforms that we've launched this year and with the pending approval in the first half of next year at Cameron, we really had never had a better portfolio end to end in our business. So as we look forward, we're optimistic about the future of our CRM business.


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

James Francescone - Morgan Stanley, Research Division

This is actually James in for David. First question on gross margins, and I apologize if I missed this our line dropped in the middle of the call. But your gross margin strength in the quarter, I think certainly margins were a little stronger than we would've expected considering that you missed in what we would consider some of your higher-margin products, I mean. So what was driving the strength there? And to what extent is that sustainable through the rest of the year?

Jeffrey D. Capello

James, this is Jeff. So the gross margins, frankly, were not a lot stronger than we expected. I think we are very clear with people that we thought that gross margins would expand as we went through the year. And the strength of PROMUS Element replacing PROMUS, that was a big part of our short-term cost opportunities in terms of expanding gross and operating margins, coupled with the benefits of getting manufacturing ramped up at our low-cost manufacturing facility down in Costa Rica, as well as our value improvement programs. So those initiatives are working. That was part of the plan a couple of years ago, and the team has executed pretty well despite some lower share within DES. So as you look at the gross margin picture year-over-year, the big factor was the PROMUS Element. That conversion to PROMUS, that was a significant part of the margin expansion. But also a big part of it was the standard cost reduction of moving a lot of our manufacturing down to Costa Rica and the consistent discipline of taking out at least 5% of our standard cost of goods sold. So those 3 factors more than offset the continued price erosion that we experienced. Looking forward, 68% to 69% is the guidance for the back half of the year. Frankly, for this quarter, if we had done better from a DES perspective and the CRM volumes have been stronger, we would've pushed a lot closer to 69%-plus. So this is all part of the plan that was put in place to drive up gross margin. And I think the team is executing pretty well in it.

James Francescone - Morgan Stanley, Research Division

Okay, perfect. Then on the stent side, can you just give a little more granularity in terms of your share in the quarter in the U.S.? And I think you said it was exiting the quarter in the high 40s. Where do you think that gets back to in the back of the year?

William H. Kucheman

James, this is Hank. We see the fact, and I think we have alluded to this on previous calls, that we anticipated that due to the competitive trialing that we would experience, what we refer to as an air pocket, and we hit that air pocket. And the low point, as I said, was in April, and then we saw recovery in May and further recovery in June. So I'm very happy with where we landed as we exited the quarter. I think that momentum will continue, as I alluded to or described in my script, to where we get back in the 40s. One of the things to keep in mind is the fact that our PROMUS Element long length did not launch until late in the quarter. And we believe that, that will be a key contributor to not only stabilizing, but increasing our share position as we march through the second half of the year.

Jeffrey D. Capello

James, just to be clear, we weren't in the high-40s at the end of the quarter. We were at 40%, right at 40%.

James Francescone - Morgan Stanley, Research Division

Okay, helpful. And then is there any way to quantify how much of the R&D disconnect was driven by valve spending or how much that item is going to be worth relative to your prior expectations?

Jeffrey D. Capello

We're not going to get into a lot of detail. The most helpful thing we can point you to is as you look at other people that have come into the U.S. market with clinical programs, clearly, the FDA has been more specific and more expansive in terms of their expectation of clinical programs. And so we are kind of reading that signal and adjusting our expectations accordingly in terms of our expected spend.


We have a question from the line of Mike Weinstein with JP Morgan.

Michael N. Weinstein - JP Morgan Chase & Co, Research Division

Maybe, Jeff, just talk about your thoughts on the overall growth profile of the company in light of this second quarter weakness that you saw on the DES and CRM sides of the business. I know you're hoping to exit the year in positive territory in terms of constant currency revenue growth. Do you still feel like that's a reasonable target?

Jeffrey D. Capello

Well, clearly, the performance in DES was a bit of a setback this quarter. Having said that, as we look at kind of the back half, despite a weaker second quarter DES-wise, as Hank has said, having the long stent -- the 2 sizes that we didn't have until the very end of the quarter will provide us a big shot in the arm of the back of the year. That, with a little bit better execution, we think, is going to get us back into the low-40s from a share perspective. And as you look at kind of the back half of last year, we ended last year with 46% share in DES, and we had 51% in the second quarter of last year. So we're up against easier comps in the back half from a stent perspective. So we think we'll kind of -- we'll recover, and we're seeing signs of that, so that's good news. The CRM market, we don't call from the beginning. Kind of you saw kind of for our kind of recordkeeping kind of 5% unit -- market declines in the first quarter of '11, 8% in the second quarter and then 10%, 10% was 3 and 4. So we're now seeing kind of some stabilization on the units, and we expect that to be kind of be -- unit-wise, kind of flattish, maybe slightly negative to flattish in the back half of this year. So the CRM market, we think, is going to stabilize. We kind of want to see Medtronic report before we officially conclude that. We think that's going to happen. So that means those 2 businesses, we think, will do better in the second half than we did in the front half. If you couple on top of the performance the other businesses, which represent 42% of sales this quarter, frankly, they all performed extremely well. And you put on top of that the emerging markets investment return that we expect [indiscernible]acceleration. So we're optimistic that we can get back to, hopefully, breakeven probably by the fourth quarter from a revenue perspective. Is there some risk in that? There might be some risk in that depending on the end markets. But we've got a number of favorable factors that we expect to benefit from.

Michael N. Weinstein - JP Morgan Chase & Co, Research Division

Okay, that's helpful. And Jeff, let me ask you on -- just on capital allocation. You and I have had this discussion, the positive is you guys have in buying back stock over the last 4 quarters as you called out. But that, obviously, isn't helping the share price at this point. Can you just, again, tell us why buybacks are better use of your cash versus the dividend?

Jeffrey D. Capello

Well, from where the company stands, frankly, I get this question all the time. You're buying back stock and the share price isn't moving. The reason the share price isn't moving isn't related to the share repurchases. It's related to the revenue. And once we reestablishe breakeven to slightly positive revenue trajectory, the share price is going to move. And it's going to move, I think, quite a bit. And we're going to look back at the share repurchases that we've done here over the last year and I think it's going to be a very good deal for the shareholders. So I'd say that, first of all. Second of all, the combination of driving the share count down at a low price with moving the revenue growth to positive and getting to low-single digits will be a much higher return for the shareholders than a dividend. So at this point in time, until we get the revenue growth back to positive, where we want it, a dividend is more of a third priority behind share repurchases and bolt-on acquisitions to drive the revenue of the company.

Michael N. Weinstein - JP Morgan Chase & Co, Research Division

And then last one just on the acquisition side. I know you guys had signaled that you were being active, going back a quarter ago, and that you're looking at different assets, maybe ones that actually had revenue stream at this point. Can you just give us a sense of what we should expect on the development front in the back half of the year?

Jeffrey D. Capello

I think we'll continue to look at different assets and look at what they bring to Boston Scientific. That is a "search for needle in a haystack" type of approach. Because we do have some disciplined financial expectations, and we're going to be really critical of assets as we look at them. So it's just going to depend on what's available and what the value equation is for shareholders. So yes, we will be active. Yes, we will be disciplined. And very difficult to predict what will get done, but we'll continue to look pretty hard at adding technology that will improve our growth outlook.


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

Bruce M. Nudell - Crédit Suisse AG, Research Division

Hank, with regards to guidance and drug-eluting stents, you're positing momentum in share in the U.S. and yet the guidance range is $295 million to $325 million versus $318 million this quarter. I know that Q3 is seasonally weak in Europe. Could you just reconcile improving share gains by constancy in overall revenues?

William H. Kucheman

I think it's multifactorial. I think what you hear us saying is we exited kind of in the 40% range here in the U.S., and I think with longs, we can improve up on that position. But if you look at the overall market, ASP pressure is still there, and the impact that we're seeing from the alignment of physicians with hospitals, as well as with RAC audits, are having an impact on the overall number of procedures that are being done. So if you add up all those factors, in terms of revenue that you put on the board, it tends to be a little bit less than more. But that's the way I would kind of handicap it at this stage in the U.S. for sure.

Bruce M. Nudell - Crédit Suisse AG, Research Division

Okay. And I agree with Jeff that the key to the stock price is positive revenue and probably the biggest swing factor that's not in many models right now is Cameron. And my question is, what sort of worldwide share gains can you get with this first device in the near rather than longer term? I think you intimated earlier-than-expected approval is plausible now, and certainly, the panel indicated that. So it's kind of a closer potential driver than a longer-term driver. And I'm just wondering if you could help scale that for us.

William H. Kucheman

Sure. And I'm going to ask Mike Mahoney to comment on that one, Bruce.

Michael F. Mahoney

Bruce, a couple of items. One is in terms of the overall market -- well, I guess, first of all in terms of the approval. As we indicated, we expect approval, clearly, in the first half of 2013. And hopefully, it will come sooner than that projection, which is great news. And that we've closed the deal -- it's been about 30 days since we closed the deal, and obviously, the integration teams are working closely together. On the market itself, what we talked about is approximately $750 million worldwide market in the future for this product. As you know, we're the only company that offers it. This a new opportunity for us. In terms of actual share projections, at this point we haven't called specifically what our anticipated share gains will be. We do believe this will drive share, not only in de novo implants with primary and secondary patients, but also in replacements, patients who already have tranvenous lead systems who would need a revision procedure. So we do believe there is share gain in both de novo implants and revision procedures, and it's a very large market. And I think as we go forward, we would provide more clarity in 2013 as what our share expectations will be.


We have a question from the line of Kristen Stewart with Deutsche Bank.

Kristen M. Stewart - Deutsche Bank AG, Research Division

I just wanted to go back to the gross margins. I was wondering if you can maybe just help us bridge just kind of the components on a year-to-year basis as you've done in the past between mix and maybe price. And then, also how we should think about foreign currency maybe influencing this quarter and also the guidance going forward since I believe your hedges do roll through that line and probably have an upper bias on the gross margin percentage?

Jeffrey D. Capello

Yes, so, Kristen, I'm not going to get into intricate detail on the gross margins. But suffice to say, that the PROMUS Element conversion was the largest positive contributor. Slightly behind that was the benefits from moving more manufacturing to Costa Rica and the value improvement programs. And then the third factor was price, which was less than the other 2. So that's about as much detail as I'm prepared to get into.

Kristen M. Stewart - Deutsche Bank AG, Research Division

Okay. Is it correct, though, to think about FX and the hedging just kind of putting at least upward pressure on gross margins, improving them basically as you roll the hedges through?

Kristen M. Stewart - Deutsche Bank AG, Research Division

FX was slightly positive for us, given the way we hedge. But we're -- unlike some other of our competitors, we hedge out -- we're predominately hedged for this year, significantly hedged for next year and partially hedged for the following year. It's just part of our programs. So FX doesn't move us around as much as other companies.

Kristen M. Stewart - Deutsche Bank AG, Research Division

Okay, perfect. And then just going back to Lotus. I know you'd mentioned you recalibrated, I guess, in process R&D, that you were down on longer timelines, you said, not just Europe but also the U.S. And maybe can you just help us understand what is different about the regulatory path relative to what you had included in expectations?

Jeffrey D. Capello

Well, what's predominantly different is the size of the clinical trials the and involvement with regard to the FDA approval process. It really isn't much different relative to the European CE Mark process or timing. So it's more of the U.S. cost of getting through the clinical trial process.


You have a question from the line of Matthew Taylor from Barclays.

Daniel Sollof - Barclays Capital, Research Division

It's actually Dan, stepping in for Adam. Quick questions. A couple of quick ones of the low voltage side, actually. So you guys have launched INGENIO. It looks like you guys are confident you guys can kind of regain some share there. So I guess my first question is what -- given the new products, are you guys seeing some improvement in like kind of the pricing dynamic there? Or is the pricing pressure still kind of stable despite the new products?

William H. Kucheman

On the pricing side, on the worldwide pacer market, we're seeing low-single digits, call them in the 2% to 4% range for pricing in pacer. We do believe with some of the new features of our INGENIO platform, which is the first platform we've launched in a decade at Boston Scientific, that as we continue to roll that product out it should improve the pricing profile. But currently, we're seeing that 2% to 4% negative range.

Daniel Sollof - Barclays Capital, Research Division

Okay, that's helpful. then on the MRI-safe pacer side, I was dropped off for a few seconds earlier, so if you could provide an update. But so I guess for Europe, would that still be on track? I mean, I'm assuming the trial is going on now, would that still be on track for launch next year? And then, I guess, maybe later part of next year, early '14 for the U.S.?

William H. Kucheman

The MRI-safe program for brady in Europe will be launched in the third quarter. And we'll actually do our first implants next week. So the MRI plan is on schedule in Europe.


We have a question from the line of Larry Biegelsen from Wells Fargo.

Kevin Strange - Wells Fargo Securities, LLC, Research Division

This is Kevin in for Larry. Just a quick question on Japan. The Japan price cuts that went into effect earlier in the year, can you provide a little bit more color on how severe they were and whether there were more significant price cuts on certain devices such as stents and pacers?

Jeffrey D. Capello

Yes. So the price cuts in Japan tend to happen every 2 years as part of kind of their methodology that they set prices, and they weren't any different than we expected, kind of in line with trends in prior years. I'm not sure I have all the details to specify price cuts versus -- DES versus CRM, but there weren't terribly dissimilar, if my memory serves me correctly.

Kevin Strange - Wells Fargo Securities, LLC, Research Division

Okay. And then one follow up question on the pipeline. I think it was mentioned on the last call, but you might be able to provide some additional color on your renal denervation program on this call. Would that be possible? And if you could provide us an update on first demand and potential launch that'd be helpful?

William H. Kucheman

Well, this is Hank, Kevin. Bottom line, we're still on plan to launch a CE Mark-ed device in Europe next year. And as we discussed in the last call, we believe will be first demand later this year that, obviously, would lead us to that CE Mark indication in 2013.

Sean Wirtjes

With that, we're going to conclude today's call. Thanks for joining us. We appreciate your interest in Boston Scientific. Before you disconnect, Linda will give you all the pertinent details for the replay.


Ladies and gentlemen, this conference will be available for replay after 11 a.m. Eastern time today until August 9 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 252545. International participants, dial 1 (320) 365-3844.

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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