Boston Scientific Corporation (BSX) Q2 2012 Earnings Report, Transcript and Summary

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.

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?

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…

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…

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

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

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.

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.

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?

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.

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.

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.

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?

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.

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?

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.

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%.

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?

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?

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?

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?

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?

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.

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

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.

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?

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.

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?

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.

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?

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.

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?

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.

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.?

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.

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?

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.

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?

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.

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.

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