BOSTON SCIENTIFIC CORP - Quarter Report: 2020 September (Form 10-Q)
UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-Q
| ☑ | QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 | ||||
For the quarterly period ended September 30, 2020
OR
| ☐ | TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 | ||||
Commission File No. 1-11083
BOSTON SCIENTIFIC CORPORATION
(Exact name of registrant as specified in its charter)
| Delaware | 04-2695240 | |||||||
| (State or other jurisdiction of incorporation or organization) | (I.R.S. Employer Identification No.) | |||||||
300 Boston Scientific Way, Marlborough, Massachusetts 01752-1234
(Address of Principal Executive Offices) (Zip Code)
508 683-4000
(Registrant’s telephone number, including area code)
Securities registered pursuant to Section 12(b) of the Act:
| Title of each class | Trading Symbol | Name of each exchange on which registered | ||||||||||||
| Common Stock, $0.01 par value | BSX | New York Stock Exchange | ||||||||||||
| 0.625% Senior Notes due 2027 | BSX27 | New York Stock Exchange | ||||||||||||
| 5.50% Mandatory Convertible Preferred Stock, Series A, par value $0.01 per share | BSX PR A | New York Stock Exchange | ||||||||||||
Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes ☑ No ☐
Indicate by check mark whether the registrant has submitted electronically every Interactive Data File required to be submitted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit such files). Yes ☑ No ☐
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, a smaller reporting company, or an emerging growth company. See the definitions of “large accelerated filer,” “accelerated filer,” “smaller reporting company,” and "emerging growth company" in Rule 12b-2 of the Exchange Act.
| Large accelerated filer | ☑ | Accelerated filer | ☐ | ||||||||
| Non-accelerated filer | ☐ | Smaller reporting company | ☐ | ||||||||
| Emerging growth company | ☐ | ||||||||||
If an emerging growth company, indicate by check mark if the registrant has elected not to use the extended transition period for complying with any new or revised financial accounting standards provided pursuant to Section 13(a) of the Exchange Act. ☐
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act). Yes ☐ No ☑
The number of shares outstanding of Common Stock, $0.01 par value per share, as of October 30, 2020 was 1,431,921,459.
TABLE OF CONTENTS
| Page No. | ||||||||
2
PART I
FINANCIAL INFORMATION
ITEM 1. CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
BOSTON SCIENTIFIC CORPORATION AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS (UNAUDITED)
| Three Months Ended September 30, | Nine Months Ended September 30, | ||||||||||||||||||||||
| (in millions, except per share data) | 2020 | 2019 | 2020 | 2019 | |||||||||||||||||||
| Net sales | $ | 2,659 | $ | 2,707 | $ | 7,204 | $ | 7,831 | |||||||||||||||
| Cost of products sold | 869 | 777 | 2,465 | 2,265 | |||||||||||||||||||
| Gross profit | 1,790 | 1,930 | 4,740 | 5,566 | |||||||||||||||||||
| Operating expenses: | |||||||||||||||||||||||
| Selling, general and administrative expenses | 984 | 1,012 | 2,760 | 2,849 | |||||||||||||||||||
| Research and development expenses | 315 | 306 | 857 | 866 | |||||||||||||||||||
| Royalty expense | 12 | 15 | 32 | 48 | |||||||||||||||||||
| Amortization expense | 197 | 178 | 595 | 498 | |||||||||||||||||||
| Intangible asset impairment charges | 219 | — | 452 | 105 | |||||||||||||||||||
| Contingent consideration expense (benefit) | 6 | 8 | (102) | (9) | |||||||||||||||||||
| Restructuring charges (credits) | 3 | 3 | 16 | 10 | |||||||||||||||||||
| Litigation-related net charges (credits) | 260 | 25 | 260 | (108) | |||||||||||||||||||
| 1,995 | 1,547 | 4,870 | 4,258 | ||||||||||||||||||||
| Operating income (loss) | (205) | 383 | (130) | 1,308 | |||||||||||||||||||
| Other income (expense): | |||||||||||||||||||||||
| Interest expense | (86) | (95) | (265) | (294) | |||||||||||||||||||
| Other, net | 64 | (197) | 9 | (322) | |||||||||||||||||||
| Income (loss) before income taxes | (227) | 91 | (386) | 693 | |||||||||||||||||||
| Income tax expense (benefit) | (72) | (35) | (94) | (11) | |||||||||||||||||||
| Net income (loss) | (155) | 126 | (292) | 704 | |||||||||||||||||||
| Preferred stock dividends | (14) | — | (19) | — | |||||||||||||||||||
| Net income (loss) available to common stockholders | $ | (169) | $ | 126 | $ | (311) | $ | 704 | |||||||||||||||
| Net income (loss) per common share — basic | $ | (0.12) | $ | 0.09 | $ | (0.22) | $ | 0.51 | |||||||||||||||
Net income (loss) per common share — assuming dilution | $ | (0.12) | $ | 0.09 | $ | (0.22) | $ | 0.50 | |||||||||||||||
| Weighted-average shares outstanding | |||||||||||||||||||||||
| Basic | 1,430.9 | 1,393.1 | 1,413.0 | 1,390.6 | |||||||||||||||||||
| Assuming dilution | 1,430.9 | 1,412.2 | 1,413.0 | 1,409.7 | |||||||||||||||||||
See notes to the unaudited condensed consolidated financial statements. Amounts may not foot due to rounding.
3
BOSTON SCIENTIFIC CORPORATION AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME (LOSS) (UNAUDITED)
| Three Months Ended September 30, | Nine Months Ended September 30, | ||||||||||||||||||||||
| (in millions) | 2020 | 2019 | 2020 | 2019 | |||||||||||||||||||
| Net income (loss) | $ | (155) | $ | 126 | $ | (292) | $ | 704 | |||||||||||||||
| Other comprehensive income (loss), net of tax: | |||||||||||||||||||||||
| Foreign currency translation adjustment | 84 | (2) | (104) | 4 | |||||||||||||||||||
| Net change in derivative financial instruments | (64) | 62 | (15) | 102 | |||||||||||||||||||
| Net change in defined benefit pensions and other items | — | — | — | (1) | |||||||||||||||||||
| Total other comprehensive income (loss) | 20 | 60 | (119) | 105 | |||||||||||||||||||
| Total comprehensive income (loss) | $ | (135) | $ | 186 | $ | (411) | $ | 809 | |||||||||||||||
See notes to the unaudited condensed consolidated financial statements. Amounts may not foot due to rounding.
4
BOSTON SCIENTIFIC CORPORATION AND SUBSIDIARIES
CONDENSED CONSOLIDATED BALANCE SHEETS
| As of | |||||||||||
| (in millions, except share and per share data) | September 30, 2020 | December 31, 2019 | |||||||||
| (unaudited) | |||||||||||
| ASSETS | |||||||||||
| Current assets: | |||||||||||
| Cash and cash equivalents | $ | 2,022 | $ | 217 | |||||||
| Trade accounts receivable, net | 1,598 | 1,828 | |||||||||
| Inventories | 1,472 | 1,579 | |||||||||
| Prepaid income taxes | 174 | 195 | |||||||||
| Other current assets | 894 | 880 | |||||||||
| Total current assets | 6,160 | 4,699 | |||||||||
| Property, plant and equipment, net | 2,064 | 2,079 | |||||||||
| Goodwill | 10,137 | 10,176 | |||||||||
| Other intangible assets, net | 6,797 | 7,886 | |||||||||
| Deferred tax assets | 4,172 | 4,196 | |||||||||
| Other long-term assets | 1,516 | 1,529 | |||||||||
| TOTAL ASSETS | $ | 30,845 | $ | 30,565 | |||||||
| LIABILITIES AND STOCKHOLDERS’ EQUITY | |||||||||||
| Current liabilities: | |||||||||||
| Current debt obligations | $ | 11 | $ | 1,416 | |||||||
| Accounts payable | 452 | 542 | |||||||||
| Accrued expenses | 2,195 | 2,109 | |||||||||
| Other current liabilities | 644 | 800 | |||||||||
| Total current liabilities | 3,302 | 4,866 | |||||||||
| Long-term debt | 9,325 | 8,592 | |||||||||
| Deferred income taxes | 522 | 595 | |||||||||
| Other long-term liabilities | 2,132 | 2,635 | |||||||||
| Commitments and contingencies | |||||||||||
| Stockholders’ equity | |||||||||||
Preferred stock, $0.01 par value - authorized 50,000,000 shares - issued 10,062,500 shares as of September 30, 2020 and none as of December 31, 2019 | — | — | |||||||||
Common stock, $0.01 par value - authorized 2,000,000,000 shares - issued 1,679,428,209 shares as of September 30, 2020 and 1,642,488,911 shares as of December 31, 2019 | 17 | 16 | |||||||||
Treasury stock, at cost - 247,566,270 shares as of September 30, 2020 and December 31, 2019 | (1,717) | (1,717) | |||||||||
| Additional paid-in capital | 19,687 | 17,561 | |||||||||
| Accumulated deficit | (2,574) | (2,253) | |||||||||
| Accumulated other comprehensive income (loss), net of tax | 151 | 270 | |||||||||
| Total stockholders’ equity | 15,564 | 13,877 | |||||||||
| TOTAL LIABILITIES AND STOCKHOLDERS' EQUITY | $ | 30,845 | $ | 30,565 | |||||||
See notes to the unaudited condensed consolidated financial statements. Amounts may not foot due to rounding.
5
BOSTON SCIENTIFIC CORPORATION AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY (UNAUDITED)
| Preferred Stock | Common Stock | Treasury Stock | Additional Paid-In Capital | Accumulated Deficit | Accumulated Other Comprehensive Income (Loss), Net of Tax | ||||||||||||||||||||||||||||||||||||||||||
| (in millions, except share data) | Shares Issued | Par Value | Shares Issued | Par Value | |||||||||||||||||||||||||||||||||||||||||||
| As of December 31, 2018 | — | $ | — | 1,632,148,030 | $ | 16 | $ | (1,717) | $ | 17,346 | $ | (6,953) | $ | 33 | |||||||||||||||||||||||||||||||||
| Net income (loss) | 424 | ||||||||||||||||||||||||||||||||||||||||||||||
| Total other comprehensive income (loss) | 54 | ||||||||||||||||||||||||||||||||||||||||||||||
| Stock-based compensation | 6,001,343 | 28 | |||||||||||||||||||||||||||||||||||||||||||||
| As of March 31, 2019 | — | $ | — | 1,638,149,373 | $ | 16 | $ | (1,717) | $ | 17,374 | $ | (6,528) | $ | 87 | |||||||||||||||||||||||||||||||||
| Net income (loss) | 154 | ||||||||||||||||||||||||||||||||||||||||||||||
| Total other comprehensive income (loss) | (9) | ||||||||||||||||||||||||||||||||||||||||||||||
| Stock-based compensation | 949,557 | 48 | |||||||||||||||||||||||||||||||||||||||||||||
| As of June 30, 2019 | — | $ | — | 1,639,098,930 | $ | 16 | $ | (1,717) | $ | 17,422 | $ | (6,375) | $ | 78 | |||||||||||||||||||||||||||||||||
| Net income (loss) | 126 | ||||||||||||||||||||||||||||||||||||||||||||||
| Total other comprehensive income (loss) | 60 | ||||||||||||||||||||||||||||||||||||||||||||||
| Stock-based compensation | 2,243,579 | 89 | |||||||||||||||||||||||||||||||||||||||||||||
| As of September 30, 2019 | — | $ | — | 1,641,342,509 | $ | 16 | $ | (1,717) | $ | 17,510 | $ | (6,249) | $ | 138 | |||||||||||||||||||||||||||||||||
| Net income (loss) | 3,996 | ||||||||||||||||||||||||||||||||||||||||||||||
| Total other comprehensive income (loss) | 132 | ||||||||||||||||||||||||||||||||||||||||||||||
| Stock-based compensation | 1,146,402 | 50 | |||||||||||||||||||||||||||||||||||||||||||||
| As of December 31, 2019 | — | $ | — | 1,642,488,911 | $ | 16 | $ | (1,717) | $ | 17,561 | $ | (2,253) | $ | 270 | |||||||||||||||||||||||||||||||||
| Net income (loss) | 11 | ||||||||||||||||||||||||||||||||||||||||||||||
| Cumulative effect adjustment for adoption of ASU 2016-13 | (10) | ||||||||||||||||||||||||||||||||||||||||||||||
| Total other comprehensive income (loss) | (101) | ||||||||||||||||||||||||||||||||||||||||||||||
| Stock-based compensation | 4,388,331 | 28 | |||||||||||||||||||||||||||||||||||||||||||||
| As of March 31, 2020 | — | $ | — | 1,646,877,242 | $ | 16 | $ | (1,717) | $ | 17,589 | $ | (2,252) | $ | 168 | |||||||||||||||||||||||||||||||||
| Net income (loss) | (147) | ||||||||||||||||||||||||||||||||||||||||||||||
| Total other comprehensive income (loss) | (37) | ||||||||||||||||||||||||||||||||||||||||||||||
| Preferred stock issuance | 10,062,500 | — | 975 | ||||||||||||||||||||||||||||||||||||||||||||
| Common stock issuance | 29,382,500 | — | 975 | ||||||||||||||||||||||||||||||||||||||||||||
| Preferred stock dividends | (5) | ||||||||||||||||||||||||||||||||||||||||||||||
| Stock-based compensation | 493,824 | 50 | |||||||||||||||||||||||||||||||||||||||||||||
| As of June 30, 2020 | 10,062,500 | $ | — | 1,676,753,566 | $ | 17 | $ | (1,717) | $ | 19,590 | $ | (2,405) | $ | 131 | |||||||||||||||||||||||||||||||||
| Net income (loss) | (155) | ||||||||||||||||||||||||||||||||||||||||||||||
| Total other comprehensive income (loss) | 20 | ||||||||||||||||||||||||||||||||||||||||||||||
| Preferred stock dividends | (14) | ||||||||||||||||||||||||||||||||||||||||||||||
| Stock-based compensation | 2,674,643 | 97 | |||||||||||||||||||||||||||||||||||||||||||||
| As of September 30, 2020 | 10,062,500 | $ | — | 1,679,428,209 | $ | 17 | $ | (1,717) | $ | 19,687 | $ | (2,574) | $ | 151 | |||||||||||||||||||||||||||||||||
See notes to the unaudited condensed consolidated financial statements. Amounts may not foot due to rounding.
6
BOSTON SCIENTIFIC CORPORATION AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS (UNAUDITED)
| Nine Months Ended September 30, | |||||||||||
| (in millions) | 2020 | 2019 | |||||||||
| Cash provided by (used for) operating activities | $ | 835 | $ | 1,144 | |||||||
| Investing activities: | |||||||||||
| Purchases of property, plant and equipment | (217) | (275) | |||||||||
| Proceeds from sale of property, plant and equipment | 6 | 5 | |||||||||
| Payments for acquisitions of businesses, net of cash acquired | (3) | (4,382) | |||||||||
| Proceeds from royalty rights | 66 | — | |||||||||
| Payments for investments and acquisitions of certain technologies | (130) | (137) | |||||||||
| Proceeds from divestiture | 15 | 90 | |||||||||
| Payments for settlements of hedge contracts | — | (294) | |||||||||
| Cash provided by (used for) investing activities | (264) | (4,992) | |||||||||
| Financing activities: | |||||||||||
| Payment of contingent consideration and royalty rights established in purchase accounting | (132) | (135) | |||||||||
| Payments on short-term borrowings | (2,950) | (1,000) | |||||||||
| Proceeds from short-term borrowings, net of debt issuance costs | 2,245 | — | |||||||||
| Net increase (decrease) in commercial paper | (714) | 13 | |||||||||
| Payments on borrowings from credit facilities | (1,919) | — | |||||||||
| Proceeds from borrowings on credit facilities | 1,916 | — | |||||||||
| Payments on long-term borrowings and debt extinguishment costs | (1,000) | (1,472) | |||||||||
| Proceeds from long-term borrowings, net of debt issuance costs | 1,683 | 6,243 | |||||||||
| Cash dividends paid on preferred stock | (14) | — | |||||||||
| Net proceeds from issuance of preferred stock in connection with public offering | 975 | — | |||||||||
| Net proceeds from issuance of common stock in connection with public offering | 975 | — | |||||||||
| Cash used to net share settle employee equity awards | (59) | (64) | |||||||||
| Proceeds from issuances of common stock pursuant to employee stock compensation and purchase plans | 107 | 113 | |||||||||
| Cash provided by (used for) financing activities | 1,112 | 3,697 | |||||||||
| Effect of foreign exchange rates on cash | (8) | (2) | |||||||||
| Net increase (decrease) in cash, cash equivalents, restricted cash and restricted cash equivalents | 1,675 | (153) | |||||||||
| Cash, cash equivalents, restricted cash and restricted cash equivalents at beginning of period | 607 | 829 | |||||||||
| Cash, cash equivalents, restricted cash and restricted cash equivalents at end of period | $ | 2,282 | $ | 676 | |||||||
| Supplemental Information | |||||||||||
| Stock-based compensation expense | $ | 128 | $ | 116 | |||||||
| Fair value of contingent consideration recorded in purchase accounting | — | 127 | |||||||||
| Non-cash impact of transferred royalty rights | (66) | — | |||||||||
| As of September 30, | |||||||||||
| Reconciliation to amounts in the unaudited condensed consolidated balance sheets: | 2020 | 2019 | |||||||||
| Cash and cash equivalents | $ | 2,022 | $ | 277 | |||||||
Restricted cash and restricted cash equivalents included in Other current assets | 214 | 357 | |||||||||
Restricted cash equivalents included in Other long-term assets | 46 | 43 | |||||||||
| Cash, cash equivalents, restricted cash and restricted cash equivalents at end of period | $ | 2,282 | $ | 676 | |||||||
See notes to the unaudited condensed consolidated financial statements. Amounts may not foot due to rounding.
7
NOTES TO THE CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)
NOTE A – BASIS OF PRESENTATION
The accompanying unaudited condensed consolidated financial statements of Boston Scientific Corporation have been prepared in accordance with accounting principles generally accepted in the United States (U.S. GAAP) and with the instructions to Form 10-Q and Article 10 of Regulation S-X. Accordingly, they do not include all of the information and footnotes required by U.S. GAAP for complete financial statements. When used in this report, the terms, "we," "us," "our," and "the Company" mean Boston Scientific Corporation and its divisions and subsidiaries. In the opinion of management, all adjustments (consisting only of normal recurring adjustments) considered necessary for fair presentation have been included. Operating results for the three and nine months ended September 30, 2020 are not necessarily indicative of the results that may be expected for the year ending December 31, 2020. For further information, refer to the consolidated financial statements and footnotes thereto included in Item 8 of our most recent Annual Report on Form 10-K.
Amounts reported in millions within this quarterly report are computed based on the amounts in thousands. As a result, the sum of the components may not equal the total amount reported in millions due to rounding. Certain columns and rows within tables may not add due to the use of rounded numbers. Percentages presented are calculated from the underlying unrounded amounts.
Subsequent Events
We evaluate events occurring after the date of our most recent accompanying unaudited condensed consolidated balance sheet for potential recognition or disclosure in our financial statements. Those items requiring recognition in the financial statements have been recorded and disclosed accordingly. Those items requiring disclosure (non-recognized subsequent events) in the financial statements have been disclosed accordingly. Refer to Note H – Commitments and Contingencies and Note I – Stockholders' Equity for more information.
Accounting Standards Implemented Since December 31, 2019
ASC Update No. 2016-13
In June 2016, the FASB issued ASC Update No. 2016-13, Financial Instruments - Credit Losses (FASB ASC Topic 326, Financial Instruments - Credit Losses). We adopted the standard as of January 1, 2020 using the modified retrospective method. Under this method, we applied the new credit loss measurement guidance to financial assets measured at amortized cost on the date of adoption and recognized the cumulative effect of initially applying the standard as an adjustment to the opening balance of retained earnings. Results for reporting periods beginning after January 1, 2020 are presented in accordance with FASB ASC Topic 326. Prior period amounts have not been restated and are reported in accordance with legacy GAAP requirements in FASB ASC Topic 310, Receivables.
Upon the adoption of FASB ASC Topic 326, credit loss reserves are recorded when financial assets are established if credit losses are expected over the asset’s contractual life. These losses were previously expensed when it became probable that a loss would be incurred. As a result of the adoption of FASB ASC Topic 326, we recorded a net reduction to opening retained earnings on January 1, 2020 related to the establishment of credit loss reserves on Trade accounts receivable and recorded a corresponding increase in the Allowance for credit losses, a contra Trade accounts receivable account. The adoption had an immaterial impact on our financial position and results of operations.
ASC Update No. 2018-15
In August 2018, the FASB issued ASC Update No. 2018-15, Intangibles – Goodwill and Other – Internal-Use Software (Subtopic 350-40): Customer’s Accounting for Implementation Costs Incurred in a Cloud Computing Arrangement That Is a Service Contract. The purpose of Update No. 2018-15 is to align the requirements for capitalizing implementation costs incurred in a hosting arrangement that is a service contract with the requirements for capitalizing implementation costs incurred to develop or obtain internal-use software (and hosting arrangements that include an internal-use software license). Update No. 2018-15 is effective for annual periods beginning after December 15, 2019, including interim periods within those annual periods. Early adoption is permitted, including adoption in any interim period. We adopted Update No. 2018-15 in the first quarter of 2020. The adoption had an immaterial impact on our financial position and results of operations.
8
ASC Update No. 2018-18
In November 2018, the FASB issued ASC Update No. 2018-18, Collaborative Arrangements (Topic 808): Clarifying the Interaction Between Topic 808 and Topic 606. The purpose of Update No. 2018-18 is to clarify the interaction between FASB ASC Topic 808 and FASB ASC Topic 606, Revenue from Contracts with Customers (FASB ASC Topic 606) as FASB ASC Topic 808 did not provide comprehensive recognition or measurement guidance for collaborative arrangements, and the accounting for those arrangements was often based on an analogy to other accounting literature or an accounting policy election. Update No. 2018-18 is effective for annual periods beginning after December 15, 2019. We adopted Update No. 2018-18 in the first quarter of 2020. The adoption had an immaterial impact on our financial position and results of operations.
NOTE B – ACQUISITIONS AND STRATEGIC INVESTMENTS
Our unaudited condensed consolidated financial statements include the operating results for acquired entities from the respective date of acquisition. We did not complete any material acquisitions or divestitures during the first nine months of 2020. We have not presented supplemental pro forma financial information for prior acquisitions given their results are not material to our unaudited condensed consolidated financial statements. We recorded immaterial purchase price adjustments during the measurement period for the preliminary purchase price allocations of acquisitions in the first nine months of 2020. Transaction costs for these acquisitions were immaterial to our unaudited condensed consolidated financial statements and were expensed as incurred.
Q3 2019 YTD Acquisitions
BTG plc
On August 19, 2019, we announced the closing of our acquisition of BTG, a public company organized under the laws of England and Wales. BTG had three key portfolios, the largest of which is its interventional medicine portfolio (Interventional Medicine) that encompasses interventional oncology therapeutic technologies for patients with liver and kidney cancers, as well as a vascular portfolio for treatment of deep vein thrombosis, pulmonary embolism, deep venous obstruction and superficial venous disease. Following the closing of the acquisition, we began to integrate BTG's Interventional Medicine business into our Peripheral Interventions division.
In addition to the Interventional Medicine product lines, the BTG portfolio also included a specialty pharmaceutical business (Specialty Pharmaceuticals) comprised of acute care antidotes to treat overexposure to certain medications and toxins and a licensing portfolio (Licensing arrangements) that generated net royalties related to BTG intellectual property and product license agreements. Refer to Note D – Hedging Activities and Fair Value Measurements for additional information.
The transaction price consisted of upfront cash in the aggregate amount of £3.312 billion (or $4.023 billion based on the exchange rate at closing on August 19, 2019) for the entire issued ordinary share capital of BTG, whereby BTG stockholders received 840 pence (or $10.20 based on the exchange rate at closing) in cash for each BTG share. The transaction price included $404 million of cash and cash equivalents acquired. We implemented our acquisition of BTG by way of a court-sanctioned scheme of arrangement under Part 26 of the United Kingdom Companies Act 2006, as amended.
Purchase Price Allocation
We accounted for the acquisition of BTG as a business combination, and in accordance with FASB ASC Topic 805, Business Combinations (FASB ASC Topic 805), we recorded the assets acquired and liabilities assumed at their respective fair values as of the acquisition date. The final purchase price was comprised of the following components:
| (in millions) | |||||
| Payment for acquisition, net of cash acquired | $ | 3,619 | |||
9
The final purchase price allocation was comprised of the following components:
| (in millions) | |||||
| Goodwill | $ | 1,644 | |||
| Trade accounts receivable, net | 108 | ||||
| Inventories | 232 | ||||
| Other current assets | 252 | ||||
| Other intangible assets, net | 1,785 | ||||
| Other long-term assets | 537 | ||||
| Accrued expenses and other current liabilities | (308) | ||||
| Other long-term liabilities | (274) | ||||
| Deferred tax liability | (358) | ||||
| $ | 3,619 | ||||
We allocated a portion of the purchase price to the specific intangible asset categories as follows:
Amount Assigned (in millions) | Amortization Period (in years) | Risk-Adjusted Discount Rates used in Purchase Price Allocation | |||||||||||||||||||||||||||
| Amortizable intangible assets: | |||||||||||||||||||||||||||||
| Technology-related | $ | 1,709 | 10 | - | 18 | 11 | % | - | 12% | ||||||||||||||||||||
| Other intangible assets | 75 | 2 | - | 11 | 11% | ||||||||||||||||||||||||
| $ | 1,785 | ||||||||||||||||||||||||||||
As a result of our acquisition of BTG, we recognized goodwill of $1.644 billion, which is attributable to the synergies expected to arise from the acquisition and revenue and cash flow projections associated with future technologies. The goodwill is not deductible for tax purposes. We allocated $1.406 billion to our Peripheral Interventions reporting unit and $238 million to the Specialty Pharmaceuticals reporting unit.
Vertiflex, Inc.
On June 11, 2019, we announced the closing of our acquisition of Vertiflex, Inc. (Vertiflex), a privately-held company which developed and commercialized the Superion™ Indirect Decompression System, a minimally-invasive device used to improve physical function and reduce pain in patients with lumbar spinal stenosis (LSS). The transaction price consisted of an upfront cash payment of $465 million and contingent payments that are based on a percentage of Vertiflex sales growth in the first three years following the acquisition close. At the time of acquisition, we estimated the sales-based contingent payments to be in a range of zero to $100 million; however, the payments are uncapped over the three year earn-out period. Following the closing of the acquisition, we integrated the Vertiflex business into our Neuromodulation division.
Millipede, Inc.
On January 29, 2019, we announced the closing of our acquisition of Millipede, Inc. (Millipede), a privately-held company that has developed the IRIS Transcatheter Annuloplasty Ring System for the treatment of severe mitral regurgitation. We were an investor in Millipede since the first quarter of 2018 as part of an investment and acquisition option agreement, whereby we purchased a portion of the outstanding shares of Millipede, along with newly issued shares of the company, for an upfront cash payment of $90 million. In the fourth quarter of 2018, upon the successful completion of a first-in-human clinical study, we exercised our option to acquire the remaining shares of Millipede. We held an interest of approximately 20 percent immediately prior to the acquisition date. We remeasured the fair value of our previously-held investment based on the implied enterprise value and allocation of purchase price consideration according to priority of equity interests. The transaction price for the remaining stake consisted of an upfront cash payment of $325 million and up to an additional $125 million payment upon achievement of a commercial milestone. Following the closing of the acquisition, we integrated the Millipede business into our Interventional Cardiology division.
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Purchase Price Allocation
We accounted for the acquisitions of Vertiflex and Millipede as business combinations, and in accordance with FASB ASC Topic 805, we recorded the assets acquired and liabilities assumed at their respective fair values as of the acquisition dates. The final purchase prices were comprised of the following components:
| (in millions) | |||||
| Payments for acquisitions, net of cash acquired | $ | 763 | |||
| Fair value of contingent consideration | 127 | ||||
| Fair value of prior interests | 102 | ||||
| $ | 992 | ||||
The final combined purchase price allocation was comprised of the following components:
| (in millions) | |||||
| Goodwill | $ | 577 | |||
| Amortizable intangible assets | 220 | ||||
| Indefinite-lived intangible assets | 240 | ||||
| Other assets acquired | 24 | ||||
| Liabilities assumed | (12) | ||||
| Net deferred tax liabilities | (58) | ||||
| $ | 992 | ||||
We allocated a portion of the combined purchase price to the specific intangible asset categories as follows:
Amount Assigned (in millions) | Amortization Period (in years) | Risk-Adjusted Discount Rates used in Purchase Price Allocation | |||||||||||||||
| Amortizable intangible assets: | |||||||||||||||||
| Technology-related | $ | 210 | 12 | 15% | |||||||||||||
| Other intangible assets | 10 | 12 | 15% | ||||||||||||||
| Indefinite-lived intangible assets: | |||||||||||||||||
| In-process research and development (IPR&D) | 240 | N/A | 19% | ||||||||||||||
| $ | 461 | ||||||||||||||||
Goodwill was primarily established due to synergies expected to be gained from leveraging our existing operations, as well as revenue and cash flow projections associated with future technologies, and has been allocated to our reportable segments based on the relative expected benefit. The goodwill recorded relating to our 2019 acquisitions is not deductible for tax purposes.
Contingent Consideration
Changes in the fair value of our contingent consideration liability were as follows:
| (in millions) | |||||
| Balance as of December 31, 2019 | $ | 354 | |||
| Contingent consideration net expense (benefit) | (102) | ||||
| Contingent consideration payments | (40) | ||||
| Balance as of September 30, 2020 | $ | 214 | |||
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As of September 30, 2020, the maximum amount of future contingent consideration (undiscounted) that we could be required to pay associated with our prior acquisitions was $627 million. Refer to Note B – Acquisitions and Strategic Investments to our audited financial statements contained in Item 8 of our most recent Annual Report on Form 10-K for additional information.
The $102 million benefit recorded in the first nine months of 2020 related to a reduction in the contingent consideration liability for certain prior acquisitions for which we reduced the probability of achievement of associated revenue and/or regulatory milestones upon which payment is conditioned, or in the case of nVision Medical Corporation (nVision) for milestones that would not be achieved due to management's discontinuation of the R&D program.
The recurring Level 3 fair value measurements of our contingent consideration liability that we expect to be required to settle include the following significant unobservable inputs:
| Contingent Consideration Liability | Fair Value as of September 30, 2020 | Valuation Technique | Unobservable Input | Range | Weighted Average (1) | ||||||||||||||||||
| R&D, Regulatory and Commercialization-based Milestones | $100 million | Discounted Cash Flow | Discount Rate | 2 | % | - | 2% | 2% | |||||||||||||||
| Probability of Payment | 90 | % | - | 90% | 90% | ||||||||||||||||||
| Projected Year of Payment | 2027 | - | 2027 | 2027 | |||||||||||||||||||
| Revenue-based Payments | $114 million | Discounted Cash Flow | Discount Rate | 11 | % | - | 14% | 13% | |||||||||||||||
| Probability of Payment | 53 | % | - | 100% | 87% | ||||||||||||||||||
| Projected Year of Payment | 2020 | - | 2024 | 2022 | |||||||||||||||||||
(1) Unobservable inputs were weighted by the relative fair value of the contingent consideration liability. For projected year of payment, the amount represents the median of the inputs and is not a weighted average.
Projected contingent payment amounts related to some of our research and development (R&D), commercialization-based and revenue-based milestones are discounted back to the current period using a discounted cash flow model. Significant increases or decreases in projected revenues, probabilities of payment, discount rates or the time until payment is made would have resulted in a significantly lower or higher fair value measurement as of September 30, 2020.
Strategic Investments
The aggregate carrying amount of our strategic investments was comprised of the following:
| As of | |||||||||||
| (in millions) | September 30, 2020 | December 31, 2019 | |||||||||
| Equity method investments | $ | 366 | $ | 264 | |||||||
| Measurement alternative investments (1) | 196 | 171 | |||||||||
| Publicly-held equity securities (2) | — | 1 | |||||||||
| Notes receivable | 4 | 23 | |||||||||
| $ | 567 | $ | 458 | ||||||||
(1) Measurement alternative investments are privately-held equity securities without readily determinable fair values that are measured at cost minus impairment, if any, adjusted to fair value for any observable price changes in orderly transactions for the identical or a similar investment of the same issuer.
(2) Publicly-held equity securities are measured at fair value with changes in fair value recognized currently in Other, net within our accompanying unaudited condensed consolidated statements of operations.
These investments are classified as Other long-term assets within our accompanying unaudited condensed consolidated balance sheets, in accordance with U.S. GAAP and our accounting policies.
As of September 30, 2020, the cost of our aggregated equity method investments exceeded our share of the underlying equity in net assets by $343 million, which represents amortizable intangible assets, IPR&D, goodwill and deferred tax liabilities. In the third quarter of 2020, we recorded a $65 million non-cash gain presented in Other, net within our unaudited condensed consolidated statements of operations to state at fair value one of our portfolio investments treated under the measurement alternative method of accounting.
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NOTE C – GOODWILL AND OTHER INTANGIBLE ASSETS
The gross carrying amount of goodwill and other intangible assets and the related accumulated amortization for intangible assets subject to amortization and accumulated write-offs of goodwill are as follows:
| As of September 30, 2020 | As of December 31, 2019 | ||||||||||||||||||||||
| (in millions) | Gross Carrying Amount | Accumulated Amortization/ Write-offs | Gross Carrying Amount | Accumulated Amortization/ Write-offs | |||||||||||||||||||
| Technology-related | $ | 11,834 | $ | (6,102) | $ | 12,020 | $ | (5,706) | |||||||||||||||
| Patents | 514 | (407) | 525 | (408) | |||||||||||||||||||
| Other intangible assets | 1,758 | (1,183) | 1,754 | (1,081) | |||||||||||||||||||
| Amortizable intangible assets | $ | 14,106 | $ | (7,692) | $ | 14,299 | $ | (7,195) | |||||||||||||||
| Goodwill | $ | 20,037 | $ | (9,900) | $ | 20,076 | $ | (9,900) | |||||||||||||||
| IPR&D | $ | 263 | $ | 662 | |||||||||||||||||||
| Technology-related | 120 | 120 | |||||||||||||||||||||
| Indefinite-lived intangible assets | $ | 383 | $ | 782 | |||||||||||||||||||
Our technology-related intangible assets consist of technical processes, intellectual property and institutional understanding with respect to products and processes that we intend to leverage in future products or processes and will carry forward from one product generation to the next. We used the multi-period excess earnings method, a form of the income approach, to derive the fair value of the technology-related intangible assets and are amortizing them on a straight-line basis over their assigned estimated useful lives. Our IPR&D represents intangible assets that are used in research and development activities but have not yet reached technological feasibility, regardless of whether they have alternative future use. The primary basis for determining the technological feasibility or completion of these projects is obtaining regulatory approval to market the underlying products in an applicable geographic region. In the first quarter of 2020, following receipt of CE Mark for certain products, we reclassified certain of our IPR&D intangible assets to amortizable technology-related assets and began amortization to reflect their use over their remaining lives.
The following represents our goodwill balance by global reportable segment and our separately presented Specialty Pharmaceuticals operating segment:
| (in millions) | MedSurg | Rhythm and Neuro | Cardiovascular | Specialty Pharmaceuticals | Total | ||||||||||||||||||||||||
| As of December 31, 2019 | $ | 2,061 | $ | 2,192 | $ | 5,676 | $ | 247 | $ | 10,176 | |||||||||||||||||||
| Impact of foreign currency fluctuations and other changes in carrying amount | (6) | 2 | (29) | (7) | (39) | ||||||||||||||||||||||||
| As of September 30, 2020 | $ | 2,056 | $ | 2,194 | $ | 5,646 | $ | 241 | $ | 10,137 | |||||||||||||||||||
Goodwill and Indefinite-Lived Intangible Asset Impairment Testing
We did not record any goodwill impairment charges in the third quarter and first nine months of 2020 or 2019. We test our goodwill balances in the second quarter of each year as of April 1 for impairment, or more frequently if impairment indicators are present or changes in circumstances suggest an impairment may exist. In the second quarter of 2020, we performed our annual goodwill impairment test for all of our reporting units and concluded that the fair value of each reporting unit exceeded its carrying value.
We assess goodwill for impairment at the reporting unit level, which is defined as an operating segment or one level below an operating segment, referred to as a component. We identified the following reporting units in our 2020 annual goodwill impairment test: Interventional Cardiology, Peripheral Interventions, Cardiac Rhythm Management, Electrophysiology, Endoscopy, Urology and Pelvic Health, Neuromodulation and Specialty Pharmaceuticals. We aggregated the Cardiac Rhythm Management and Electrophysiology reporting units, components of the Rhythm Management operating segment, based on the criteria prescribed in FASB ASC Topic 350, Intangibles - Goodwill and Other.
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In 2020, we utilized the qualitative assessment approach to test all of our reporting units. We assessed recent events, including the COVID-19 pandemic, as well as changes in macroeconomic factors, industry and market conditions, overall financial performance and other entity-specific factors since the most recently performed quantitative test. After assessing the totality of events, we determined that it is more likely than not that the fair value of each of our reporting units has sufficient excess over its carrying value, and concluded that goodwill was not impaired or at risk of impairment in the second quarter of 2020. There were no impairment indicators in the third quarter of 2020 that necessitated an interim impairment test.
We recorded Intangible asset impairment charges of $219 million in the third quarter of 2020, none in the third quarter of 2019, $452 million in the first nine months of 2020 and $105 million in the first nine months of 2019. The impairment charges recorded in the third quarter of 2020 were primarily associated with IPR&D acquired with Apama Medical Inc. following management’s decision to cancel the program. Intangible asset impairment charges in the first nine months of 2020 also included charges related to nVision and certain other intangible assets initially established following acquisition. In general, these charges were recorded as a result of management’s decision to change commercial launch plans or discontinue certain R&D programs based on cost to complete, time to market, overall economic viability or, specific to nVision, our understanding of the clinical evidence necessary to commercialize the technology.
We test our indefinite-lived intangible assets at least annually during the third quarter for impairment and reassess their classification as indefinite-lived assets. In addition, we review our indefinite-lived intangible assets for classification and impairment more frequently if impairment indicators exist. We assess qualitative factors to determine whether the existence of events and circumstances indicate that it is more likely than not that our indefinite-lived intangible assets are impaired. If we conclude that it is more likely than not that the asset is impaired, we then determine the fair value of the intangible asset and perform the quantitative impairment test by comparing the fair value with the carrying value in accordance with FASB ASC Topic 350. If the carrying value exceeds the fair value of the indefinite-lived intangible asset, we write the carrying value down to the fair value. In the third quarter of 2020, we performed our annual IPR&D impairment test and evaluated our indefinite-lived core technology assets using the optional qualitative assessment approach and concluded a quantitative test was required for certain IPR&D assets, resulting in the ultimate impairment of the Apama assets discussed above. We also verified that the classification of IPR&D projects and our indefinite-lived core technology assets recognized within our unaudited condensed consolidated balance sheets continues to be appropriate.
We review intangible assets subject to amortization quarterly to determine if any adverse conditions exist or a change in circumstances has occurred that would indicate impairment or a change in the remaining useful life. If we determine it is more likely than not that the asset is impaired based on our qualitative assessment of impairment indicators, we test the intangible asset for recoverability. If the carrying value of the intangible asset or asset group exceeds the undiscounted cash flows expected to result from the use and eventual disposition of the intangible asset or asset group, we will write the carrying value down to fair value in the period impairment is identified. In the third quarter of 2020, we determined a recoverability test was required for certain amortizable intangible assets based on our qualitative assessment of impairment indicators, and recorded intangible asset impairment charges as appropriate.
Refer to Critical Accounting Policies and Estimates within Part II, Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations contained in our most recent Annual Report on Form 10-K for further discussion of our annual goodwill and intangible asset impairment testing.
NOTE D – HEDGING ACTIVITIES AND FAIR VALUE MEASUREMENTS
Derivative Instruments and Hedging Activities
We address market risk from changes in foreign currency exchange rates and interest rates through risk management programs which include the use of derivative and nonderivative financial instruments. We operate these programs pursuant to documented corporate risk management policies and do not enter into derivative transactions for speculative purposes. Our derivative instruments do not subject our earnings to material risk, as the gains or losses on these derivatives generally offset losses or gains recognized on the hedged item.
We manage concentration of counterparty credit risk by limiting acceptable counterparties to major financial institutions with investment grade credit ratings, limiting the amount of credit exposure to individual counterparties and by actively monitoring counterparty credit ratings and the amount of individual credit exposure. We also employ master netting arrangements that limit the risk of counterparty non-payment on a particular settlement date to the net gain that would have otherwise been received from the counterparty. Although not completely eliminated, we do not consider the risk of counterparty default to be significant as a result of these protections. Further, none of our derivative instruments are subject to collateral or other security arrangements, nor do they contain provisions that are dependent on our credit ratings from any credit rating agency.
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Currency Hedging Instruments
Risk Management Strategy
Our risk from changes in currency exchange rates consists primarily of monetary assets and liabilities; forecasted intercompany and third-party transactions; net investments in certain subsidiaries; and, during 2019 prior to our acquisition of BTG, the purchase price of BTG, which was denominated in a currency other than the U.S. dollar. We manage currency exchange rate risk at a consolidated level to reduce the cost of hedging by taking advantage of offsetting transactions. We employ derivative and nonderivative instruments, primarily forward currency contracts, to reduce the risk to our earnings and cash flows associated with changes in currency exchange rates.
The success of our currency risk management program depends, in part, on forecast transactions denominated primarily in Japanese yen, Euro, Chinese renminbi, Australian dollar and British pound sterling. We may experience unanticipated currency exchange gains or losses to the extent the actual activity is different than forecast, particularly resulting from the impact of COVID-19 on transaction volumes. In addition, changes in currency exchange rates related to any unhedged transactions may impact our earnings and cash flows.
Hedge Designations and Relationships
Certain of our currency derivative instruments are designated as cash flow hedges under FASB ASC Topic 815, Derivatives and Hedging (FASB ASC Topic 815), and are intended to protect the U.S. dollar value of forecasted transactions. The gain or loss on a derivative instrument designated as a cash flow hedge is recorded in the Net change in derivative financial instruments component of Other comprehensive income (loss), net of tax (OCI) within our unaudited condensed consolidated statements of comprehensive income (loss) until the underlying third-party transaction occurs. When the underlying third-party transaction occurs, we recognize the gain or loss in earnings within Cost of products sold in our unaudited condensed consolidated statements of operations. In the event the hedging relationship is no longer effective, or if the occurrence of the hedged forecast transaction becomes no longer probable, we reclassify the gains or losses within Accumulated other comprehensive income (loss), net of tax (AOCI) to earnings at that time.
We also designate certain forward currency contracts as net investment hedges to hedge a portion of our net investments in certain of our entities with functional currencies denominated in the Euro, Swiss franc, Japanese yen, British pound sterling, South Korean won and Taiwan dollar. We elected to use the spot method to assess effectiveness for our derivatives that are designated as net investment hedges. Under the spot method, the change in fair value attributable to changes in the spot rate is recorded in the Foreign currency translation adjustment (CTA) component of OCI. We have elected to exclude the spot-forward difference from the assessment of hedge effectiveness and are amortizing this amount separately, as calculated at the date of designation, on a straight-line basis over the term of the currency forward contracts. Amortization of the spot-forward difference is then reclassified from AOCI to current period earnings as a component of Interest expense in our unaudited condensed consolidated statements of operations.
In November 2019, we completed an offering of €900 million (approximately $1.000 billion) in aggregate principal amount of 0.625% senior notes due in 2027 (December 2027 Notes). The euro-denominated debt principal is a nonderivative instrument designated as a net investment hedge of our net investments in certain of our euro functional entities. We dedesignated a portion of the net investment hedge in the second and third quarters of 2020. The notional value of our outstanding net investment hedges was $1.885 billion as of September 30, 2020 and $1.950 billion as of December 31, 2019, which includes our derivative and nonderivative instruments designated as net investment hedges.
We also use forward currency contracts that are not part of designated hedging relationships under FASB ASC Topic 815 as a part of our strategy to manage our exposure to currency exchange rate risk related to monetary assets and liabilities and related forecast transactions. These non-designated currency forward contracts have an original time to maturity consistent with the hedged currency transaction exposures, generally less than one year, and are marked-to-market with changes in fair value recorded to earnings within Other, net in our unaudited condensed consolidated statements of operations.
Certain of our non-designated forward currency contracts were entered into for the purpose of managing our exposure to currency exchange rate risk related to the British pound sterling-denominated purchase price of BTG. In the first nine months of 2019, we settled all outstanding contracts for $294 million, which is presented within Payments for settlements of hedge contracts in our unaudited condensed consolidated statements of cash flows. Upon settlement in 2019, we received £3.312 billion of cash to fund our acquisition of BTG, which translated into $4.303 billion based on hedged currency exchange rates.
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We recognized a $207 million loss in the third quarter of 2019 and a $323 million loss in the first nine months of 2019 in Other, net due to changes in fair value of the contracts.
Interest Rate Hedging Instruments
Risk Management Strategy
Our interest rate risk relates primarily to U.S. dollar borrowings partially offset by U.S. dollar cash investments. We use interest rate derivative instruments to mitigate the risk to our earnings and cash flows associated with exposure to changes in interest rates. Under these agreements, we and the counterparty, at specified intervals, exchange the difference between fixed and floating interest amounts calculated by reference to an agreed-upon notional principal amount. We designate these derivative instruments either as fair value or cash flow hedges in accordance with FASB ASC Topic 815.
Hedge Designations and Relationships
We had no interest rate derivative instruments designated as cash flow hedges outstanding as of September 30, 2020 and December 31, 2019. Prior to 2020, we terminated interest rate derivative instruments that were designated as cash flow hedges and are continuing to recognize the amortization of the gains or losses originally recorded within AOCI to earnings as a component of Interest expense over the same period that the hedged item affects earnings, provided the hedge relationship remains effective. If we determine the hedge relationship is no longer effective, or if the occurrence of the hedged forecast transaction becomes no longer probable, we reclassify the amount of gains or losses from AOCI to earnings at that time. In the event that we designate outstanding interest rate derivative instruments as cash flow hedges, we record the changes in the fair value of the derivatives within OCI until the underlying hedged transaction occurs. The balance of the deferred amounts on our terminated cash flow hedges within AOCI was a $30 million loss as of September 30, 2020 and a $34 million loss as of December 31, 2019. We recognized immaterial gains and losses in Interest expense relating to the amortization of our terminated cash flow hedges in the current and prior periods.
We had no interest rate derivative instruments designated as fair value hedges outstanding as of September 30, 2020 and December 31, 2019. Prior to 2018, we terminated interest rate derivative instruments that were designated as fair value hedges and are continuing to recognize the amortization of the gains or losses originally recorded within the Long-term debt caption in our unaudited condensed consolidated balance sheets into earnings as a component of Interest expense over the same period that the discount or premium associated with the hedged items affects earnings. In the event that we designate outstanding interest rate derivative instruments as fair value hedges, we record the changes in the fair values of interest rate derivatives designated as fair value hedges and of the underlying hedged debt instruments in Interest expense, which generally offset. The balance of the deferred gains on our terminated fair value hedges within Long-term debt was immaterial as of September 30, 2020 and December 31, 2019. We recognized immaterial gains in Interest expense relating to the amortization of the terminated fair value hedges in the current and prior periods.
The following table presents the contractual amounts of our hedging instruments outstanding:
| (in millions) | FASB ASC Topic 815 Designation | As of | ||||||||||||||||||
| September 30, 2020 | December 31, 2019 | |||||||||||||||||||
| Forward currency contracts | Cash flow hedge | $ | 4,118 | $ | 3,891 | |||||||||||||||
| Forward currency contracts | Net investment hedge | 991 | 953 | |||||||||||||||||
Foreign currency-denominated debt(1) | Net investment hedge | 894 | 997 | |||||||||||||||||
| Forward currency contracts | Non-designated | 4,283 | 4,377 | |||||||||||||||||
| Total Notional Outstanding | $ | 10,286 | $ | 10,218 | ||||||||||||||||
(1) The €900 million (approximately $1.000 billion) debt principal is a nonderivative instrument designated as a net investment hedge of our net investments in certain of our euro functional subsidiaries. We dedesignated a portion of the net investment hedges in the second and third quarters of 2020.
The remaining time to maturity as of September 30, 2020 is within 60 months for all forward currency contracts designated as cash flow hedges and generally less than one year for all non-designated forward currency contracts. The forward currency contracts designated as net investment hedges generally mature within the next two years. The euro-denominated debt principal designated as a net investment hedge has a contractual maturity of December 1, 2027.
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The following presents the effect of our derivative and nonderivative instruments designated as cash flow and net investment hedges under FASB ASC Topic 815 in our accompanying unaudited condensed consolidated statements of operations. Refer to Note M – Changes in Other Comprehensive Income for the total amounts relating to derivative and nonderivative instruments presented within our unaudited condensed consolidated statements of comprehensive income (loss).
| Effect of Hedging Relationships on Accumulated Other Comprehensive Income | ||||||||||||||||||||||||||||||||
| Amount Recognized in OCI on Hedges | Unaudited Condensed Consolidated Statements of Operations (1) | Amount Reclassified from AOCI into Earnings | ||||||||||||||||||||||||||||||
| (in millions) | Pre-Tax Gain (Loss) | Tax Benefit (Expense) | Gain (Loss) Net of Tax | Location of Amount Reclassified and Total Amount of Line Item | Pre-Tax (Gain) Loss | Tax (Benefit) Expense | (Gain) Loss Net of Tax | |||||||||||||||||||||||||
| Three Months Ended September 30, 2020 | ||||||||||||||||||||||||||||||||
| Forward currency contracts | ||||||||||||||||||||||||||||||||
| Cash flow hedges | $ | (64) | $ | 14 | $ | (50) | Cost of products sold | $ | 869 | $ | (20) | $ | 4 | $ | (15) | |||||||||||||||||
| Net investment hedges (2) | (21) | 5 | (16) | Interest expense | 86 | (6) | 1 | (5) | ||||||||||||||||||||||||
| Foreign currency-denominated debt | ||||||||||||||||||||||||||||||||
| Net investment hedges (3) | (46) | 10 | (36) | Other, net | (64) | — | — | — | ||||||||||||||||||||||||
| Interest rate derivative contracts | ||||||||||||||||||||||||||||||||
| Cash flow hedges | — | — | — | Interest expense | 86 | 1 | — | 1 | ||||||||||||||||||||||||
| Three Months Ended September 30, 2019 | ||||||||||||||||||||||||||||||||
| Forward currency contracts | ||||||||||||||||||||||||||||||||
| Cash flow hedges | $ | 101 | $ | (23) | $ | 78 | Cost of products sold | $ | 777 | $ | (22) | $ | 5 | $ | (17) | |||||||||||||||||
| Net investment hedges (2) | 64 | (14) | 50 | Interest expense | 95 | (12) | 3 | (9) | ||||||||||||||||||||||||
| Interest rate derivative contracts | ||||||||||||||||||||||||||||||||
| Cash flow hedges | — | — | — | Interest Expense | 95 | 1 | — | 1 | ||||||||||||||||||||||||
| Nine Months Ended September 30, 2020 | ||||||||||||||||||||||||||||||||
| Forward currency contracts | ||||||||||||||||||||||||||||||||
| Cash flow hedges | $ | 47 | $ | (11) | $ | 36 | Cost of products sold | $ | 2,465 | $ | (70) | $ | 16 | $ | (55) | |||||||||||||||||
| Net investment hedges (2) | (4) | (21) | (25) | Interest expense | 265 | (18) | 4 | (14) | ||||||||||||||||||||||||
| Foreign currency-denominated debt | ||||||||||||||||||||||||||||||||
| Net investment hedges (3) | (44) | 13 | (31) | Other, net | (9) | — | — | — | ||||||||||||||||||||||||
| Interest rate derivative contracts | ||||||||||||||||||||||||||||||||
| Cash flow hedges | — | — | — | Interest expense | 265 | 4 | (1) | 3 | ||||||||||||||||||||||||
| Nine Months Ended September 30, 2019 | ||||||||||||||||||||||||||||||||
| Forward currency contracts | ||||||||||||||||||||||||||||||||
| Cash flow hedges | $ | 176 | $ | (40) | $ | 136 | Cost of products sold | $ | 2,265 | $ | (47) | $ | 10 | $ | (36) | |||||||||||||||||
| Net investment hedges (2) | 92 | (21) | 71 | Interest expense | 294 | (33) | 7 | (25) | ||||||||||||||||||||||||
| Interest rate derivative contracts | ||||||||||||||||||||||||||||||||
| Cash flow hedges | — | — | — | Interest expense | 294 | 3 | (1) | 2 | ||||||||||||||||||||||||
(1) In all periods presented in the table above, the pre-tax (gain) loss amounts reclassified from AOCI to earnings represent the effect of the hedging relationships on earnings. All other amounts included in earnings related to hedging relationships were immaterial.
(2) For our outstanding forward currency contracts designated as net investment hedges, the net gain or loss reclassified from AOCI to earnings as a reduction of Interest expense represents the straight-line amortization of the excluded component as calculated at the date of designation. This initial value of the excluded component has been excluded from the assessment of effectiveness in accordance with FASB ASC Topic 815. In the current period, we did not recognize any gains or losses on the components included in the assessment of hedge effectiveness in earnings.
(3) For our outstanding euro-denominated debt principal designated as a net investment hedge, the change in fair value attributable to changes in the spot rate is recorded in the Foreign currency translation adjustment (CTA) component of OCI. No amounts were reclassified from AOCI to current period earnings.
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As of September 30, 2020, pre-tax net gains or losses for our derivative instruments designated, or previously designated, as cash flow and net investment hedges under FASB ASC Topic 815 that may be reclassified from AOCI to earnings within the next twelve months are presented below (in millions):
| Designated Hedging Instrument | FASB ASC Topic 815 Designation | Location on Unaudited Condensed Consolidated Statements of Operations | Amount of Pre-Tax Gain (Loss) that may be Reclassified to Earnings | |||||||||||||||||
| Forward currency contracts | Cash flow hedge | Cost of products sold | $ | 79 | ||||||||||||||||
| Forward currency contracts | Net investment hedge | Interest expense | 17 | |||||||||||||||||
| Interest rate derivative contracts | Cash flow hedge | Interest expense | (5) | |||||||||||||||||
Net gains and losses on currency hedge contracts not designated as hedging instruments offset by net gains and losses from currency transaction exposures are presented below:
| Location on Unaudited Condensed Consolidated Statements of Operations | Three Months Ended September 30, | Nine Months Ended September 30, | ||||||||||||||||||||||||||||||
| (in millions) | 2020 | 2019 | 2020 | 2019 | ||||||||||||||||||||||||||||
| Net gain (loss) on currency hedge contracts | Other, net | $ | 29 | $ | (202) | $ | 20 | $ | (334) | |||||||||||||||||||||||
| Net gain (loss) on currency transaction exposures | Other, net | (30) | (4) | (33) | — | |||||||||||||||||||||||||||
| Net currency exchange gain (loss) | $ | (1) | $ | (207) | $ | (13) | $ | (334) | ||||||||||||||||||||||||
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Fair Value Measurements
FASB ASC Topic 815 requires all derivative and nonderivative instruments to be recognized at their fair values as either assets or liabilities on the balance sheet. We determine the fair value of our derivative and nonderivative instruments using the framework prescribed by FASB ASC Topic 820, Fair Value Measurements and Disclosures (FASB ASC Topic 820) and considering the estimated amount we would receive or pay to transfer these instruments at the reporting date with respect to current currency exchange rates, interest rates, the creditworthiness of the counterparty for unrealized gain positions and our own creditworthiness for unrealized loss positions. In certain instances, we may utilize financial models to measure fair value of our derivative and nonderivative instruments. In doing so, we use inputs that include quoted prices for similar assets or liabilities in active markets, quoted prices for identical or similar assets or liabilities in markets that are not active, other observable inputs for the asset or liability and inputs derived principally from, or corroborated by, observable market data by correlation or other means. The following are the balances of our derivative and nonderivative assets and liabilities:
| Location on Unaudited Condensed Consolidated Balance Sheets (1) | As of | |||||||||||||||||||
| (in millions) | September 30, 2020 | December 31, 2019 | ||||||||||||||||||
| Derivative and Nonderivative Assets: | ||||||||||||||||||||
| Designated Hedging Instruments | ||||||||||||||||||||
| Forward currency contracts | Other current assets | $ | 90 | $ | 72 | |||||||||||||||
| Forward currency contracts | Other long-term assets | 179 | 216 | |||||||||||||||||
| 270 | 288 | |||||||||||||||||||
| Non-Designated Hedging Instruments | ||||||||||||||||||||
| Forward currency contracts | Other current assets | 56 | 33 | |||||||||||||||||
| Total Derivative and Nonderivative Assets | $ | 325 | $ | 321 | ||||||||||||||||
| Derivative and Nonderivative Liabilities: | ||||||||||||||||||||
| Designated Hedging Instruments | ||||||||||||||||||||
| Forward currency contracts | Other current liabilities | $ | 6 | $ | 3 | |||||||||||||||
| Forward currency contracts | Other long-term liabilities | 9 | 8 | |||||||||||||||||
| Foreign currency-denominated debt | Other long-term liabilities | 1,042 | 998 | |||||||||||||||||
| 1,058 | 1,009 | |||||||||||||||||||
| Non-Designated Hedging Instruments | ||||||||||||||||||||
| Forward currency contracts | Other current liabilities | 58 | 29 | |||||||||||||||||
| Total Derivative and Nonderivative Liabilities | $ | 1,116 | $ | 1,037 | ||||||||||||||||
(1) We classify derivative and nonderivative assets and liabilities as current when the settlement date of the contract is one year or less.
Recurring Fair Value Measurements
On a recurring basis, we measure certain financial assets and financial liabilities at fair value based upon quoted market prices. Where quoted market prices or other observable inputs are not available, we apply valuation techniques to estimate fair value. FASB ASC Topic 820 establishes a three-level valuation hierarchy for disclosure of fair value measurements. The category of a financial asset or a financial liability within the valuation hierarchy is based upon the lowest level of input that is significant to the measurement of fair value. The three levels of the hierarchy are defined as follows:
•Level 1 – Inputs to the valuation methodology are quoted market prices for identical assets or liabilities.
•Level 2 – Inputs to the valuation methodology are other observable inputs, including quoted market prices for similar assets or liabilities and market-corroborated inputs.
•Level 3 – Inputs to the valuation methodology are unobservable inputs based on management’s best estimate of inputs market participants would use in pricing the asset or liability at the measurement date, including assumptions about risk.
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Assets and liabilities measured at fair value on a recurring basis consist of the following:
| As of | |||||||||||||||||||||||||||||||||||||||||||||||
| September 30, 2020 | December 31, 2019 | ||||||||||||||||||||||||||||||||||||||||||||||
| (in millions) | Level 1 | Level 2 | Level 3 | Total | Level 1 | Level 2 | Level 3 | Total | |||||||||||||||||||||||||||||||||||||||
| Assets | |||||||||||||||||||||||||||||||||||||||||||||||
| Money market funds and time deposits | $ | 1,716 | $ | — | $ | — | $ | 1,716 | $ | 50 | $ | — | $ | — | $ | 50 | |||||||||||||||||||||||||||||||
| Publicly-held securities | — | — | — | — | 1 | — | — | 1 | |||||||||||||||||||||||||||||||||||||||
| Hedging instruments | — | 325 | — | 325 | — | 321 | — | 321 | |||||||||||||||||||||||||||||||||||||||
| Licensing arrangements | — | — | 396 | 396 | — | — | 518 | 518 | |||||||||||||||||||||||||||||||||||||||
| $ | 1,717 | $ | 325 | $ | 396 | $ | 2,438 | $ | 51 | $ | 321 | $ | 518 | $ | 890 | ||||||||||||||||||||||||||||||||
| Liabilities | |||||||||||||||||||||||||||||||||||||||||||||||
| Hedging instruments | $ | — | $ | 1,116 | $ | — | $ | 1,116 | $ | — | $ | 1,037 | $ | — | $ | 1,037 | |||||||||||||||||||||||||||||||
| Contingent consideration liability | — | — | 214 | 214 | — | — | 354 | 354 | |||||||||||||||||||||||||||||||||||||||
| Licensing arrangements | — | — | 413 | 413 | — | — | 571 | 571 | |||||||||||||||||||||||||||||||||||||||
| $ | — | $ | 1,116 | $ | 627 | $ | 1,743 | $ | — | $ | 1,037 | $ | 925 | $ | 1,963 | ||||||||||||||||||||||||||||||||
Our investments in money market funds and time deposits are classified within Level 1 of the fair value hierarchy because they are valued using quoted market prices. These investments are classified as Cash and cash equivalents within our accompanying unaudited condensed consolidated balance sheets, in accordance with U.S. GAAP and our accounting policies. In addition to $1.716 billion invested in money market funds and time deposits as of September 30, 2020 and $50 million as of December 31, 2019, we held $305 million in interest-bearing and non-interest-bearing bank accounts as of September 30, 2020 and $165 million as of December 31, 2019.
Our recurring fair value measurements using Level 3 inputs related to our contingent consideration liability. Refer to Note B – Acquisitions and Strategic Investments for a discussion of the changes in the fair value of our contingent consideration liability.
In addition, our recurring fair value measurements using Level 3 inputs related to our licensing arrangements, principally the contractual right to receive future royalty payments related to Zytiga™. This contractual right was acquired with BTG on August 19, 2019. Prior to our acquisition of BTG, BTG agreed to pay 50 percent of the Zytiga™ royalty stream, net of certain offsets, to the inventors associated with the intellectual property. In the fourth quarter of 2019, we sold the remaining 50 percent we acquired through our acquisition of BTG of the future Zytiga™ royalty stream for an upfront cash payment of $256 million to the Ontario Municipal Employees Retirement System (OMERS). In accordance with FASB ASC Topic 860, Transfers and Servicing, we are accounting for the transfer of the royalty stream to OMERS as a secured borrowing, continue to recognize the financial asset and associated liability in our unaudited condensed consolidated balance sheets and do not expect to receive any future cash benefit from Zytiga™ royalties.
We have elected the fair value option to account for our licensing arrangements' financial asset and financial liability in accordance with FASB ASC Topic 825, Financial Instruments. As of September 30, 2020, we have recorded the fair values using a discounted cash flow approach considering the probability-weighted expected future cash flows to be generated by the royalty stream. The fair value of the financial liability also considers the related contractual provisions that govern our payment obligations.
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The recurring Level 3 fair value measurements of our licensing arrangements recognized in our unaudited condensed consolidated balance sheets as of September 30, 2020 include the following significant unobservable inputs:
| Licensing Arrangements | Fair Value as of September 30, 2020 | Valuation Technique | Unobservable Input | Range | Weighted Average (1) | ||||||||||||||||||
| Financial Asset | $396 million | Discounted Cash Flow | Discount Rate | 11 | % | - | 15% | 15% | |||||||||||||||
| Projected Year of Payment | 2020 | - | 2028 | 2024 | |||||||||||||||||||
| Financial Liability | $413 million | Discounted Cash Flow | Discount Rate | 12 | % | - | 15% | 13% | |||||||||||||||
| Projected Year of Payment | 2020 | - | 2027 | 2024 | |||||||||||||||||||
(1) Unobservable inputs relate to a single financial asset and liability. As such, unobservable inputs were not weighted by the relative fair value of the instruments. For projected year of payment, the amount represents the median of the inputs and is not a weighted average.
Significant increases or decreases in projected cash flows of the royalty stream and the related contractual provisions that govern our payment obligations, discount rates or the time until payment is made would have resulted in a significantly lower or higher fair value measurement of the licensing arrangements' financial asset and liability as of September 30, 2020. However, increases or decreases in the financial asset would be offset by increases or decreases in the financial liability, other than for timing of receipt and remittance; as such our earnings are not subject to material gains or losses from the licensing arrangement.
Changes in the fair value of our licensing arrangements' financial asset were as follows:
| (in millions) | |||||
| Balance as of December 31, 2019 | $ | 518 | |||
| Proceeds from royalty rights | (132) | ||||
| Fair value adjustment (expense) benefit | 9 | ||||
| Balance as of September 30, 2020 | $ | 396 | |||
Changes in the fair value of our licensing arrangements' financial liability were as follows:
| (in millions) | |||||
| Balance as of December 31, 2019 | $ | 571 | |||
| Payments for royalty rights | (165) | ||||
| Fair value adjustment expense (benefit) | 7 | ||||
| Balance as of September 30, 2020 | $ | 413 | |||
Non-Recurring Fair Value Measurements
We hold certain assets and liabilities that are measured at fair value on a non-recurring basis in periods after initial recognition. The fair value of a measurement alternative investment is not estimated if there are no identified events or changes in circumstances that may have a significant adverse effect on the fair value of the investment. Refer to Note B – Acquisitions and Strategic Investments for a discussion of our strategic investments, and Note C – Goodwill and Other Intangible Assets for a discussion of the fair values of our intangible assets including goodwill.
The fair value of our outstanding debt obligations was $10.901 billion as of September 30, 2020, including $1.050 billion relating to our euro-denominated December 2027 Notes, and $11.020 billion as of December 31, 2019, including $1.004 billion relating to our euro-denominated December 2027 Notes. We determined fair value by using quoted market prices for our publicly registered senior notes, classified as Level 1 within the fair value hierarchy, and face value for commercial paper, term loans and credit facility borrowings outstanding. Refer to Note E – Contractual Obligations and Commitments for a discussion of our debt obligations.
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NOTE E – CONTRACTUAL OBLIGATIONS AND COMMITMENTS
Borrowings and Credit Arrangements
We had total debt outstanding of $9.336 billion as of September 30, 2020 and $10.008 billion as of December 31, 2019, presented net of unamortized debt issuance discounts and deferred financing costs. The debt maturity schedule for our long-term debt obligations is presented below:
| (in millions, except interest rates) | Issuance Date | Maturity Date | As of | Coupon Rate (1) | ||||||||||||||||||||||||||||
| September 30, 2020 | December 31, 2019 | |||||||||||||||||||||||||||||||
| May 2022 Notes | May 2015 | May 2022 | $ | 500 | $ | 500 | 3.375% | |||||||||||||||||||||||||
| October 2023 Notes | August 2013 | October 2023 | 244 | 244 | 4.125% | |||||||||||||||||||||||||||
| March 2024 Notes | February 2019 | March 2024 | 850 | 850 | 3.450% | |||||||||||||||||||||||||||
| May 2025 Notes | May 2015 | May 2025 | 523 | 523 | 3.850% | |||||||||||||||||||||||||||
| June 2025 Notes | May 2020 | June 2025 | 500 | — | 1.900% | |||||||||||||||||||||||||||
| March 2026 Notes | February 2019 | March 2026 | 850 | 850 | 3.750% | |||||||||||||||||||||||||||
| December 2027 Notes | November 2019 | December 2027 | 1,054 | 1,011 | 0.625% | |||||||||||||||||||||||||||
| March 2028 Notes | February 2018 | March 2028 | 434 | 434 | 4.000% | |||||||||||||||||||||||||||
| March 2029 Notes | February 2019 | March 2029 | 850 | 850 | 4.000% | |||||||||||||||||||||||||||
| June 2030 Notes | May 2020 | June 2030 | 1,200 | — | 2.650% | |||||||||||||||||||||||||||
November 2035 Notes (2) | November 2005 | November 2035 | 350 | 350 | 7.000% | |||||||||||||||||||||||||||
| March 2039 Notes | February 2019 | March 2039 | 750 | 750 | 4.550% | |||||||||||||||||||||||||||
| January 2040 Notes | December 2009 | January 2040 | 300 | 300 | 7.375% | |||||||||||||||||||||||||||
| March 2049 Notes | February 2019 | March 2049 | 1,000 | 1,000 | 4.700% | |||||||||||||||||||||||||||
| August 2022 Term Loan | August 2019 | August 2022 | — | 1,000 | ||||||||||||||||||||||||||||
Unamortized Debt Issuance Discount and Deferred Financing Costs | 2020 - 2049 | (91) | (83) | |||||||||||||||||||||||||||||
| Unamortized Gain on Fair Value Hedges | 2020 - 2023 | 6 | 7 | |||||||||||||||||||||||||||||
| Finance Lease Obligation | Various | 6 | 6 | |||||||||||||||||||||||||||||
| Long-term debt | $ | 9,325 | $ | 8,592 | ||||||||||||||||||||||||||||
Note: The table above does not include unamortized amounts related to interest rate contracts designated as cash flow hedges.
(1) Coupon rates are semi-annual, except for the euro-denominated December 2027 Notes, which bear an annual coupon, and the August 2022 Term Loan, which is a variable-rate instrument based on LIBOR.
(2) Corporate credit rating improvements may result in a decrease in the adjusted interest rate on our November 2035 Notes to the extent that our lowest credit rating is above BBB- or Baa3. The interest rates on our November 2035 Notes will be permanently reinstated to the issuance rate if the lowest credit ratings assigned to these senior notes is either A- or A3 or higher.
Revolving Credit Facility
We maintain a $2.750 billion revolving credit facility (Revolving Credit Facility) with a global syndicate of commercial banks that matures on December 19, 2023 with one-year extension options, subject to certain conditions. This facility provides backing for our commercial paper program, and outstanding commercial paper directly reduces borrowing capacity under the Revolving Credit Facility. The credit agreement requires that we comply with certain covenants, including a financial covenant described within Financial Covenant below. In the first quarter of 2020, we refinanced $1.360 billion of commercial paper using proceeds from the Revolving Credit Facility. In April 2020, we entered into the April 2021 Term Loan, described below, and used the proceeds to repay a portion of the amounts outstanding under the Revolving Credit Facility. On May 28, 2020, we entered into an amendment of the credit agreement to permit payment of regularly scheduled quarterly cash dividends and other limited cash payments on our issued 5.50% Mandatory Convertible Preferred Stock, Series A (MCPS) and other capital stock issued by us, which is or becomes mandatorily convertible into or exchangeable for shares of our common stock. In May 2020, we completed our senior notes offering described below and used a portion of the proceeds to repay $450 million outstanding under the Revolving Credit Facility. There were no amounts outstanding under the Revolving Credit Facility as of September 30, 2020 or December 31, 2019.
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Term Loans
On April 21, 2020, in a proactive step to offset the potential impact of the COVID-19 pandemic on our short-term liquidity, we entered into a $1.250 billion term loan credit agreement scheduled to mature on April 20, 2021 (April 2021 Term Loan). We used proceeds from the April 2021 Term Loan to repay a portion of the amounts outstanding under the Revolving Credit Facility and the remaining amount under the December 2020 Term Loan described below. In May 2020, as described in further detail below, we used a portion of the proceeds from the May 2020 senior notes offering to prepay $500 million of amounts outstanding under the April 2021 Term Loan, and a portion of the combined net proceeds from our MCPS and common stock offerings to repay in full the remaining $750 million outstanding under the April 2021 Term Loan and to pay related fees, expenses and premiums, after which it was terminated.
On February 27, 2020, we entered into a $1.000 billion term loan credit agreement scheduled to mature on February 25, 2021 (February 2021 Term Loan). We used the proceeds from the February 2021 Term Loan to repay the remaining amounts outstanding of the Three-Year Delayed Draw Term Loan, described below. On May 28, 2020, we entered into an amendment of the credit agreement to permit payment of regularly scheduled quarterly cash dividends and other limited cash payments on our issued MCPS and other capital stock issued by us, which is or becomes mandatorily convertible into or exchangeable for shares of our common stock. The February 2021 Term Loan bears interest at an annual rate of LIBOR plus a margin of 0.85%. The credit agreement is subject to a financial covenant described below under Financial Covenant, and also contains customary events of default, which may result in the acceleration of any outstanding commitments. We used a portion of the proceeds from our May 2020 senior notes offering, described below, to prepay $750 million of amounts outstanding under the February 2021 Term Loan in the second quarter of 2020. In the third quarter of 2020, we prepaid the remaining $250 million and terminated the February 2021 Term Loan.
On December 5, 2019, we entered into a $700 million term loan credit agreement, which was scheduled to mature on December 3, 2020 (December 2020 Term Loan). As of December 31, 2019, we had $700 million outstanding under the December 2020 Term Loan, and we used the proceeds to repay a portion of the Two-Year Delayed Draw Term Loan, described below. In January 2020, we repaid $300 million of the outstanding balance of the December 2020 Term Loan with proceeds from our commercial paper program. In April 2020, we used the proceeds from the April 2021 Term Loan to repay the remaining amounts outstanding under the December 2020 Term Loan and terminated the December 2020 Term Loan.
On December 19, 2018, we entered into a $2.000 billion senior unsecured delayed-draw term loan facility consisting of a $1.000 billion two-year delayed draw term loan credit facility maturing in two years from the date of the closing of the acquisition of BTG (Two-Year Delayed Draw Term Loan) and a $1.000 billion three-year delayed draw term loan credit facility maturing in three years from the date of the closing of the acquisition of BTG (Three-Year Delayed Draw Term Loan). On August 19, 2019, for the purpose of funding the acquisition of BTG, we borrowed $1.000 billion under the Two-Year Delayed Draw Term Loan and $1.000 billion under the Three-Year Delayed Draw Term Loan. In 2019, we repaid all amounts outstanding on the Two-Year Delayed Draw Term Loan with proceeds from the sale of the Zytiga-related royalty interests, December 2020 Term Loan and commercial paper and terminated the facility. As of December 31, 2019, we had $1.000 billion outstanding under the Three-Year Delayed Draw Term Loan (also referred to as the "August 2022 Term Loan" in the debt maturity schedule above). In the first quarter of 2020, we repaid all amounts outstanding on the Three-Year Delayed Draw Term Loan with proceeds from the February 2021 Term Loan and terminated the facility. As of September 30, 2020, we had no amounts outstanding under the Two and Three-Year Delayed Draw Term Loans and the facilities were terminated.
Financial Covenant
As of and through September 30, 2020, we were in compliance with the financial covenant required by all existing credit facilities described above:
| Covenant Requirement | Actual | |||||||||||||
| as of September 30, 2020 | as of September 30, 2020 | |||||||||||||
| Maximum permitted leverage ratio (1) | 4.75 times | 3.40 times | ||||||||||||
(1)Ratio of total debt to deemed consolidated EBITDA, as defined by the credit agreements, as amended.
On April 21, 2020, we entered into an agreement with our banking syndicates to amend the financial covenant requirement for all of our outstanding credit arrangements as follows: (i) establish a deemed Consolidated EBITDA of $671 million for the second, third and fourth quarters of 2020, reflecting average quarterly Consolidated EBITDA, as defined in the credit agreements, for 2018 and 2019; and (ii) maintain the maximum permitted leverage ratio of 4.75 times through the remainder of
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2020, with a step-down for each succeeding fiscal quarter end to 4.50 times, 4.25 times, 4.00 times and ultimately 3.75 times for the fourth quarter of 2021 and through the remaining term of the facility. In addition, pursuant to the April 21, 2020 Revolving Credit Facility and February 2021 Term Loan amendments, the definition of “Material Adverse Effect” has been amended to remove the direct and indirect effects of the COVID-19 pandemic from what constitutes a material adverse effect through the remainder of 2020.
The financial covenant requirement provides for an exclusion from the calculation of consolidated EBITDA, as defined by the agreements, through maturity, of any non-cash charges and up to $500 million in restructuring charges and restructuring-related expenses related to our current or future restructuring plans. As of September 30, 2020, we had $194 million of the restructuring charge exclusion remaining. In addition, any cash litigation payments (net of any cash litigation receipts), as defined by the agreements, are excluded from the calculation of consolidated EBITDA, as defined by the agreements, provided that the sum of any excluded net cash litigation payments do not exceed $2.624 billion in the aggregate. As of September 30, 2020, we had $946 million of the litigation exclusion remaining.
Any inability to maintain compliance with this amended covenant could require us to seek to further renegotiate the terms of our Revolving Credit Facility or seek waivers from compliance with this covenant, both of which could result in additional borrowing costs. Further, there can be no assurance that our lenders would agree to such new terms or grant such waivers on terms acceptable to us. In this case, all Revolving Credit Facility commitments would terminate, and any amounts borrowed under the facility would become immediately due and payable. Furthermore, any termination of our Revolving Credit Facility may negatively impact the credit ratings assigned to our commercial paper program which may impact our ability to refinance any then outstanding commercial paper as it becomes due and payable.
Commercial Paper
Our commercial paper program is backed by the Revolving Credit Facility, as discussed above. Outstanding commercial paper directly reduces borrowing capacity under the Revolving Credit Facility. In the first quarter of 2020, we refinanced $1.360 billion of commercial paper using proceeds from the Revolving Credit Facility and did not have any commercial paper outstanding as of September 30, 2020.
| As of | |||||||||||
| (in millions, except maturity and yield) | September 30, 2020 | December 31, 2019 | |||||||||
| Commercial paper outstanding (at par) | $ | — | $ | 711 | |||||||
| Maximum borrowing capacity | 2,750 | 2,750 | |||||||||
| Borrowing capacity available | 2,750 | 2,039 | |||||||||
| Weighted average maturity | 0 days | 55 days | |||||||||
| Weighted average yield | — | % | 2.21 | % | |||||||
Senior Notes
We had senior notes outstanding of $9.404 billion as of September 30, 2020 and $7.661 billion as of December 31, 2019. In May 2020, we completed an offering of $1.700 billion in aggregate principal amount of senior notes comprised of $500 million of 1.900% senior notes due June 2025 and $1.200 billion of 2.650% senior notes due June 2030. We used the net proceeds from the offering to refinance $450 million of amounts outstanding under the Revolving Credit Facility, prepay $750 million of amounts outstanding under the $1.000 billion February 2021 Term Loan, prepay $500 million of amounts outstanding under the $1.250 billion April 2021 Term Loan and pay related fees, expenses and premiums.
In November 2019, we completed an offering of €900 million (approximately $1.000 billion) in aggregate principal amount of 0.625% senior notes due in 2027 (December 2027 Notes). The euro-denominated debt principal is a nonderivative instrument designated as a net investment hedge of our net investments in certain of our euro functional entities. Refer to Note D – Hedging Activities and Fair Value Measurements for additional information. We used a portion of the net proceeds from our November 2019 senior notes offering to repay certain outstanding principal amounts of our senior notes including $206 million of our $450 million 4.125% senior notes due 2023, $566 million of our $1.000 billion 4.000% senior notes due 2028 and $227 million of our $750 million 3.850% senior notes due 2025 and pay accrued and unpaid interest, premiums, fees and expenses in connection with the transaction.
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In February 2019, we completed an offering of $4.300 billion in aggregate principal amount of senior notes comprised of $850 million of 3.450% senior notes due March 2024, $850 million of 3.750% senior notes due March 2026, $850 million of 4.000% senior notes due March 2029, $750 million of 4.550% senior notes due March 2039 and $1.000 billion of 4.700% senior notes due March 2049. We used a portion of the net proceeds from the offering to repay the $850 million plus accrued interest and premium of our 6.000% senior notes due in January 2020, the $600 million plus accrued interest and premium of our 2.850% senior notes due in May 2020 and the $1.000 billion plus accrued interest of our August 2019 Term Loan. In the third quarter of 2019, the remaining proceeds were used to finance a portion of the acquisition of BTG.
Our senior notes were issued in public offerings, are redeemable prior to maturity and are not subject to sinking fund requirements. Our senior notes are unsecured, unsubordinated obligations and rank on parity with each other. These notes are effectively junior to liabilities of our subsidiaries (see Other Arrangements below).
Other Arrangements
We have accounts receivable factoring programs in certain European countries and with commercial banks in China and Japan which include promissory notes discounting programs. We account for our factoring programs as sales under FASB ASC Topic 860, Transfers and Servicing. We have no retained interest in the transferred receivables, other than collection and administration, and once sold, the accounts receivable are no longer available to satisfy creditors in the event of bankruptcy. Amounts de-recognized for accounts and notes receivable, which are excluded from Trade accounts receivable, net in our accompanying unaudited condensed consolidated balance sheets, are aggregated by contract denominated currency below (in millions):
| Factoring Arrangements | As of September 30, 2020 | As of December 31, 2019 | |||||||||||||||||||||
| Amount De-recognized | Average Interest Rate | Amount De-recognized | Average Interest Rate | ||||||||||||||||||||
| Euro denominated | $ | 150 | 1.8 | % | $ | 171 | 1.4 | % | |||||||||||||||
| Yen denominated | 191 | 0.6 | % | 226 | 0.6 | % | |||||||||||||||||
Renminbi denominated | 1 | 3.5 | % | n/a | n/a | ||||||||||||||||||
Other Contractual Obligations and Commitments
We had outstanding letters of credit of $125 million as of September 30, 2020 and $105 million as of December 31, 2019, which consisted primarily of bank guarantees and collateral for workers' compensation insurance arrangements. As of September 30, 2020 and December 31, 2019, none of the beneficiaries had drawn upon the letters of credit or guarantees, accordingly, we have not recognized a related liability for our outstanding letters of credit in our unaudited condensed consolidated balance sheets as of September 30, 2020 and December 31, 2019.
Refer to Note E – Contractual Obligations and Commitments to our audited financial statements contained in Item 8 of our most recent Annual Report on Form 10-K for additional information on our borrowings and credit agreements.
NOTE F – SUPPLEMENTAL BALANCE SHEET INFORMATION
Components of selected captions in our accompanying unaudited condensed consolidated balance sheets are as follows:
Cash, cash equivalents, restricted cash and restricted cash equivalents
| As of | |||||||||||
| (in millions) | September 30, 2020 | December 31, 2019 | |||||||||
| Cash and cash equivalents | $ | 2,022 | $ | 217 | |||||||
Restricted cash and restricted cash equivalents in Other current assets | 214 | 346 | |||||||||
Restricted cash equivalents in Other long-term assets | 46 | 43 | |||||||||
| $ | 2,282 | $ | 607 | ||||||||
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Trade accounts receivable, net
| As of | |||||||||||
| (in millions) | September 30, 2020 | December 31, 2019 | |||||||||
| Trade accounts receivable | $ | 1,701 | $ | 1,902 | |||||||
| Allowance for credit losses | (103) | (74) | |||||||||
| $ | 1,598 | $ | 1,828 | ||||||||
The following is a rollforward of our Allowance for credit losses:
| Three Months Ended September 30, | Nine Months Ended September 30, | ||||||||||||||||||||||
| (in millions) | 2020 | 2019 | 2020 | 2019 | |||||||||||||||||||
| Beginning balance | $ | 94 | $ | 73 | $ | 74 | $ | 68 | |||||||||||||||
| Cumulative effect adjustment for adoption of ASU 2016-13 | n/a | n/a | 10 | n/a | |||||||||||||||||||
| Credit loss expense | 16 | 8 | 39 | 19 | |||||||||||||||||||
| Write-offs | (7) | (5) | (19) | (11) | |||||||||||||||||||
| Ending balance | $ | 103 | $ | 75 | $ | 103 | $ | 75 | |||||||||||||||
Note: Effective January 1, 2020, we adopted FASB ASC Topic 326 using the modified retrospective method, which requires that we recognize credit loss reserves when financial assets are established if credit losses are expected over the asset’s contractual life. Prior period amounts have not been restated and are presented in accordance with FASB ASC Topic 310. Please refer to Note A – Basis of Presentation for additional information.
In accordance with FASB ASC Topic 326, we record credit loss reserves to Allowance for credit losses when we establish Trade accounts receivable if credit losses are expected over the asset's contractual life. We base our estimates of credit loss reserves on historical experience and adjust, as necessary, to reflect current conditions using reasonable and supportable forecasts not already reflected in the historical loss information. We utilize an accounts receivable aging approach to determine the reserve to record at accounts receivable commencement for certain customers, applying country or region-specific factors. In performing the assessment of outstanding accounts receivable, regardless of country or region, we may consider significant factors relevant to collectability including those specific to a customer such as bankruptcy, lengthy average payment cycles and type of account.
Inventories
| As of | |||||||||||
| (in millions) | September 30, 2020 | December 31, 2019 | |||||||||
| Finished goods | $ | 871 | $ | 971 | |||||||
| Work-in-process | 179 | 192 | |||||||||
| Raw materials | 421 | 416 | |||||||||
| $ | 1,472 | $ | 1,579 | ||||||||
Other current assets
| As of | |||||||||||
| (in millions) | September 30, 2020 | December 31, 2019 | |||||||||
| Restricted cash and restricted cash equivalents | $ | 214 | $ | 346 | |||||||
| Derivative assets | 146 | 105 | |||||||||
| Licensing arrangements | 149 | 186 | |||||||||
| Other | 385 | 243 | |||||||||
| $ | 894 | $ | 880 | ||||||||
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Property, plant and equipment, net
| As of | |||||||||||
| (in millions) | September 30, 2020 | December 31, 2019 | |||||||||
| Land | $ | 120 | $ | 117 | |||||||
| Buildings and improvements | 1,243 | 1,198 | |||||||||
| Equipment, furniture and fixtures | 3,411 | 3,411 | |||||||||
| Capital in progress | 402 | 442 | |||||||||
| 5,176 | 5,169 | ||||||||||
| Less: accumulated depreciation | 3,112 | 3,089 | |||||||||
| $ | 2,064 | $ | 2,079 | ||||||||
Depreciation expense was $84 million for the third quarter of 2020, $79 million for the third quarter of 2019, $238 million for the first nine months of 2020 and $220 million for the first nine months of 2019.
Other long-term assets
| As of | |||||||||||
| (in millions) | September 30, 2020 | December 31, 2019 | |||||||||
| Restricted cash equivalents | $ | 46 | $ | 43 | |||||||
| Operating lease right-of-use assets | 311 | 336 | |||||||||
| Derivative assets | 179 | 216 | |||||||||
| Investments | 567 | 458 | |||||||||
| Licensing arrangements | 246 | 332 | |||||||||
| Other | 165 | 144 | |||||||||
| $ | 1,516 | $ | 1,529 | ||||||||
Accrued expenses
| As of | |||||||||||
| (in millions) | September 30, 2020 | December 31, 2019 | |||||||||
| Legal reserves | $ | 552 | $ | 470 | |||||||
| Payroll and related liabilities | 728 | 708 | |||||||||
| Rebates | 324 | 298 | |||||||||
| Contingent consideration | 47 | 56 | |||||||||
| Other | 544 | 576 | |||||||||
| $ | 2,195 | $ | 2,109 | ||||||||
Other current liabilities
| As of | |||||||||||
| (in millions) | September 30, 2020 | December 31, 2019 | |||||||||
| Deferred revenue | $ | 147 | $ | 144 | |||||||
| Licensing arrangements | 151 | 197 | |||||||||
| Taxes payable | 37 | 265 | |||||||||
| Other | 310 | 195 | |||||||||
| $ | 644 | $ | 800 | ||||||||
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Other long-term liabilities
| As of | |||||||||||
| (in millions) | September 30, 2020 | December 31, 2019 | |||||||||
| Accrued income taxes | $ | 571 | $ | 667 | |||||||
| Legal reserves | 48 | 227 | |||||||||
| Accrued contingent consideration | 167 | 299 | |||||||||
| Licensing arrangements | 262 | 374 | |||||||||
| Operating lease liabilities | 256 | 276 | |||||||||
| Deferred revenue | 258 | 257 | |||||||||
| Other | 569 | 535 | |||||||||
| $ | 2,132 | $ | 2,635 | ||||||||
NOTE G – INCOME TAXES
Our effective tax rate from continuing operations is presented below:
| Three Months Ended September 30, | Nine Months Ended September 30, | ||||||||||||||||||||||
| 2020 | 2019 | 2020 | 2019 | ||||||||||||||||||||
| Effective tax rate from continuing operations | 31.7 | % | (38.7) | % | 24.3 | % | (1.6) | % | |||||||||||||||
The change in our reported tax rates for the third quarter and first nine months of 2020, as compared to the same periods in 2019, relates primarily to a shift in geographical mix of earnings to higher-tax jurisdictions, partially offset by the impact of certain receipts and charges that are taxed at different rates than our effective tax rate. These receipts and charges include intangible asset impairment charges, acquisition/divestiture-related net charges, restructuring and restructuring-related net charges, litigation-related net charges as well as certain discrete tax items primarily related to the resolution of an Internal Revenue Service (IRS) audit, as explained below, tax windfall benefits associated with share-based payments, and impacts of the Coronavirus Aid, Relief and Economic Security (CARES) Act, enacted on March 27, 2020.
In the third quarter of 2020, we received notification from the IRS regarding the examination of our 2014 through 2016 tax years. The Joint Committee on Taxation completed its review on July 21, 2020, and the IRS examination was resolved. Due to the resolution of these tax years, we recorded a net tax benefit of $91 million in the third quarter of 2020 to release the reserves related to these years. We anticipate receiving a refund of $62 million from the IRS in the fourth quarter of 2020 reflecting the net balance of amounts owed to us by the IRS after consideration of tax and interest due for these years.
As of September 30, 2020, we had $279 million of gross unrecognized tax benefits, of which a net $185 million, if recognized, would affect our effective tax rate. As of December 31, 2019, we had $455 million of gross unrecognized tax benefits, of which a net $355 million, if recognized, would affect our effective tax rate. The change in our gross unrecognized tax benefit is primarily related to reaching settlements with tax authorities.
It is reasonably possible that within the next 12 months we will resolve multiple issues with foreign, federal and state taxing authorities, resulting in a reduction in our balance of unrecognized tax benefits of up to $23 million.
Economic stimulus legislation has been enacted in many countries in response to COVID-19. In the U.S., the CARES Act was signed into law on March 27, 2020 and provided an estimated $2.2 trillion in COVID-19 pandemic related relief, and included tax relief and government loans, subsidies and other relief for entities in affected industries. While we have not applied for government loans, we have taken advantage of the benefits offered in multiple jurisdictions, including the U.S. provision allowing taxpayers to defer payment of the employer portion of certain payroll taxes through the end of 2020. This allows us to preserve cash generated from operations to service our debt obligations and other near-term commitments.
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NOTE H – COMMITMENTS AND CONTINGENCIES
The medical device market in which we participate is largely technology driven. As a result, intellectual property rights, particularly patents and trade secrets, play a significant role in product development and differentiation. Over the years, there has been litigation initiated against us by others, including our competitors, claiming that our current or former product offerings infringe patents owned or licensed by them. Intellectual property litigation is inherently complex and unpredictable. In addition, competing parties frequently file multiple suits to leverage patent portfolios across product lines, technologies and geographies and to balance risk and exposure between the parties. In some cases, several competitors are parties in the same proceeding, or in a series of related proceedings, or litigate multiple features of a single class of devices. These dynamics frequently drive settlement not only for individual cases, but also for a series of pending and potentially related and unrelated cases. Although monetary and injunctive relief is typically sought, remedies and restitution are generally not determined until the conclusion of the trial court proceedings and can be modified on appeal. Accordingly, the outcomes of individual cases are difficult to time, predict or quantify and are often dependent upon the outcomes of other cases in other geographies.
During recent years, we successfully negotiated closure of several long-standing legal matters and have received favorable rulings in several other matters; however, there continues to be outstanding intellectual property litigation. Adverse outcomes in one or more of these matters could have a material adverse effect on our ability to sell certain products and on our operating margins, financial position, results of operations and/or liquidity.
In the normal course of business, product liability, securities and commercial claims are asserted against us. Similar claims may be asserted against us in the future related to events not known to management at the present time. We maintain an insurance policy providing limited coverage against securities claims and we are substantially self-insured with respect to product liability claims and fully self-insured with respect to intellectual property infringement claims. The absence of significant third-party insurance coverage increases our potential exposure to unanticipated claims or adverse decisions. Product liability claims, securities and commercial litigation and other legal proceedings in the future, regardless of their outcome, could have a material adverse effect on our ability to sell certain products and on our operating margins, financial position, results of operations and/or liquidity.
In addition, like other companies in the medical device industry, we are subject to extensive regulation by national, state and local government agencies in the U.S. and other countries in which we operate. From time to time we are the subject of qui tam actions and governmental investigations often involving regulatory, marketing and other business practices. These qui tam actions and governmental investigations could result in the commencement of civil and criminal proceedings, substantial fines, penalties and administrative remedies and have a material adverse effect on our financial position, results of operations and/or liquidity.
In accordance with FASB ASC Topic 450, Contingencies, we accrue anticipated costs of settlement, damages, losses for product liability claims and, under certain conditions, costs of defense, based on historical experience or to the extent specific losses are probable and estimable. Otherwise, we expense these costs as incurred. If the estimate of a probable loss is a range and no amount within the range is more likely, we accrue the minimum amount of the range.
Our accrual for legal matters that are probable and estimable was $600 million as of September 30, 2020 and $697 million as of December 31, 2019 and includes certain estimated costs of settlement, damages and defense. The decrease in our legal accrual was mainly due to settlement payments related to litigation with Channel Medsystems, Inc. (Channel) and those associated with product liability cases or claims related to transvaginal surgical mesh products, partially offset by incremental reserves recorded in the third quarter of 2020 described below. A portion of our legal accrual is already funded through our qualified settlement fund (QSF), which is included in restricted cash and restricted cash equivalents in Other current assets of $214 million as of September 30, 2020 and $346 million as of December 31, 2019. Refer to Note F – Supplemental Balance Sheet Information for additional information.
We recorded litigation-related charges of $260 million during the third quarter and first nine months of 2020, primarily related to transvaginal mesh products, inclusive of a reserve related to claims made by a coalition of state attorneys general. In the first nine months of 2019, our litigation-related net credits included a gain of $148 million, which represents a portion of the total $180 million one-time settlement payment received from Edwards Lifesciences Corporation (Edwards) in January 2019. We record certain legal and product liability charges, credits and costs of defense, which we consider to be unusual or infrequent and significant as Litigation-related net charges (credits) in our unaudited condensed consolidated financial statements. All other legal and product liability charges, credits and costs are recorded within Selling, general and administrative expenses. As such, a portion of the related gain from this settlement was recorded in Selling, general and administrative expenses in our unaudited condensed consolidated statements of operations. We continue to assess certain litigation and claims to determine the amounts, if any, that management believes will be paid as a result of such claims and litigation and, therefore, additional losses
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may be accrued and paid in the future, which could materially adversely impact our operating results, cash flows and/or our ability to comply with our financial covenant.
In management's opinion, we are not currently involved in any legal proceedings other than those disclosed in our most recent Annual Report on Form 10-K, our Quarterly Reports on Form 10-Q for the periods ended March 31, 2020 and June 30, 2020 and those specifically identified below, which, individually or in the aggregate, could have a material adverse effect on our financial condition, operations and/or cash flows. Unless included in our legal accrual or otherwise indicated below, a range of loss associated with any individual material legal proceeding cannot be reasonably estimated.
Product Liability Litigation
As of October 21, 2020, approximately 54,000 product liability cases or claims related to transvaginal surgical mesh products designed to treat stress urinary incontinence and pelvic organ prolapse have been asserted against us. As of October 21, 2020, we have entered into master settlement agreements in principle or are in the final stages of entering one with certain plaintiffs' counsel to resolve an aggregate of approximately 52,000 cases and claims, adjusted to reflect the Company’s analysis of expected non-participation and duplicate claims. These master settlement agreements provide that the settlement and distribution of settlement funds to participating claimants are conditional upon, among other things, achieving minimum required claimant participation thresholds. Of the approximately 52,000 cases and claims, approximately 47,500 have met the conditions of the settlement and are final. All settlement agreements were entered into solely by way of compromise and without any admission or concession by us of any liability or wrongdoing. The pending cases are in various federal and state courts in the U.S. Generally, the plaintiffs allege personal injury associated with use of our transvaginal surgical mesh products. The plaintiffs assert design and manufacturing claims, failure to warn, breach of warranty, fraud, violations of state consumer protection laws and loss of consortium claims. Over 3,100 of the cases were specially assigned to one judge in state court in Massachusetts. On February 7, 2012, the Judicial Panel on Multi-District Litigation (MDL) established MDL-2326 in the U.S. District Court for the Southern District of West Virginia and transferred the federal court transvaginal surgical mesh cases to MDL-2326 for coordinated pretrial proceedings. During the fourth quarter of 2013, we received written discovery requests from certain state attorneys general offices regarding our transvaginal surgical mesh products. We have responded to those requests. On December 12, 2019 the Mississippi Attorney General filed suit against BSC in State Court alleging violations of the Mississippi Consumer Protection Act which the Company plans to vigorously defend. There are fewer than 25 claims in the United Kingdom. There are also fewer than 15 cases in Canada, inclusive of one certified class action, which has settled and received Court approval. On April 16, 2019, the U.S. Food and Drug Administration (FDA) ordered that all manufacturers of surgical mesh products indicated for the transvaginal repair of pelvic organ prolapse stop selling and distributing their products in the United States immediately, stemming from the FDA’s 2016 reclassification of these devices to class III (high risk) devices, and as a result, the Company ceased global sales and distribution of surgical mesh products indicated for transvaginal pelvic organ prolapse.
We have established a product liability accrual for known and estimated future cases and claims asserted against us as well as with respect to the actions that have resulted in verdicts against us and the costs of defense thereof associated with our transvaginal surgical mesh products. While we believe that our accrual associated with this matter is adequate, changes to this accrual may be required in the future as additional information becomes available. While we continue to engage in discussions with plaintiffs’ counsel regarding potential resolution of pending cases and claims and intend to vigorously contest the cases and claims asserted against us that do not settle, the final resolution of the cases and claims is uncertain and could have a material impact on our results of operations, financial condition and/or liquidity. Initial trials involving our transvaginal surgical mesh products have resulted in both favorable and unfavorable judgments for us. We do not believe that the judgment in any one trial is representative of potential outcomes of all cases or claims related to our transvaginal surgical mesh products.
We are currently named a defendant in 92 filed product liability cases involving our Greenfield Vena Cava Filter, alleging various injuries, including perforation of the vena cava, post-implant deep vein thrombosis, fracture, and other injuries. Most of the filed cases are part of a consolidated matter in Middlesex County, Massachusetts. We have received notice of an additional 624 claims, none of which have been filed.
Other Proceedings
On September 6, 2019, Boston Scientific Corporation, Boston Scientific Scimed, Inc., and Fortis Advisors, LLC, as a Securityholder Representative for the former Securityholders of nVision Medical Corp. filed a declaratory judgment action against BioCardia, Inc. in the United States District Court for the Northern District of California to address threats and allegations by BioCardia challenging inventorship and ownership of various patents that Boston Scientific Corporation acquired through an April 13, 2018 merger with nVision as well as related threats and allegations by BioCardia of trade secret misappropriation and unjust enrichment. On December 11, 2019, BioCardia filed an amended answer and counterclaims. On
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April 23, 2020, BioCardia filed a complaint against nVision, which had not been named as a defendant in the original case. On May 22, 2020, BioCardia amended its complaint against nVision to add twenty former nVision shareholders as defendants. On August 20, 2020, BioCardia again amended its complaint against Boston Scientific Corporation/Boston Scientific Scimed, Inc./Fortis Advisors, LLC and its complaint against nVision/nVision shareholders.
Refer to Note G – Income Taxes for information regarding our tax litigation.
Matters Concluded Since December 31, 2019
On April 30, 2019, Tissue Anchor Innovations filed a complaint for patent infringement in the United States District Court Central District of California against Fountain Valley Regional Hospital and Medical Center, Los Alamitos Medical Center and us. The complaint alleged that the Solyx™ Sling System infringes US Patent 6,506,190. We reached a confidential settlement in this matter in July 2020, pursuant to which the action was dismissed.
On March 10, 2017, Imran Niazi filed a patent infringement action against us in the U.S. District Court for the Western District of Wisconsin alleging that a U.S. patent owned by him is infringed by our Acuity™ Lead Delivery System. On June 30, 2017, we filed a motion to dismiss for improper venue and on November 7, 2017 the Wisconsin Court granted the motion to dismiss. On November 13, 2017 Niazi refiled the same action in the U.S. District of Minnesota. We reached a confidential settlement on this matter on February 3, 2020 pursuant to which the action was dismissed.
On November 1, 2017, we entered into a definitive agreement with Channel pursuant to which we could have been obligated to pay $145 million in cash up-front and a maximum of $130 million in contingent payments to acquire Channel. The agreement contained a provision allowing Channel to sell the remaining equity interests of Channel to us upon achievement of a regulatory milestone and an option allowing us to acquire the remaining equity interests. We sent a notice of termination of that agreement to Channel in the second quarter of 2018. On September 12, 2018, Channel filed a complaint in Delaware Chancery Court against us for alleged breach of the agreement. Channel alleged that we breached the agreement by terminating it. We answered the complaint, denied the claims by Channel and counterclaimed to recover part of our investment in Channel, alleging fraud in the inducement. On April 2, 2019, Channel announced its receipt of FDA approval of the Cerene™ Cryotherapy Device. Trial testimony was taken in April 2019, and the post-trial briefing and hearing were completed. During the third quarter of 2019, Channel notified us that they were exercising their option to sell the remaining equity interests in Channel to us. We responded to the notification that we did not intend to purchase Channel since the previous agreement had been terminated. On December 18, 2019, the Chancery Court ruled that Boston Scientific was in breach of the agreement and granted Channel's request for specific performance to require the Company to complete the purchase. On January 10, 2020, we filed a Notice of Appeal of the Chancery Court’s decision to the Delaware Supreme Court. On February 4, 2020, the Company settled the dispute with Channel resulting in termination of the agreement, payment by the Company of an undisclosed sum and surrender of the Company's equity interest in Channel.
NOTE I – STOCKHOLDERS' EQUITY
Preferred Stock
We are authorized to issue 50 million shares of preferred stock in one or more series and to fix the powers, designations, preferences and relative participating, option or other rights thereof, including dividend rights, conversion rights, voting rights, redemption terms, liquidation preferences and the number of shares constituting any series, without any further vote or action by our stockholders.
On May 27, 2020, we completed an offering of 10,062,500 shares of 5.50% Mandatory Convertible Preferred Stock (MCPS), Series A at a price to the public and liquidation preference of $100 per share. The net proceeds from the MCPS offering were approximately $975 million after deducting underwriting discounts and commissions and offering expenses. As of September 30, 2020, our MCPS had an aggregate liquidation preference of $1.006 billion.
Holders of MCPS will be entitled to receive, when, as and if declared by our Board of Directors, or an authorized committee thereof, out of funds legally available for payment, cumulative dividends at the annual rate of 5.50% of the liquidation preference of $100 per share, payable in cash or, subject to certain limitations, by delivery of shares of common stock or any combination of cash and shares of common stock, at our election; provided, however, that any unpaid dividends on the MCPS will continue to accumulate as described in the Certificate of Designations.
Subject to certain exceptions, no dividend or distribution will be declared or paid on shares of our common stock, and no common stock will be purchased, redeemed or otherwise acquired for consideration by us or any of our subsidiaries unless, in
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each case, all accumulated and unpaid dividends for all preceding dividend periods have been declared and paid, or a sufficient amount of cash or number of shares of common stock has been set apart for the payment of such dividends, on all outstanding shares of MCPS. In the event of our voluntary or involuntary liquidation, winding-up or dissolution, no distribution of our assets may be made to holders of our common stock until we have paid holders of our MCPS, each of which will be entitled to receive a liquidation preference in the amount of $100 per share plus accumulated and unpaid dividends.
Unless earlier converted, each share of MCPS will automatically convert on June 1, 2023, subject to postponement for certain market disruption events, into between 2.3834 and 2.9197 shares of common stock, subject to customary anti-dilution adjustments. The number of shares of common stock issuable upon conversion will be determined based on the average volume-weighted average price per share of common stock over the 20 consecutive trading day period beginning on, and including, the 21st scheduled trading day immediately preceding June 1, 2023.
The MCPS is not subject to any redemption, sinking fund or other similar provisions. However, at our option, we may purchase or exchange the MCPS from time to time in the open market, by tender or exchange offer or otherwise, without the consent of, or notice to, holders of MCPS. The holders of the MCPS will not have any voting rights, with limited exceptions.
On September 1, 2020, we paid to holders of our MCPS as of August 15, 2020 a cash dividend of $1.4361 per MCPS share (or $14 million in aggregate cash dividends), representing a dividend period beginning on the May 27, 2020 issuance date through August 31, 2020.
On October 27, 2020, the Audit Committee of our Board of Directors, pursuant to authority delegated to such committee by our Board of Directors, declared a cash dividend of $1.375 per MCPS share (or $14 million in aggregate cash dividends) to be paid on December 1, 2020 to holders of our MCPS as of November 15, 2020, representing a dividend period beginning on September 1, 2020 through November 30, 2020. We have presented cumulative, unpaid dividends covering the period from September 1, 2020 through September 30, 2020 totaling $5 million within Accrued expenses within our unaudited condensed consolidated balance sheet as of September 30, 2020.
Common Stock
We are authorized to issue 2.000 billion shares of common stock, $0.01 par value per share. Holders of common stock are entitled to one vote per share. Holders of common stock are entitled to receive dividends, if and when declared by our Board of Directors, and to share ratably in our assets legally available for distribution to our stockholders in the event of liquidation. Holders of common stock have no preemptive, subscription, redemption, or conversion rights. The holders of common stock do not have cumulative voting rights. The holders of a majority of the shares of common stock can elect all of the directors and can control our management and affairs. Holders of common stock are junior to holders of MCPS in terms of liquidation preference.
On May 27, 2020, we completed an offering of 29,382,500 shares of common stock at a public offering price of $34.25 per share. The net proceeds from the common stock offering were approximately $975 million after deducting underwriting discounts and commissions and offering expenses.
We used a portion of the net proceeds from the May 27, 2020 MCPS and common stock offerings to repay remaining amounts outstanding under the April 2021 Term Loan and to pay related fees, expenses and premiums as discussed in Note E – Contractual Obligations and Commitments. The remaining proceeds will be used for general corporate purposes, which may include refinancing or repayment of other outstanding indebtedness and funding potential future acquisitions and investments.
NOTE J – WEIGHTED AVERAGE SHARES OUTSTANDING
| Three Months Ended September 30, | Nine Months Ended September 30, | ||||||||||||||||||||||
| (in millions) | 2020 | 2019 | 2020 | 2019 | |||||||||||||||||||
| Weighted average shares outstanding - basic | 1,430.9 | 1,393.1 | 1,413.0 | 1,390.6 | |||||||||||||||||||
| Net effect of common stock equivalents | — | 19.0 | — | 19.1 | |||||||||||||||||||
| Weighted average shares outstanding - assuming dilution | 1,430.9 | 1,412.2 | 1,413.0 | 1,409.7 | |||||||||||||||||||
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The following securities were excluded from the calculation of weighted average shares outstanding - assuming dilution because their effect in the periods presented below would have been antidilutive:
| Three Months Ended September 30, | Nine Months Ended September 30, | ||||||||||||||||||||||
| (in millions) | 2020 | 2019 | 2020 | 2019 | |||||||||||||||||||
| Common stock equivalents (1) | 14 | 0 | 14 | 0 | |||||||||||||||||||
| Stock options outstanding (2) | 6 | 0 | 6 | 0 | |||||||||||||||||||
| MCPS (3) | 24 | 0 | 11 | 0 | |||||||||||||||||||
(1) Represents common stock equivalents pursuant to our employee stock-based compensation plans, which are anti-dilutive in the third quarter and first nine months of 2020 due to our Net loss positions in those periods.
(2) Represents stock options outstanding pursuant to our employee stock-based compensation plans with exercise prices that were greater than the average fair market value of our common stock for the related periods.
(3) Represents common stock issuable upon the conversion of MCPS. Refer to Note I – Stockholders' Equity for additional information.
We base Net income (loss) per common share - assuming dilution upon the weighted-average number of common shares and common stock equivalents outstanding during each year. Potential common stock equivalents are determined using the treasury stock method. We exclude stock options, stock awards and MCPS from the calculation if the effect would be anti-dilutive. The dilutive effect of MCPS is calculated using the if-converted method. The if-converted method assumes that these securities were converted to shares of common stock at the later of the May 27, 2020 issuance date or the beginning of the reporting period to the extent that the effect is dilutive.
For the third quarter and first nine months of 2020, the effect of assuming the conversion of MCPS into shares of common stock was anti-dilutive, and therefore excluded from the calculation of earnings per share (EPS). Accordingly, Net loss was reduced by cumulative Preferred stock dividends, as presented in our unaudited condensed consolidated statements of operations, for purposes of calculating EPS.
We issued approximately three million shares of our common stock in the third quarter of 2020, two million shares in the third quarter of 2019, eight million shares in the first nine months of 2020, and nine million shares in the first nine months of 2019, following the exercise of stock options, vesting of deferred stock units or purchases under our employee stock purchase plan. We did not repurchase any shares of our common stock in the first nine months of 2020 or 2019.
NOTE K – SEGMENT REPORTING
Our seven core businesses are organized into three reportable segments: MedSurg, Rhythm and Neuro, and Cardiovascular, which represent an aggregation of our operating segments that generate revenues from the sale of medical devices. We measure and evaluate our reportable segments based on net sales of reportable segments, operating income of reportable segments, excluding intersegment profits, and operating income of reportable segments as a percentage of net sales of reportable segments. Operating income of reportable segments as a percentage of net sales of reportable segments is defined as operating income of reportable segments divided by net sales of reportable segments. We exclude from operating income of reportable segments certain corporate-related expenses and certain transactions or adjustments that our chief operating decision maker (CODM) considers to be non-operational, such as amounts related to amortization expense, intangible asset impairment charges, acquisition/divestitures-related net charges/(credits), restructuring and restructuring-related net charges/(credits), certain EU Medical Device Regulation (MDR) implementation costs and litigation-related charges/(credits). Although we exclude these amounts from operating income of reportable segments, they are included in reported Income (loss) before income taxes in our unaudited condensed consolidated statements of operations and are included in the reconciliation below.
Following our integration of BTG, the acquisition of which closed during the third quarter of 2019, we have included BTG’s Interventional Medicine business within our Peripheral Interventions operating segment, within the Cardiovascular reportable segment. We present BTG’s Specialty Pharmaceuticals business as a standalone operating segment alongside our reportable segments. In our Quarterly Report on Form 10-Q for the period ended September 30, 2019, we presented Interventional Medicine and Specialty Pharmaceuticals together as "BTG Acquisition" and outside of our operating and reportable segments for sales of reportable segments, operating income of reportable segments, excluding intersegment profits, and operating income of reportable segments as a percentage of net sales of reportable segments. We have revised amounts for the third quarter and first nine months of 2019 to conform to the current year presentation.
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A reconciliation of the totals reported for the reportable segments to the applicable line items within our accompanying unaudited condensed consolidated statements of operations is as follows (in millions, except percentages):
| Three Months Ended September 30, | Nine Months Ended September 30, | ||||||||||||||||||||||
| Net sales | 2020 | 2019 | 2020 | 2019 | |||||||||||||||||||
| MedSurg | $ | 825 | $ | 845 | $ | 2,175 | $ | 2,429 | |||||||||||||||
| Rhythm and Neuro | 757 | 780 | 1,985 | 2,323 | |||||||||||||||||||
| Cardiovascular | 1,002 | 1,058 | 2,862 | 3,057 | |||||||||||||||||||
| Total net sales of reportable segments | 2,584 | 2,684 | 7,021 | 7,807 | |||||||||||||||||||
| All other (Specialty Pharmaceuticals) | 74 | 23 | 183 | 23 | |||||||||||||||||||
| Consolidated net sales | $ | 2,659 | $ | 2,707 | $ | 7,204 | $ | 7,831 | |||||||||||||||
| Three Months Ended September 30, | Nine Months Ended September 30, | ||||||||||||||||||||||
| Income (loss) before income taxes | 2020 | 2019 | 2020 | 2019 | |||||||||||||||||||
| MedSurg | $ | 307 | $ | 319 | $ | 738 | $ | 870 | |||||||||||||||
| Rhythm and Neuro | 165 | 166 | 296 | 488 | |||||||||||||||||||
| Cardiovascular | 208 | 283 | 593 | 860 | |||||||||||||||||||
| Total operating income of reportable segments | 680 | 768 | 1,628 | 2,218 | |||||||||||||||||||
| All other (Specialty Pharmaceuticals) | 49 | 13 | 124 | 13 | |||||||||||||||||||
| Unallocated amounts: | |||||||||||||||||||||||
| Corporate expenses, including hedging activities | (108) | (75) | (330) | (215) | |||||||||||||||||||
| Intangible asset impairment charges, acquisition/divestiture-related net (charges) credits, restructuring- and restructuring-related net (charges) credits, EU MDR implementation costs and litigation-related net (charges) credits | (629) | (146) | (957) | (210) | |||||||||||||||||||
| Amortization expense | (197) | (178) | (595) | (498) | |||||||||||||||||||
| Operating income (loss) | (205) | 383 | (130) | 1,308 | |||||||||||||||||||
| Other expense, net | (22) | (292) | (256) | (615) | |||||||||||||||||||
| Income (loss) before income taxes | $ | (227) | $ | 91 | $ | (386) | $ | 693 | |||||||||||||||
| Operating income of reportable segments as a percentage of net sales of reportable segments | Three Months Ended September 30, | Nine Months Ended September 30, | |||||||||||||||||||||
| 2020 | 2019 | 2020 | 2019 | ||||||||||||||||||||
| MedSurg | 37.2 | % | 37.8 | % | 33.9 | % | 35.8 | % | |||||||||||||||
| Rhythm and Neuro | 21.9 | % | 21.3 | % | 14.9 | % | 21.0 | % | |||||||||||||||
| Cardiovascular | 20.8 | % | 26.7 | % | 20.7 | % | 28.1 | % | |||||||||||||||
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NOTE L – REVENUE
We generate revenue primarily from the sale of single-use medical devices and present revenue net of sales taxes in our unaudited condensed consolidated statements of operations. The following tables disaggregate our revenue from contracts with customers by business and geographic region (in millions):
| Three Months Ended September 30, | |||||||||||||||||||||||||||||||||||
| 2020 | 2019 | ||||||||||||||||||||||||||||||||||
| Businesses | U.S. | OUS | Total | U.S. | OUS | Total | |||||||||||||||||||||||||||||
| Endoscopy | $ | 270 | $ | 205 | $ | 475 | $ | 277 | $ | 209 | $ | 486 | |||||||||||||||||||||||
| Urology and Pelvic Health | 251 | 99 | 350 | 257 | 102 | 359 | |||||||||||||||||||||||||||||
| Cardiac Rhythm Management | 275 | 190 | 465 | 284 | 194 | 478 | |||||||||||||||||||||||||||||
| Electrophysiology | 33 | 43 | 76 | 38 | 43 | 81 | |||||||||||||||||||||||||||||
| Neuromodulation | 176 | 41 | 216 | 183 | 39 | 222 | |||||||||||||||||||||||||||||
| Interventional Cardiology | 255 | 331 | 586 | 327 | 373 | 700 | |||||||||||||||||||||||||||||
| Peripheral Interventions | 236 | 179 | 416 | 195 | 163 | 358 | |||||||||||||||||||||||||||||
| Specialty Pharmaceuticals | 65 | 10 | 74 | 19 | 4 | 23 | |||||||||||||||||||||||||||||
| Net Sales | $ | 1,560 | $ | 1,098 | $ | 2,659 | $ | 1,580 | $ | 1,126 | $ | 2,707 | |||||||||||||||||||||||
| Nine Months Ended September 30, | |||||||||||||||||||||||||||||||||||
| 2020 | 2019 | ||||||||||||||||||||||||||||||||||
| Businesses | U.S. | OUS | Total | U.S. | OUS | Total | |||||||||||||||||||||||||||||
| Endoscopy | $ | 715 | $ | 550 | $ | 1,265 | $ | 800 | $ | 596 | $ | 1,396 | |||||||||||||||||||||||
| Urology and Pelvic Health | 650 | 260 | 910 | 737 | 297 | 1,033 | |||||||||||||||||||||||||||||
| Cardiac Rhythm Management | 738 | 515 | 1,253 | 860 | 607 | 1,467 | |||||||||||||||||||||||||||||
| Electrophysiology | 86 | 116 | 202 | 113 | 132 | 245 | |||||||||||||||||||||||||||||
| Neuromodulation | 426 | 103 | 529 | 487 | 125 | 612 | |||||||||||||||||||||||||||||
| Interventional Cardiology | 741 | 973 | 1,714 | 942 | 1,126 | 2,067 | |||||||||||||||||||||||||||||
| Peripheral Interventions | 649 | 499 | 1,148 | 507 | 482 | 989 | |||||||||||||||||||||||||||||
| Specialty Pharmaceuticals | 162 | 21 | 183 | 19 | 4 | 23 | |||||||||||||||||||||||||||||
| Net Sales | $ | 4,167 | $ | 3,037 | $ | 7,204 | $ | 4,462 | $ | 3,369 | $ | 7,831 | |||||||||||||||||||||||
| Three Months Ended September 30, | Nine Months Ended September 30, | ||||||||||||||||||||||
| Geographic Regions | 2020 | 2019 | 2020 | 2019 | |||||||||||||||||||
| U.S. | $ | 1,496 | $ | 1,561 | $ | 4,005 | $ | 4,443 | |||||||||||||||
| EMEA (Europe, Middle East and Africa) | 540 | 535 | 1,507 | 1,667 | |||||||||||||||||||
| APAC (Asia-Pacific) | 472 | 485 | 1,292 | 1,403 | |||||||||||||||||||
| LACA (Latin America and Canada) | 77 | 102 | 217 | 294 | |||||||||||||||||||
| Medical Devices | 2,584 | 2,684 | 7,021 | 7,807 | |||||||||||||||||||
| U.S. | 65 | 19 | 162 | 19 | |||||||||||||||||||
| OUS | 10 | 4 | 21 | 4 | |||||||||||||||||||
| Specialty Pharmaceuticals | 74 | 23 | 183 | 23 | |||||||||||||||||||
| Net Sales | $ | 2,659 | $ | 2,707 | $ | 7,204 | $ | 7,831 | |||||||||||||||
| Emerging Markets (1) | $ | 278 | $ | 310 | $ | 800 | $ | 925 | |||||||||||||||
(1) We define Emerging Markets as the 20 countries that we believe have strong growth potential based on their economic conditions, healthcare sectors and our global capabilities. Periodically, we assess our list of Emerging Markets, which is currently comprised of the following countries: Argentina, Brazil, Chile, China, Colombia, Czech Republic, India, Indonesia, Malaysia, Mexico, Philippines, Poland, Russia, Saudi Arabia, Slovakia, South Africa, South Korea, Thailand, Turkey and Vietnam.
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Deferred Revenue
Contract liabilities are classified within Other current liabilities and Other long-term liabilities in our accompanying unaudited condensed consolidated balance sheets. Our deferred revenue balance was $405 million as of September 30, 2020 and $400 million as of December 31, 2019. Our contractual liabilities are primarily composed of deferred revenue related to the LATITUDE™ Patient Management System. Revenue is recognized over the average service period which is based on device and patient longevity. We recognized revenue of $28 million in the third quarter and $84 million in the first nine months of 2020 that was included in the above contract liability balance as of December 31, 2019. We have elected not to disclose the transaction price allocated to unsatisfied performance obligations when the original expected contract duration is one year or less. In addition, we have not identified material unfulfilled performance obligations for which revenue is not currently deferred.
Variable Consideration
We generally allow our customers to return defective, damaged and, in certain cases, expired products for credit and record the amount for estimated sales returns as a reduction to revenue when we sell the initial product. In addition, we may allow customers to return previously purchased products for next-generation product offerings. For these transactions, we defer recognition of revenue on the sale of the earlier generation product based upon an estimate of the amount of product to be returned when the next-generation products are shipped to the customer. We recently received FDA approval and began the U.S. launch of our next generation WATCHMAN FLX™ Left Atrial Appendage Closure (LAAC) Device within our Interventional Cardiology business. The next generation WATCHMAN FLX™ Device is indicated to reduce the risk of stroke in patients with non-valvular atrial fibrillation (NVAF) who need an alternative to oral anticoagulation therapy by permanently closing off the left atrial appendage. In the third quarter of 2020, we incurred $63 million in revenue charges primarily related to our conversion to a consignment inventory model for our LAAC franchise with the launch of our next-generation WATCHMAN FLX™ Device in the U.S.
We also offer sales rebates and discounts to certain customers. We treat sales rebates and discounts as a reduction of revenue and classify the corresponding liability as current. If we are unable to reasonably estimate the expected rebates, we record a liability for the maximum rebate percentage offered. We have entered certain agreements with group purchasing organizations to sell our products to participating hospitals at negotiated prices. We recognize revenue from these agreements following the same revenue recognition criteria discussed above.
NOTE M – CHANGES IN OTHER COMPREHENSIVE INCOME
The following tables provide the reclassifications out of Other comprehensive income (loss), net of tax:
| (in millions) | Foreign Currency Translation Adjustments | Net Change in Derivative Financial Instruments | Net Change in Defined Benefit Pensions and Other Items | Total | |||||||||||||||||||
| Balance as of June 30, 2020 | $ | (46) | $ | 222 | $ | (45) | $ | 131 | |||||||||||||||
| Other comprehensive income (loss) before reclassifications | 88 | (50) | — | 38 | |||||||||||||||||||
| (Income) loss amounts reclassified from accumulated other comprehensive income | (5) | (14) | — | (19) | |||||||||||||||||||
| Total other comprehensive income (loss) | 84 | (64) | — | 20 | |||||||||||||||||||
| Balance as of September 30, 2020 | $ | 38 | $ | 158 | $ | (45) | $ | 151 | |||||||||||||||
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| (in millions) | Foreign Currency Translation Adjustments | Net Change in Derivative Financial Instruments | Net Change in Defined Benefit Pensions and Other Items | Total | |||||||||||||||||||
| Balance as of June 30, 2019 | $ | (46) | $ | 150 | $ | (26) | $ | 78 | |||||||||||||||
| Other comprehensive income (loss) before reclassifications | 7 | 78 | — | 86 | |||||||||||||||||||
| (Income) loss amounts reclassified from accumulated other comprehensive income | (9) | (16) | — | (26) | |||||||||||||||||||
| Total other comprehensive income (loss) | (2) | 62 | — | 60 | |||||||||||||||||||
| Balance as of September 30, 2019 | $ | (48) | $ | 213 | $ | (26) | $ | 138 | |||||||||||||||
| (in millions) | Foreign Currency Translation Adjustments | Net Change in Derivative Financial Instruments | Net Change in Defined Benefit Pensions and Other Items | Total | |||||||||||||||||||
| Balance as of December 31, 2019 | $ | 142 | $ | 173 | $ | (45) | $ | 270 | |||||||||||||||
| Other comprehensive income (loss) before reclassifications | (90) | 36 | — | (54) | |||||||||||||||||||
| (Income) loss amounts reclassified from accumulated other comprehensive income | (14) | (52) | — | (65) | |||||||||||||||||||
| Total other comprehensive income (loss) | (104) | (15) | — | (119) | |||||||||||||||||||
| Balance as of September 30, 2020 | $ | 38 | $ | 158 | $ | (45) | $ | 151 | |||||||||||||||
| (in millions) | Foreign Currency Translation Adjustments | Net Change in Derivative Financial Instruments | Net Change in Defined Benefit Pensions and Other Items | Total | |||||||||||||||||||
| Balance as of December 31, 2018 | $ | (53) | $ | 111 | $ | (25) | $ | 33 | |||||||||||||||
| Other comprehensive income (loss) before reclassifications | 30 | 136 | (1) | 165 | |||||||||||||||||||
| (Income) loss amounts reclassified from accumulated other comprehensive income | (25) | (34) | — | (59) | |||||||||||||||||||
| Total other comprehensive income (loss) | 4 | 102 | (1) | 105 | |||||||||||||||||||
| Balance as of September 30, 2019 | $ | (48) | $ | 213 | $ | (26) | $ | 138 | |||||||||||||||
Refer to Note D – Hedging Activities and Fair Value Measurements for further detail on our net investment hedges recorded in Foreign currency translation adjustments and our cash flow hedges recorded in Net change in derivative financial instruments.
The gains and losses on defined benefit and pension items before reclassifications and gains and losses on defined benefit and pension items reclassified from Accumulated other comprehensive income (loss), net of tax were reduced by immaterial income tax impacts in the third quarter and first nine months of 2020 and 2019.
NOTE N – NEW ACCOUNTING PRONOUNCEMENTS
Periodically, new accounting pronouncements are issued by the FASB or other standard setting bodies. Recently issued standards typically do not require adoption until a future effective date. Prior to their effective date, we evaluate the pronouncements to determine the potential effects of adoption on our unaudited condensed consolidated financial statements.
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Standards to be Implemented
ASC Update No. 2020-10
In October 2020, the FASB issued ASC Update No. 2020-10, Codification Improvements. Update No. 2020-10 amends a wide variety of Topics in the Codification in order to improve the consistency of the Codification and the application thereof, while leaving Generally Accepted Accounting Principles unchanged. Update No. 2020-10 is effective for annual periods beginning after December 15, 2020, for public business entities. Early application of the amendments is permitted for any annual or interim period for which financial statements have not been issued. We are currently in the process of determining the effect that the amendments will have on our financial position and results of operations.
ASC Update No. 2020-06
In August 2020, the FASB issued ASC Update No. 2020-06, Debt - Debt with Conversion and Other Options (Subtopic 470-20) and Derivatives and Hedging - Contracts in Entity’s Own Equity (Subtopic 815-40): Accounting for Convertible Instruments and Contracts in an Entity’s Own Equity. The amendments in Update No. 2020-06 simplify the complexity associated with applying U.S. GAAP for certain financial instruments with characteristics of liabilities and equity. More specifically, the amendments focus on the guidance for convertible instruments and derivative scope exception for contracts in an entity’s own equity. Update No. 2020-06 is effective for fiscal years beginning after December 15, 2021, including interim periods within those fiscal years. Early adoption is permitted, but no earlier than fiscal years beginning after December 15, 2020, including interim periods within those fiscal years. We are currently in the process of determining the effect that the adoption will have on our financial position and results of operations.
ASC Update No. 2019-12
In December 2019, the FASB issued ASC Update No. 2019-12, Income Taxes (Topic 740): Simplifying the Accounting for Income Taxes. The purpose of Update No. 2019-12 is to continue the FASB’s Simplification Initiative to reduce complexity in accounting standards. The amendments in Update No. 2019-12 simplify the accounting for income taxes by removing certain exceptions related to the incremental approach for intraperiod tax allocation, the requirement to recognize or derecognize deferred tax liabilities related to equity method investments that are also foreign subsidiaries, and the methodology for calculating income taxes in an interim period. In addition to removing these exceptions, Update No. 2019-12 also clarifies and simplifies other aspects of the accounting for income taxes. Update No. 2019-12 is effective for annual periods beginning after December 15, 2020, including interim periods within those annual periods. Early adoption is permitted, including adoption in an interim period. We are currently in the process of assessing in which quarter to adopt, as well as determining the effect that the adoption will have on our financial position and results of operations.
No other new accounting pronouncements issued or effective in the period had or are expected to have a material impact on our unaudited condensed consolidated financial statements.
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ITEM 2.MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
Introduction
Boston Scientific Corporation is a global developer, manufacturer and marketer of medical devices that are used in a broad range of interventional medical specialties. Our mission is to transform lives through innovative medical solutions that improve the health of patients around the world. Our products and technologies are used to diagnose or treat a wide range of medical conditions, including cardiovascular, digestive, respiratory, urological, pelvic health and neurological conditions. We continue to innovate in these areas and are committed to the goal of extending our innovations into new geographies and high-growth, adjacent markets. When used in this report, the terms, "we," "us," "our," and "the Company" mean Boston Scientific Corporation and its divisions and subsidiaries.
COVID-19 Pandemic
In December 2019, the novel strain of coronavirus (SARS-Cov-2), and its disease commonly known as COVID-19 (COVID-19), was reported in China and has since widely impacted the global public health and economic environment. In March 2020, the World Health Organization (WHO) declared COVID-19, including all additional variations and strains thereof, a global pandemic (COVID-19 pandemic). Our business trends through the first two months of the year were in line with internal expectations; however, as COVID-19 reached a global pandemic level, procedural volumes significantly declined, negatively impacting revenue and operating income. While the majority of procedures using our products are deferrable, most of the conditions that we treat are generally fairly acute and cannot be deferred for extended periods. As the pandemic spread worldwide and with COVID-19 cases confirmed in all major geographies, many elective and semi-emergent procedures were postponed, enabling hospital staff to focus critical resources on caring for COVID-19 patients. Some jurisdictions mandated elective procedure bans that included financial penalties for non-compliance in the second quarter. Certain of these bans continued to be in effect in the third quarter or evolved to reduce capacity available for elective procedures. In other jurisdictions, the timing of the pandemic and public health measures have resulted in lower levels of COVID-19 cases, while hospitals have also developed protocols such that elective procedures may be conducted safely and are approaching pre-COVID-19 pandemic levels.
While much of the global economy reopened in the third quarter, the COVID-19 pandemic is ongoing, and renewed restrictions are being contemplated or implemented in areas that had previously reopened, including in parts of Europe and the U.S where COVID-19 cases are rising. The ongoing pandemic and accompanying restrictions continue to negatively impact our net sales, gross profit margin, operating income and net income. Our net sales declined 1.8 percent in the third quarter and 8.0 percent in the first nine months of 2020, with the most significant decline occurring in the second quarter, particularly in April 2020, and relatively smaller declines during the third quarter. Global sales trends consistently improved as physicians resumed performing elective and semi-emergent procedures previously deferred and referral rates of new patients improved.
Entering the second quarter of 2020, we implemented cost reduction initiatives, including decreases in travel, meetings and customer events, hiring, clinical programs and certain research and development projects which largely remained in effect during the third quarter of 2020. We also implemented a temporary four-day work week for many employees globally and reduced employee compensation, including temporary significant cuts in the salaries of our executive officers and the cash retainer paid to our Board of Directors. In addition, we temporarily closed and/or reduced production levels at certain of our manufacturing sites in an effort to align our build plans to the current and expected demand environment. During the second quarter of 2020, as COVID-19 cases began to decrease in certain geographies, we implemented a careful and tiered approach for employees to return to our sites following state and local ordinances. Employees with the greatest need to access onsite resources to perform their roles have returned first, while those who can effectively work remotely will continue to do so in order to facilitate maximum social distancing in our sites and within our communities. All of our plants have now resumed manufacturing and are increasing their utilization levels, but many remained below full capacity in the third quarter of 2020. For non-executive officer employees, in those jurisdictions where temporary four-day work weeks and reductions in employee compensation were in effect, those measures concluded at the beginning of the third quarter. We also announced during the third quarter the end of the aforementioned reductions in executive officer pay, except for the salary reduction for our Chief Executive Officer, which continued through October 2020. We further announced that a portion of the annual cash retainer for our Board of Directors would be restored, beginning with a payment made during the fourth quarter of 2020. While we have implemented measures to reduce costs, our operating expenses as a percentage of net sales increased during the third quarter of 2020, as compared to the prior year, as approximately 70 percent of our operating expenses are fixed in nature. Our gross profit margin was also unfavorably impacted particularly in the second quarter of 2020, as compared to prior year, due primarily to manufacturing costs associated with abnormally low production levels in our plants, and improved sequentially in the third quarter as production levels increased. Because the severity, magnitude, and duration of the COVID-19 pandemic and its
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economic consequences are uncertain and rapidly changing, the pandemic’s impact on our operations and financial performance, as well as its impact on our ability to execute our business strategies and initiatives successfully, remains uncertain and difficult to predict. Procedural delays from the further resurgence of COVID-19 infections may negatively impact demand for our products, net sales, gross profit margin and operating expenses as a percentage of net sales in the fourth quarter of 2020.
We continue to focus our efforts on the health and safety of patients, healthcare providers and employees, while executing our mission of transforming lives through innovative medical solutions to improve the health of patients around the world. Since the onset of COVID-19, our global crisis management team has focused on protecting our employees and customers, optimizing our operations and securing our supply chain. We have successfully implemented business continuity plans including establishing a medical advisory group for employees, leveraging work from home infrastructure to facilitate social distancing, limiting sales visits to critical cases and accelerating capabilities to provide remote physician support. While we expect the COVID-19 pandemic will continue to negatively impact our 2020 performance, we continue to believe our long-term fundamentals remain strong and we will manage through these challenges with strategic focus and the winning spirit of our global team.
We have evaluated the recoverability of the assets in our unaudited condensed consolidated balance sheet as of September 30, 2020 in accordance with relevant authoritative accounting literature. We considered the disruptions caused by COVID-19, including revised forecasted sales and customer demand, a decline in the price of our common stock and macroeconomic factors potentially impacting accounts receivable, inventory, investments, intangible assets, goodwill and other assets and liabilities. Where forward-looking estimates are required, we made a good-faith estimate based on information available as of the balance sheet date. We have continued to monitor for indicators of impairment through the date of this Quarterly Report filed on Form 10-Q, and reflected accordingly in the accompanying condensed consolidated financial statements.
Corporate Social Responsibility
Enabling a culture of diversity, equity and inclusion is essential to enhance employee engagement and our performance. Within our workplace, our Employee Resource Groups are at the heart of this culture. They provide forums for us to learn from one another, celebrate our diversity and develop inclusive leadership skills. Within many of the communities in which we operate, we have launched and funded a multi-year program to combat racism, inequity and injustice focused on five pillars: community, economic empowerment, education, healthcare disparities and government/legislative change. We also continue our long-term sponsorship of our Close the Gap initiative, which focuses on raising awareness and empowering healthcare providers to reach more patients of color, fight longstanding inequities, and address barriers to care. Through Close the Gap, hospitals and health systems are provided with zip code level data that highlight the disparities in treatment between white and non-white patients in their communities. The information allows health care administrators and providers to focus on improving care to underserved populations within their communities. As evidence of our progress, in the third quarter of 2020, we were named among the Top 50 of America’s Most Just Companies by Forbes/Just Capital, ranking #38 overall and also tied for #1 for diversity, equity and inclusion.
We also recognize the need to minimize the impact of the manufacturing of our products on the environment and have committed to carbon neutrality in our manufacturing and key distribution sites by 2030.
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Financial Summary
Three Months Ended September 30, 2020
Our net sales for the third quarter of 2020 were $2.659 billion, as compared to $2.707 billion for the third quarter of 2019. This decrease of $48 million, or 1.8 percent, included operational net sales declines of 2.5 percent and the positive impact of 70 basis points from foreign currency fluctuations.1 Operational net sales included $99 million in the third quarter of 2020 associated with our acquisition of BTG plc (BTG) for the period prior to mid-August 2020, for which there were no prior period net sales. Refer to Quarterly Results and Business Overview for a discussion of our net sales by global business.
Our reported net loss available to common stockholders for the third quarter of 2020 was $169 million, or $(0.12) per diluted share. Our reported results for the third quarter of 2020 included certain charges and/or credits totaling $698 million (after-tax), or $0.48 per diluted share. Excluding these items, adjusted net income available to common stockholders for the third quarter of 2020 was $530 million, or $0.37 per diluted share.1,2
Our reported net income for the third quarter of 2019 was $126 million, or $0.09 per diluted share. Our reported results for the third quarter of 2019 included certain charges and/or credits totaling $424 million (after-tax), or $0.30 per diluted share. Excluding these items, adjusted net income for the third quarter of 2019 was $550 million, or $0.39 per diluted share.1
1Operational net sales growth rates, which exclude the impact of foreign currency fluctuations, and adjusted measures, which exclude certain items required by generally accepted accounting principles in the United States (U.S. GAAP), are not prepared in accordance with U.S. GAAP and should not be considered in isolation from, or as a replacement for, the most directly comparable GAAP measure. Refer to Additional Information for a discussion of management’s use of these non-GAAP financial measures.
2In May 2020, we completed an offering of 10,062,500 shares of 5.50% Mandatory Convertible Preferred Stock, Series A (MCPS) at a price to the public and liquidation preference of $100 per share. Refer to the reconciliations below for the impact of the MCPS cumulative preferred stock dividends on our calculations of earnings per share (EPS).
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The following is a reconciliation of our results of operations prepared in accordance with U.S. GAAP to those adjusted results considered by management. Refer to Quarterly Results and Business Overview and Additional Information for a discussion of these reconciling items:
| Three Months Ended September 30, 2020 | |||||||||||
| (in millions, except per share data) | Earnings | Impact per Share(3) | |||||||||
| Reported Net income (loss) | $ | (155) | |||||||||
| Reported Preferred stock dividends | (14) | ||||||||||
| Reported Net income (loss) available to common stockholders | $ | (169) | $ | (0.12) | |||||||
| Non-GAAP adjustments: | |||||||||||
| Amortization expense | 176 | 0.12 | |||||||||
| Intangible asset impairment charges | 189 | 0.13 | |||||||||
| Acquisition/divestiture-related net charges (credits) | 87 | 0.06 | |||||||||
| Restructuring and restructuring-related net charges (credits) | 21 | 0.01 | |||||||||
| Litigation-related net charges (credits) | 255 | 0.18 | |||||||||
| Investment impairment charges (credits) | (50) | (0.03) | |||||||||
| EU Medical device regulation (MDR) implementation costs | 7 | 0.00 | |||||||||
| Deferred tax expenses (benefits) | 18 | 0.01 | |||||||||
| Discrete tax items | (3) | (0.00) | |||||||||
| Adjusted net income (loss) available to common stockholders | $ | 530 | $ | 0.37 | |||||||
(3) For the third quarter of 2020, the effect of assuming the conversion of MCPS into shares of common stock was anti-dilutive, and therefore excluded from the calculation of EPS. Accordingly, GAAP Net loss and Adjusted net income were reduced by cumulative Preferred stock dividends, as presented in our unaudited condensed consolidated statements of operations, for purposes of calculating EPS. We have assumed dilution of 13.6 million common stock equivalents related to employee stock options for all or a portion of the non-GAAP adjustments, which were anti-dilutive for GAAP purposes due to our Net loss position.
| Three Months Ended September 30, 2019 | |||||||||||
| (in millions, except per share data) | Earnings | Impact per Share | |||||||||
| Reported Net income (loss) | $ | 126 | $ | 0.09 | |||||||
| Non-GAAP adjustments: | |||||||||||
| Amortization expense | 157 | 0.11 | |||||||||
| Acquisition-related net charges (credits) | 236 | 0.17 | |||||||||
| Restructuring and restructuring-related net charges (credits) | 12 | 0.01 | |||||||||
| Litigation-related net charges (credits) | 19 | 0.01 | |||||||||
| Investment impairment charges (credits) | 1 | 0.00 | |||||||||
| EU MDR implementation costs | 2 | 0.00 | |||||||||
| Discrete tax items | (2) | (0.00) | |||||||||
| Adjusted net income (loss) | $ | 550 | $ | 0.39 | |||||||
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Nine Months Ended September 30, 2020
Our net sales for the first nine months of 2020 were $7.204 billion, as compared to $7.831 billion for the first nine months of 2019. This decrease of $626 million, or 8.0 percent, included operational net sales declines of 7.6 percent and the negative impact of 40 basis points from foreign currency fluctuations. Operational net sales included $413 million in the first nine months of 2020 associated with our acquisition of Vertiflex, Inc. (Vertiflex) for the period prior to June 2020 and our acquisition of BTG plc (BTG) for the period prior to mid-August 2020, for both of which there were no prior period net sales. Refer to Quarterly Results and Business Overview for a discussion of our net sales by global business.
Our reported net loss available to common stockholders for the first nine months of 2020 was $311 million, or $(0.22) per diluted share. Our reported results for the first nine months of 2020 included certain charges and/or credits totaling $1.351 billion (after-tax), or $0.95 per diluted share. Excluding these items, adjusted net income available to common stockholders for the first nine months of 2020 was $1.040 billion, or $0.73 per diluted share.
Our reported net income for the first nine months of 2019 was $704 million, or $0.50 per diluted share. Our reported results for the first nine months of 2019 included certain charges and/or credits totaling $887 million (after-tax), or $0.63 per diluted share. Excluding these items, adjusted net income for the first nine months of 2019 was $1.590 billion, or $1.13 per diluted share.
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The following is a reconciliation of our results of operations prepared in accordance with U.S. GAAP to those adjusted results considered by management. Refer to Quarterly Results and Business Overview and Additional Information for a discussion of these reconciling items:
| Nine Months Ended September 30, 2020 | |||||||||||
| (in millions, except per share data) | Earnings | Impact per Share(4) | |||||||||
| Reported Net income (loss) | $ | (292) | |||||||||
| Reported Preferred stock dividends | (19) | ||||||||||
| Reported Net income (loss) available to common stockholders | $ | (311) | $ | (0.22) | |||||||
| Non-GAAP adjustments: | |||||||||||
| Amortization expense | 533 | 0.38 | |||||||||
| Intangible asset impairment charges | 384 | 0.27 | |||||||||
| Acquisition/divestitures-related net charges (credits) | 100 | 0.07 | |||||||||
| Restructuring and restructuring-related net charges (credits) | 66 | 0.05 | |||||||||
| Litigation-related net charges (credits) | 255 | 0.18 | |||||||||
| Investment impairment charges (credits) | (50) | (0.04) | |||||||||
| EU MDR implementation costs | 17 | 0.01 | |||||||||
| Deferred tax expenses (benefits) | 26 | 0.02 | |||||||||
| Discrete tax items | 20 | 0.01 | |||||||||
| Adjusted net income (loss) available to common stockholders | $ | 1,040 | $ | 0.73 | |||||||
(4) For the first nine months of 2020, the effect of assuming the conversion of MCPS into shares of common stock was anti-dilutive, and therefore excluded from the calculation of EPS. Accordingly, GAAP Net loss and Adjusted net income were reduced by cumulative Preferred stock dividends, as presented in our unaudited condensed consolidated statements of operations, for purposes of calculating EPS. We have assumed dilution of 14.1 million common stock equivalents related to employee stock options for all or a portion of the non-GAAP adjustments, which were anti-dilutive for GAAP purposes due to our Net loss position.
| Nine Months Ended September 30, 2019 | |||||||||||
| (in millions, except per share data) | Earnings | Impact per Share | |||||||||
| Reported Net income (loss) | $ | 704 | $ | 0.50 | |||||||
| Non-GAAP adjustments: | |||||||||||
| Amortization expense | 444 | 0.31 | |||||||||
| Intangible asset impairment charges | 97 | 0.07 | |||||||||
| Acquisition-related net charges (credits) | 391 | 0.28 | |||||||||
| Restructuring and restructuring-related net charges (credits) | 31 | 0.02 | |||||||||
| Litigation-related net charges (credits) | (96) | (0.07) | |||||||||
| Investment impairment charges (credits) | 3 | 0.00 | |||||||||
| EU MDR implementation costs | 2 | 0.00 | |||||||||
| Discrete tax items | 16 | 0.01 | |||||||||
| Adjusted net income (loss) | $ | 1,590 | $ | 1.13 | |||||||
Cash provided by operating activities was $835 million for the first nine months of 2020. As of September 30, 2020, we had total debt outstanding of $9.336 billion net of unamortized debt issuance discounts and deferred financing costs, Cash and cash equivalents of $2.022 billion and working capital of $2.858 billion. Refer to Liquidity and Capital Resources for further discussion.
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Quarterly Results and Business Overview
The following section describes an overview of our product offerings and results of operations by business unit. For additional information on our businesses and their product offerings, see Item 1. Business of our most recent Annual Report on Form 10-K.
Our seven core businesses are organized into three reportable segments: MedSurg, Rhythm and Neuro, and Cardiovascular. Following our integration of BTG, the acquisition of which closed during the third quarter of 2019, we have included BTG’s Interventional Medicine business within our Peripheral Interventions operating segment, within the Cardiovascular reportable segment. We present BTG’s Specialty Pharmaceuticals business as a standalone operating segment alongside our reportable segments. In our Quarterly Report on Form 10-Q for the period ended September 30, 2019, we presented Interventional Medicine and Specialty Pharmaceuticals together as "BTG Acquisition" and outside of our operating and reportable segments for net sales. We have revised amounts for the third quarter and first nine months of 2019 to conform to the current year presentation.
Net Sales
The following table provides our net sales by business and the relative change in growth on a reported basis.
| Three Months Ended September 30, | |||||||||||||||||
| (in millions) | 2020 | 2019 | Change | ||||||||||||||
Endoscopy | $ | 475 | $ | 486 | (2.1)% | ||||||||||||
Urology and Pelvic Health | 350 | 359 | (2.6)% | ||||||||||||||
| MedSurg | 825 | 845 | (2.3)% | ||||||||||||||
Cardiac Rhythm Management | 465 | 478 | (2.7)% | ||||||||||||||
Electrophysiology | 76 | 81 | (6.0)% | ||||||||||||||
Neuromodulation | 216 | 222 | (2.5)% | ||||||||||||||
| Rhythm and Neuro | 757 | 780 | (3.0)% | ||||||||||||||
Interventional Cardiology | 586 | 700 | (16.3)% | ||||||||||||||
Peripheral Interventions | 416 | 358 | 16.1% | ||||||||||||||
| Cardiovascular | 1,002 | 1,058 | (5.3)% | ||||||||||||||
| Medical Devices | 2,584 | 2,684 | (3.7)% | ||||||||||||||
| Specialty Pharmaceuticals | 74 | 23 | n/a | ||||||||||||||
| Net Sales | $ | 2,659 | $ | 2,707 | (1.8)% | ||||||||||||
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| Nine Months Ended September 30, | |||||||||||||||||
| (in millions) | 2020 | 2019 | Change | ||||||||||||||
Endoscopy | $ | 1,265 | $ | 1,396 | (9.4)% | ||||||||||||
Urology and Pelvic Health | 910 | 1,033 | (11.9)% | ||||||||||||||
| MedSurg | 2,175 | 2,429 | (10.5)% | ||||||||||||||
Cardiac Rhythm Management | 1,253 | 1,467 | (14.5)% | ||||||||||||||
Electrophysiology | 202 | 245 | (17.5)% | ||||||||||||||
Neuromodulation | 529 | 612 | (13.5)% | ||||||||||||||
| Rhythm and Neuro | 1,985 | 2,323 | (14.6)% | ||||||||||||||
Interventional Cardiology | 1,714 | 2,067 | (17.1)% | ||||||||||||||
Peripheral Interventions | 1,148 | 989 | 16.0% | ||||||||||||||
| Cardiovascular | 2,862 | 3,057 | (6.4)% | ||||||||||||||
| Medical Devices | 7,021 | 7,807 | (10.1)% | ||||||||||||||
| Specialty Pharmaceuticals | 183 | 23 | n/a | ||||||||||||||
| Net Sales | $ | 7,204 | $ | 7,831 | (8.0)% | ||||||||||||
MedSurg
Endoscopy
Our Endoscopy business develops and manufactures devices to diagnose and treat a broad range of gastrointestinal (GI) and pulmonary conditions with innovative, less-invasive technologies. Our net sales of Endoscopy products for the third quarter of 2020 were $475 million or 18 percent of our consolidated net sales and for the first nine months of 2020 were $1.265 billion or 18 percent of our consolidated net sales. Our Endoscopy net sales decreased $10 million, or 2.1 percent, in the third quarter of 2020 and decreased $131 million, or 9.4 percent, in the first nine months of 2020, compared to the prior year periods. In the third quarter of 2020, this decrease included operational net sales declines of 3.0 percent and a positive impact of 90 basis points from foreign currency fluctuations, compared to the prior year period. In the first nine months of 2020, this decrease included operational net sales declines of 9.1 percent and a negative impact of 30 basis points from foreign currency fluctuations, compared to the prior year period. These year-over-year changes were primarily driven by declines in elective or semi-emergent upper endoscopy and colonoscopy procedures due to the COVID-19 pandemic environment, partially offset by growth of our pancreaticobiliary and infection prevention products.
Urology and Pelvic Health
Our Urology and Pelvic Health business develops and manufactures devices to treat various urological and pelvic conditions for both male and female anatomies. Our net sales of Urology and Pelvic Health products for the third quarter of 2020 were $350 million or 13 percent of our consolidated net sales and for the first nine months of 2020 were $910 million or 13 percent of our consolidated net sales. Our Urology and Pelvic Health net sales decreased $9 million, or 2.6 percent, in the third quarter of 2020 and decreased $123 million, or 11.9 percent, in the first nine months of 2020, compared to the prior year periods. In the third quarter of 2020, this decrease included operational net sales declines of 3.0 percent and a positive impact of 40 basis points from foreign currency fluctuations, compared to the prior year period. In the first nine months of 2020, this decrease included operational net sales declines of 11.6 percent and a negative impact of 30 basis points from foreign currency fluctuations, compared to the prior year period. The decline in sales for the first nine months of 2020 compared to the prior year was due primarily to a reduction in sales of our prosthetic urology and pelvic floor franchises, which were negatively impacted by COVID -19 given their elective or semi-emergent nature. During the third quarter of 2020, our stone and prostate health franchises returned to growth, which was offset by the reduction in sales due to the divestiture of our Intrauterine Health business in the second quarter of 2020.
Rhythm and Neuro
Cardiac Rhythm Management
Our Cardiac Rhythm Management (CRM) business develops and manufactures a variety of implantable devices that monitor the heart and deliver electricity to treat cardiac abnormalities. Our net sales of CRM products for the third quarter of 2020 were
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$465 million or 17 percent of our consolidated net sales and for the first nine months of 2020 were $1.253 billion or 17 percent of our consolidated net sales. Our CRM net sales decreased $13 million, or 2.7 percent, in the third quarter of 2020 and decreased $213 million, or 14.5 percent, in the first nine months of 2020, compared to the prior year periods. In the third quarter of 2020, this decrease included operational net sales declines of 3.7 percent and a positive impact of 100 basis points from foreign currency fluctuations, compared to the prior year period. In the first nine months of 2020, this decrease included operational net sales declines of 14.3 percent and a negative impact of 20 basis points from foreign currency fluctuations, compared to the prior year period. These year-over-year changes were primarily due to a decline in both defibrillator and pacemaker procedures due to the deferral of semi-emergent and emergent procedures in the COVID-19 pandemic environment. In June 2020, we announced U.S. 510(k) clearance for the LUX-Dx™ Insertable Cardiac Monitor (ICM) system, a new, long-term diagnostic device implanted in patients to detect arrhythmias associated with conditions such as atrial fibrillation (AF), cryptogenic stroke, and syncope. We started U.S. commercialization of this device in the third quarter of 2020.
Electrophysiology
Our Electrophysiology business develops and manufactures less-invasive medical technologies used in the diagnosis and treatment of rate and rhythm disorders of the heart. Our net sales of Electrophysiology products for the third quarter of 2020 were $76 million or 3 percent of our consolidated net sales and for the first nine months of 2020 were $202 million or 3 percent of our consolidated net sales. Our Electrophysiology net sales decreased $5 million, or 6.0 percent, in the third quarter of 2020 and decreased $43 million, or 17.5 percent, in the first nine months of 2020, compared to the prior year periods. In the third quarter of 2020, this decrease included operational net sales declines of 7.5 percent and a positive impact of 150 basis points from foreign currency fluctuations, compared to the prior year period. In the first nine months of 2020, this decrease included operational net sales declines of 17.6 percent and a positive impact of 10 basis points from foreign currency fluctuations, compared to the prior year period. Sales of our mapping and navigation products and our core diagnostic and therapeutic devices declined year over year due to the impact of COVID-19 and deferral of elective Electrophysiology procedures. In June 2020, we announced the U.S. launch of the DIRECTSENSE™ Technology, a tool for monitoring radiofrequency (RF) energy delivery during cardiac ablation procedures available on the Rhythmia™ Mapping System. Additionally, in the second quarter of 2020 we received CE mark approval for the INTELLANAV STABLEPOINT™ Ablation Catheter enabled with DIRECTSENSE Technology and contact force assessment. This technology, along with our early 2020 CE mark approval for the POLARx™ Cryoablation System, began European commercialization in the third quarter of 2020.
Neuromodulation
Our Neuromodulation business develops and manufactures devices to treat various neurological movement disorders and manage chronic pain. Our net sales of Neuromodulation products for the third quarter of 2020 were $216 million or 8 percent of our consolidated net sales and for the first nine months of 2020 were $529 million or 7 percent of our consolidated net sales. Our Neuromodulation net sales decreased $5 million, or 2.5 percent, in the third quarter of 2020 and decreased $83 million, or 13.5 percent, in the first nine months of 2020, compared to the prior year periods. In the third quarter of 2020, this decrease included operational net sales declines of 3.0 percent and a positive impact of 50 basis points from foreign currency fluctuations, compared to the prior year period. In the first nine months of 2020, this decrease included operational net sales declines of 13.4 percent and a negative impact of 10 basis points from foreign currency fluctuations, compared to the prior year period. These year-over-year changes were primarily due to sales declines in our spinal cord stimulation (SCS) systems due to deferral of elective procedures in the COVID-19 pandemic environment. The unfavorable impact was partially offset by higher Superion™ Indirect Decompression System sales, which was purchased as part of our Vertiflex acquisition in the second quarter of 2019, and deep brain stimulation (DBS) system sales. In the third quarter of 2020, we received CE Mark and initiated a limited market release of the fourth generation Vercise Genus™ DBS System in Europe and we announced the European launch of the WaveWriter Alpha™ Spinal Cord Stimulator (SCS) Systems.
Cardiovascular
Interventional Cardiology
Our Interventional Cardiology business develops and manufactures technologies for diagnosing and treating coronary artery disease and structural heart conditions. Our net sales of Interventional Cardiology products for the third quarter of 2020 were $586 million or 22 percent of our consolidated net sales and for the first nine months of 2020 were $1.714 billion or 24 percent of our consolidated net sales. Our Interventional Cardiology net sales decreased $114 million, or 16.3 percent, in the third quarter of 2020 and decreased $353 million, or 17.1 percent, in the first nine months of 2020, compared to the prior year periods. In the third quarter of 2020, this decrease included operational net sales declines of 16.8 percent and a positive impact of 50 basis points from foreign currency fluctuations, compared to the prior year period. In the first nine months of 2020, this decrease included operational net sales declines of 16.4 percent and a negative impact of 70 basis points from foreign currency
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fluctuations, compared to the prior year period. These year-over-year changes were primarily driven by our coronary stent and other complex percutaneous coronary intervention (PCI) franchises, with a significant slowdown in procedural volumes in the COVID-19 pandemic environment. Within our structural heart business, in the first half of 2020, sales of our WATCHMAN™ Left Atrial Appendage Closure (LAAC) Device were also negatively impacted by COVID-19. In the third quarter of 2020, they were further negatively impacted by $63 million in revenue charges primarily related to our conversion to a consignment inventory model for our LAAC franchise with the launch of our next-generation WATCHMAN FLX™ Device in the U.S. Based on the progress of our U.S. limited market release, we have moved into full launch ahead of schedule and are targeting a complete conversion to WATCHMAN FLX™ Device by mid-2021.
Peripheral Interventions
Our Peripheral Interventions business develops and manufactures products to diagnose and treat peripheral arterial and venous diseases, as well as products to diagnose, treat and ease various forms of cancer. In the third quarter of 2019, we completed the acquisition of BTG. We are integrating BTG's Interventional Medicine (IM) portfolio into the Peripheral Interventions division, adding complementary technologies in the areas of venous disease and interventional oncology. Our net sales of Peripheral Interventions products for the third quarter of 2020 were $416 million or 16 percent of our consolidated net sales and for the first nine months of 2020 were $1.148 billion or 16 percent of our consolidated net sales. Our Peripheral Interventions net sales increased $58 million, or 16.1 percent, in the third quarter of 2020 and increased $159 million, or 16.0 percent, in the first nine months of 2020, compared to the prior year periods. In the third quarter of 2020, this increase included operational net sales growth of 15.4 percent and a positive impact of 70 basis points from foreign currency fluctuations, compared to the prior year period. In the first nine months of 2020, this increase included operational net sales growth of 16.5 percent and a negative impact of 50 basis points from foreign currency fluctuations, compared to the prior year period. These year-over-year changes were primarily driven by the Interventional Oncology franchise, including our TheraSphere™ Y-90 radioactive glass microspheres acquired with BTG, as well as growth in our drug-eluting portfolio, including the Eluvia™ drug-eluting stent and Ranger ™ drug-coated balloon. Excluding BTG for the period prior to mid-August 2020 for which there were no prior year net sales and the related divestiture of our drug-eluting and bland embolic microsphere portfolio, our Peripheral Interventions net sales increased $7 million, or 2.0 percent, in the third quarter of 2020 and decreased $54 million, or 5.5 percent, in the first nine months of 2020, compared to the prior year periods, primarily due to the deferral of semi-emergent and elective procedures in the COVID-19 pandemic environment, notably impacting core peripheral technologies and stents.
Specialty Pharmaceuticals
Following the closing of the BTG acquisition in the third quarter of 2019, we present BTG’s Specialty Pharmaceuticals business as a standalone operating segment alongside our reportable segments. Our Specialty Pharmaceuticals business develops and manufactures acute care antidotes to treat overexposure to certain medications and toxins. These products are sold primarily in the U.S. through small, specialist sales teams and through commercial partners elsewhere, where approved or permitted. Our net sales of Specialty Pharmaceuticals products for the third quarter of 2020 were $74 million or 3 percent of our consolidated net sales and for the first nine months of 2020 were $183 million or 3 percent of our consolidated net sales, and have not been significantly impacted by the COVID-19 pandemic. Our net sales prior to the mid-August 2019 closing date of the BTG acquisition do not include Specialty Pharmaceuticals.
Emerging Markets
As part of our strategic imperative to drive global expansion, we are seeking to grow net sales and market share by expanding our global presence, including in Emerging Markets. We define Emerging Markets as the 20 countries that we believe have strong growth potential based on their economic conditions, healthcare sectors and our global capabilities. Periodically, we assess our list of Emerging Markets, which is currently comprised of the following countries: Argentina, Brazil, Chile, China, Colombia, Czech Republic, India, Indonesia, Malaysia, Mexico, Philippines, Poland, Russia, Saudi Arabia, Slovakia, South Africa, South Korea, Thailand, Turkey and Vietnam. Our Emerging Markets net sales represented 10 percent of our consolidated net sales in the third quarter of 2020 and 11 percent in the third quarter of 2019. Our Emerging Markets net sales represented 11 percent of our consolidated net sales in the first nine months of 2020 and 12 percent in the first nine months of 2019. In the third quarter of 2020, our Emerging Markets net sales declined 10.3 percent on a reported basis including operational net sales declines of 7.1 percent and a negative impact of 320 basis points from foreign currency fluctuations, compared to the prior year period. In the first nine months of 2020, our Emerging Markets net sales declined 13.5 percent on a reported basis including operational net sales declines of 9.1 percent and a negative impact of 440 basis points from foreign currency fluctuations, compared to the prior year period. The decline in the third quarter and first nine months of 2020 was largely driven by the impact of COVID-19 on our sales in Brazil in the second and third quarters of 2020, as the situation
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deteriorated in Latin America, and our sales in China in the first quarter of 2020, where COVID-19 first emerged and was the most prevalent for the duration of the quarter.
Gross Profit
Our Gross profit was $1.790 billion for the third quarter of 2020, $1.930 billion for the third quarter of 2019, $4.740 billion for the first nine months of 2020 and $5.566 billion for the first nine months of 2019. As a percentage of net sales, our Gross profit decreased to 67.3 percent in the third quarter of 2020, as compared to 71.3 percent in the third quarter of 2019. As a percentage of net sales, our Gross profit decreased to 65.8 percent in the first nine months of 2020, as compared to 71.1 percent in the first nine months of 2019. The following is a reconciliation of our gross profit margins and a description of the drivers of the changes from period to period:
| Percentage of Net Sales | |||||||||||
| Three Months | Nine Months | ||||||||||
| Gross profit margin - period ended September 30, 2019 | 71.3% | 71.1% | |||||||||
| Abnormal production variances | (0.7) | (2.0) | |||||||||
| Inventory charges | (1.0) | (1.0) | |||||||||
| Sales pricing and mix | (0.7) | (1.6) | |||||||||
| Manufacturing cost reductions | 0.6 | 0.9 | |||||||||
| Net impact of foreign currency fluctuations | — | 0.5 | |||||||||
| WATCHMAN FLX™ transition | (0.7) | (0.3) | |||||||||
| All other, including other period expense | (1.5) | (1.8) | |||||||||
| Gross profit margin - period ended September 30, 2020 | 67.3% | 65.8% | |||||||||
The primary factors contributing to the decrease in our gross profit margin in the first nine months of 2020, as compared to the same periods in 2019, were manufacturing costs of $19 million in the third quarter and $145 million in the first nine months of 2020 associated with abnormally low production levels resulting from plant shutdowns and reduced operations. During the third quarter of 2020, our gross margin was further negatively impacted by $63 million in revenue charges primarily related to our conversion to a consignment inventory model for our LAAC franchise with the launch of our next-generation WATCHMAN FLX™ Device. In addition, the decrease in gross margin in each period was attributable to unfavorable product mix due to the deferral of procedures using higher-margin products, price declines related primarily to sales of our coronary drug-eluting stent products, excess and obsolete inventory charges due to lower forecasted demand for certain of our products as well as the amortization of the inventory fair value step up recorded in connection with our acquisition of BTG. These decreases were partially offset by manufacturing cost reductions driven by our process improvement programs in each period as well as favorable foreign currency fluctuations in the first nine months of 2020. In the fourth quarter of 2020, we anticipate a negative impact to total gross profit margin associated with the ongoing conversion of LAAC customers to a consignment inventory model. Refer to COVID-19 Pandemic above for additional information on the fourth quarter of 2020.
Operating Expenses
The following table provides a summary of certain of our operating expenses:
| Three Months Ended September 30, | Nine Months Ended September 30, | ||||||||||||||||||||||||||||||||||
| 2020 | 2019 | 2020 | 2019 | ||||||||||||||||||||||||||||||||
| (in millions) | $ | % of Net Sales | $ | % of Net Sales | $ | % of Net Sales | $ | % of Net Sales | |||||||||||||||||||||||||||
| Selling, general and administrative (SG&A) expenses | $ | 984 | 37.0 | % | $ | 1,012 | 37.4 | % | $ | 2,760 | 38.3 | % | $ | 2,849 | 36.4 | % | |||||||||||||||||||
| Research and development (R&D) expenses | 315 | 11.9 | % | 306 | 11.3 | % | 857 | 11.9 | % | 866 | 11.1 | % | |||||||||||||||||||||||
| Royalty expense | 12 | 0.4 | % | 15 | 0.6 | % | 32 | 0.4 | % | 48 | 0.6 | % | |||||||||||||||||||||||
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SG&A Expenses
In the third quarter of 2020, our SG&A expenses decreased $28 million, or 3 percent, as compared to the third quarter of 2019 and were 40 basis points lower as a percentage of net sales. In the first nine months of 2020, our SG&A expenses decreased $89 million, or 3 percent, as compared to the first nine months of 2019 and were 190 basis points higher as a percentage of net sales. The decrease in SG&A expenses for the third quarter and first nine months of 2020, as compared to the same periods in the prior year, was due primarily to our efforts to reduce expenditures to minimize the impact of the COVID-19 pandemic. We implemented several cost reduction initiatives, including decreases in travel, meetings and customer events, hiring and other variable spending. During the second quarter, we also implemented a temporary four-day work week for many employees globally and reduced employee compensation, including temporary significant cuts in the salaries of our executive officers and the cash retainer paid to our Board of Directors. For non-executive officer employees, in those jurisdictions where temporary four-day work weeks and reductions in employee compensation were in effect, those measures concluded at the beginning of the third quarter. We also announced during the third quarter the end of the aforementioned reductions in executive officer pay, except for the salary reduction for our Chief Executive Officer, which continued through October 2020. We further announced that a portion of the annual cash retainer for our Board of Directors would be restored, beginning with a payment made during the fourth quarter of 2020.
R&D Expenses
We remain committed to advancing medical technologies and investing in meaningful R&D projects across our businesses. In the third quarter of 2020, our R&D expenses increased $9 million, or 3 percent, as compared to the third quarter of 2019 and were 60 basis points higher as a percentage of net sales. In the first nine months of 2020, our R&D expenses decreased $9 million, or 1 percent, as compared to the first nine months of 2019, and were 80 basis points higher as a percentage of net sales. As we seek to recover from the COVID-19 pandemic, we expect to continue to make investments across our businesses in order to maintain a pipeline of new products that we believe will contribute to profitable sales growth.
Royalty Expense
In the third quarter of 2020, our Royalty expense decreased $4 million, or 25 percent, as compared to the third quarter of 2019, and was 20 basis points lower as a percentage of net sales. In the first nine months of 2020, our Royalty expense decreased $16 million, or 34 percent, as compared to the first nine months of 2019, and was 20 basis points lower as a percentage of net sales. The decrease in Royalty expense in the third quarter and first nine months of 2020, as compared to the same periods in the prior year, relates primarily to the expiration of certain royalty agreements.
The following table provides a summary of certain of our other operating expenses, which are excluded by management for purposes of evaluating operating performance, refer to Additional Information for a further description of certain operating expenses:
| Three Months Ended September 30, | Nine Months Ended September 30, | ||||||||||||||||||||||
| (in millions) | 2020 | 2019 | 2020 | 2019 | |||||||||||||||||||
| Amortization expense | $ | 197 | $ | 178 | $ | 595 | $ | 498 | |||||||||||||||
| Intangible asset impairment charges | 219 | — | 452 | 105 | |||||||||||||||||||
| Contingent consideration expense (benefit) | 6 | 8 | (102) | (9) | |||||||||||||||||||
| Restructuring charges (credits) | 3 | 3 | 16 | 10 | |||||||||||||||||||
| Litigation-related net charges (credits) | 260 | 25 | 260 | (108) | |||||||||||||||||||
Amortization Expense
In the third quarter of 2020, our Amortization expense increased $19 million, or 11 percent, as compared to third quarter of 2019. In the first nine months of 2020, our Amortization expense increased $97 million, or 19 percent, as compared to first nine months of 2019. The increase in Amortization expense in the third quarter and first nine months of 2020, as compared to the same periods in the prior year, was driven by an increase in the balance of amortizable intangible assets due to recent acquisitions, including BTG.
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Intangible Asset Impairment Charges
Our Intangible asset impairment charges were $219 million in the third quarter of 2020, none in the third quarter of 2019, $452 million in the first nine months of 2020 and $105 million in the first nine months of 2019. The impairment charges recorded in the third quarter of 2020 were primarily associated with IPR&D acquired with Apama Medical Inc. following management’s decision to cancel the program. Intangible asset impairment charges in the first nine months of 2020 also included charges related to nVision Medical Corporation (nVision) and certain other intangible assets initially established following acquisition. In general, these charges were recorded as a result of management’s decision to change commercial launch plans or discontinue certain R&D programs based on cost to complete, time to market, overall economic viability or, specific to nVision, our understanding of the clinical evidence necessary to commercialize the technology. Refer to Note C – Goodwill and Other Intangible Assets to our unaudited condensed consolidated financial statements contained in Item 1 of this Quarterly Report on Form 10-Q and Critical Accounting Estimates in Item 7 of our most recent Annual Report on Form 10-K for additional details for a discussion of key assumptions used in our goodwill and intangible asset impairment testing and future events that could have a negative impact on the recoverability of our goodwill and intangible assets.
Contingent Consideration Expense (Benefit)
To recognize changes in the fair value of our contingent consideration liability, we recorded net expenses in the third quarter of 2020 and third quarter of 2019. We recorded net benefits in the first nine months of 2020 and first nine months of 2019. The $102 million benefit recorded in the first nine months of 2020 related to a reduction in the contingent consideration liability for certain prior acquisitions for which we reduced the probability of achievement of associated revenue and/or regulatory milestones upon which payment is conditioned, or in the case of nVision for milestones that would not be achieved due to management's discontinuation of the R&D program. Refer to Note B – Acquisitions and Strategic Investments to our unaudited condensed consolidated financial statements contained in Item 1 of this Quarterly Report on Form 10-Q for additional details related to our contingent consideration arrangements.
Restructuring Charges (Credits)
In June 2016, our Board of Directors approved, and we committed to, a restructuring initiative (the 2016 Restructuring Plan), which was initiated in the second quarter of 2016 and substantially completed in 2019. The 2016 Restructuring Plan resulted in total pre-tax charges of $271 million and approximately $255 million in cash outlays.
In addition, in November 2018, our Board of Directors approved, and we committed to, a new global restructuring program (the 2019 Restructuring Plan). The 2019 Restructuring Plan is expected to result in total pre-tax charges of approximately $200 million to $300 million and approximately $180 million to $280 million of these charges are expected to result in cash outlays. A substantial portion of the savings are being reinvested in strategic growth initiatives.
Restructuring charges, net of credits, pursuant to these programs were $3 million in the third quarter of 2020, $3 million in the third quarter of 2019, $16 million in the first nine months of 2020 and $10 million in first nine months of 2019. Refer to Note G – Restructuring-related Activities to our audited financial statements contained in Item 8 of our most recent Annual Report on Form 10-K for additional details related to our restructuring plans.
Litigation-related net charges (credits)
We recorded litigation-related charges of $260 million during the third quarter and first nine months of 2020, primarily related to transvaginal mesh products, inclusive of a reserve related to claims made by a coalition of state attorneys general. In first nine months of 2019, our litigation-related net credits included a gain of $148 million, which represents a portion of the total $180 million one-time settlement payment received from Edwards in January 2019. We record certain legal and product liability charges, credits and costs of defense, which we consider to be unusual or infrequent and significant as Litigation-related net charges (credits) in our unaudited condensed consolidated financial statements. All other legal and product liability charges, credits and costs are recorded within SG&A expenses. As such, a portion of the related gain from the Edwards settlement was recorded in SG&A expenses in our unaudited condensed consolidated financial statements.
We continue to assess certain litigation and claims to determine the amounts, if any, that management believes will be paid as a result of such claims and litigation, and therefore, additional losses may be accrued and paid in the future, which could materially adversely impact our operating results, cash flows and/or our ability to comply with the financial covenant required by our credit arrangements. Refer to Note H – Commitments and Contingencies to our unaudited condensed consolidated financial statements contained in Item 1 of this Quarterly Report on Form 10-Q for discussion of our material legal proceedings.
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Interest Expense
The following table provides a summary of our Interest expense and average borrowing rate:
| Three Months Ended September 30, | Nine Months Ended September 30, | ||||||||||||||||||||||
| 2020 | 2019 | 2020 | 2019 | ||||||||||||||||||||
Interest expense (in millions) | $ | (86) | $ | (95) | $ | (265) | $ | (294) | |||||||||||||||
| Average borrowing rate | 3.4 | % | 3.5 | % | 3.4 | % | 4.1 | % | |||||||||||||||
Interest expense and our average borrowing rate decreased in the third quarter of 2020 and first nine months of 2020, both as compared to the same periods in the prior year, primarily due to our euro-denominated senior notes offering in November 2019, which carries lower interest rates than the senior notes we partially repaid with proceeds from the offering.
Refer to Liquidity and Capital Resources and Note E – Contractual Obligations and Commitments to our unaudited condensed consolidated financial statements contained in Item 1 of this Quarterly Report on Form 10-Q for information regarding our debt obligations.
Other, net
The following are the components of Other, net:
| Three Months Ended September 30, | Nine Months Ended September 30, | ||||||||||||||||||||||
| (in millions) | 2020 | 2019 | 2020 | 2019 | |||||||||||||||||||
| Interest income | $ | 1 | $ | 8 | $ | 3 | $ | 29 | |||||||||||||||
| Net foreign currency gain (loss) | (1) | (207) | (13) | (334) | |||||||||||||||||||
| Net gains (losses) on investments | 48 | (5) | 14 | (17) | |||||||||||||||||||
| Other income (expense), net | 16 | 7 | 6 | — | |||||||||||||||||||
| $ | 64 | $ | (197) | $ | 9 | $ | (322) | ||||||||||||||||
As of September 30, 2019, we settled all outstanding non-designated forward currency contracts that we entered into for the purpose of managing our exposure to currency exchange rate risk related to the British pound sterling-denominated purchase price of BTG. We recognized a $207 million loss in the third quarter of 2019 and a $323 million loss in the first nine months of 2019 in Other, net due to changes in fair value of the contracts. These amounts are included in Acquisition/divestiture-related net charges (credits) presented in the reconciliation of our results of operations prepared in accordance with U.S. GAAP to those adjusted results considered by management. Refer to Financial Summary for the reconciliation and Additional Information for a discussion of management's use of non-GAAP financial measures.
In the third quarter of 2020, we recorded a $65 million non-cash gain presented in Other, net within our unaudited condensed consolidated statements of operations to state at fair value one of our portfolio investments treated under the measurement alternative method of accounting. This gain is included in Investment impairment charges (credits) presented in the reconciliation of our results of operations prepared in accordance with U.S. GAAP to those adjusted results considered by management. Refer to Financial Summary for the reconciliation and Additional Information for a discussion of management's use of non-GAAP financial measures.
Tax Rates
Our effective tax rate from continuing operations is presented below:
| Three Months Ended September 30, | Nine Months Ended September 30, | ||||||||||||||||||||||
| 2020 | 2019 | 2020 | 2019 | ||||||||||||||||||||
| Effective tax rate from continuing operations | 31.7 | % | (38.7) | % | 24.3 | % | (1.6) | % | |||||||||||||||
The change in our reported tax rates for the third quarter and first nine months of 2020, as compared to the same periods in 2019, relates primarily to a shift in geographical mix of earnings to higher-tax jurisdictions, partially offset by the impact of certain receipts and charges that are taxed at different rates than our effective tax rate. These receipts and charges include intangible asset impairment charges, acquisition/divestiture-related net charges, restructuring and restructuring-related net
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charges, litigation-related net charges as well as certain discrete tax items primarily related to the resolution of an Internal Revenue Service (IRS) audit, as explained below, tax windfall benefits associated with share-based payments, and impacts of the Coronavirus Aid, Relief and Economic Security (CARES) Act, enacted on March 27, 2020.
In the third quarter of 2020, we received notification from the IRS regarding the examination of our 2014 through 2016 tax years. The Joint Committee on Taxation completed its review on July 21, 2020, and the IRS examination was resolved. Due to the resolution of these tax years, we recorded a net tax benefit of $91 million in the third quarter of 2020 to release the reserves related to these years. We anticipate receiving a refund of $62 million from the IRS in the fourth quarter of 2020 reflecting the net balance of amounts owed to us by the IRS after consideration of tax and interest due for these years.
Economic stimulus legislation has been enacted in many countries in response to COVID-19. In the U.S., the CARES Act was signed into law on March 27, 2020 and provided an estimated $2.2 trillion in COVID-19 pandemic related relief, and included tax relief and government loans, subsidies and other relief for entities in affected industries. While we have not applied for government loans, we have taken advantage of the benefits offered in multiple jurisdictions, including the U.S. provision allowing taxpayers to defer payment of the employer portion of certain payroll taxes through the end of 2020. This allows us to preserve cash generated from operations to service our debt obligations and other near-term commitments.
Critical Accounting Policies and Estimates
Our financial results are affected by the selection and application of accounting policies and methods. In the nine months ended September 30, 2020, there were no changes to the application of critical accounting policies previously disclosed in our most recent Annual Report on Form 10-K. We have included below information relating to our annual goodwill impairment test performed in the second quarter of 2020.
Goodwill Valuation
We did not record any goodwill impairment charges in the third quarter and first nine months of 2020 or 2019. We test our goodwill balances in the second quarter of each year as of April 1 for impairment, or more frequently if impairment indicators are present or changes in circumstances suggest an impairment may exist. In the second quarter of 2020, we performed our annual goodwill impairment test for all of our reporting units and concluded that the fair value of each reporting unit exceeded its carrying value.
We assess goodwill for impairment at the reporting unit level, which is defined as an operating segment or one level below an operating segment, referred to as a component. We identified the following reporting units in our 2020 annual goodwill impairment test: Interventional Cardiology, Peripheral Interventions, Cardiac Rhythm Management, Electrophysiology, Endoscopy, Urology and Pelvic Health, Neuromodulation and Specialty Pharmaceuticals. We aggregated the Cardiac Rhythm Management and Electrophysiology reporting units, components of the Rhythm Management operating segment, based on the criteria prescribed in FASB ASC Topic 350, Intangibles - Goodwill and Other.
In 2020, we utilized the qualitative assessment approach to test all of our reporting units. We assessed recent events, including the COVID-19 pandemic, as well as changes in macroeconomic factors, industry and market conditions, overall financial performance and other entity-specific factors since the most recently performed quantitative test. After assessing the totality of events, we determined that it is more likely than not that the fair value of each of our reporting units has sufficient excess over its carrying value, and concluded that goodwill was not impaired or at risk of impairment in the second quarter of 2020.
Liquidity and Capital Resources
We are currently in a strong financial position with solid liquidity, a prudent debt maturity profile, and have credit arrangements with a broad, global, and robust commercial banking syndicate. We believe our long-term fundamentals remain strong given our innovative product portfolio and pipeline, our category leadership strategy and talented global team. As a result of the impact of the COVID-19 pandemic on our business, we took proactive steps in the second quarter of 2020 to reduce costs and ensure we are in a strong position to support customers and patients as healthcare systems recover and elective and semi-emergent procedures resume. These actions included increasing available liquidity and preemptively amending our financial covenant requirement for our outstanding credit arrangements, implementing significant cost reductions as described above in COVID-19 Pandemic and slowing planned capital expenditures.
We have a cross-functional strategic cash management team to take appropriate actions to ensure we continue to optimize funds in the near and long-term to execute our core mission. To address the temporary adverse impacts of COVID-19 on our business, we have taken steps to manage outstanding borrowings and increase available liquidity. In May 2020, we completed an offering
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of $1.700 billion in aggregate principal amount of senior notes and used the net proceeds to prepay $1.250 billion of amounts outstanding under our February 2021 and April 2021 Term Loan and pay related fees, expenses and premiums, as well as to refinance $450 million of amounts outstanding under our Revolving Credit Facility. We now have full access to the $2.750 billion of available liquidity under our Revolving Credit Facility. In May 2020, we also completed public equity offerings of preferred stock and common stock, as discussed below, and used a portion of the combined net proceeds to repay in full the remaining amounts outstanding under the April 2021 Term Loan. During the third quarter of 2020, we made a further prepayment of the remaining $250 million outstanding under our February 2021 Term Loan and terminated the facility. For additional details related to our debt obligations, including our financial covenant requirement, refer to Note E – Contractual Obligations and Commitments to our unaudited condensed consolidated financial statements contained in Item 1 of this Quarterly Report on Form 10-Q, which is incorporated herein by reference.
Based on our current business plan, we believe our existing balance of Cash and cash equivalents, future cash generated from operations, access to capital markets and existing credit facilities will be sufficient to fund our operations, invest in our infrastructure, pay our legal-related liabilities, pay taxes due and service and repay our existing debt for the next 12 months.
Financial Covenant
As of and through September 30, 2020, we were in compliance with the financial covenant required by all existing credit facilities.
On April 21, 2020, we entered into an agreement with our banking syndicates to amend the financial covenant requirement for all of our outstanding credit arrangements as follows: (i) establish a deemed Consolidated EBITDA of $671 million for the second, third and fourth quarters of 2020, reflecting average quarterly Consolidated EBITDA, as defined in the credit agreements, for 2018 and 2019; and (ii) maintain the maximum permitted leverage ratio of 4.75 times through the remainder of 2020, with a step-down for each succeeding fiscal quarter end to 4.50 times, 4.25 times, 4.00 times and ultimately 3.75 times for the fourth quarter of 2021 and through the remaining term of the facility. In addition, pursuant to the April 21, 2020 Revolving Credit Facility and February 2021 Term Loan amendments, the definition of “Material Adverse Effect” has been amended to remove the direct and indirect effects of the COVID-19 pandemic from what constitutes a material adverse effect through the remainder of 2020. We believe that we have the ability to comply with the amended covenant requirement for the next 12 months.
Contractual Obligations and Commitments
Certain of our acquisitions involve the payment of contingent consideration. See Note B – Acquisitions and Strategic Investments to our unaudited condensed consolidated financial statements contained in Item 1 of this Quarterly Report on Form 10-Q for further details regarding the estimated potential amount of future contingent consideration we could be required to pay associated with our acquisitions.
In response to the COVID-19 pandemic, we are optimizing operational output and continuing to work with suppliers to renegotiate open purchase obligations. As we execute these plans, there may be reductions to our future minimum purchase obligations and commitments as reported in our most recent Annual Report filed on Form 10-K. These purchase obligations relate primarily to non-cancellable raw material supply commitments and capital expenditures entered in the normal course of business. In addition, recent transactions within our debt portfolio may result in changes to our interest payment schedule and amounts within.
There have been no other material changes to our contractual obligations and commitments as reported in our most recent Annual Report filed on Form 10-K, with the exception of our debt obligations discussed in Liquidity and Capital Resources and Note E – Contractual Obligations and Commitments to our unaudited condensed consolidated financial statements contained in Item 1 of this Quarterly Report on Form 10-Q.
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Equity
On May 27, 2020, we completed an offering of 10,062,500 shares of 5.50% Mandatory Convertible Preferred Stock, Series A (MCPS) at a price to the public and liquidation preference of $100 per share. The net proceeds from the MCPS offering were approximately $975 million after deducting underwriting discounts and commissions and offering expenses. On May 27, 2020, we also completed an offering of 29,382,500 shares of common stock at a public offering price of $34.25 per share. The net proceeds from the common stock offering were approximately $975 million after deducting underwriting discounts and commissions and offering expenses. We used a portion of the net proceeds to repay remaining amounts outstanding under the April 2021 Term Loan and to pay related fees, expenses and premiums as discussed in Note E – Contractual Obligations and Commitments to our unaudited condensed consolidated financial statements contained in Item 1 of this Quarterly Report on Form 10-Q. The remaining proceeds will be used for general corporate purposes, which may include refinancing or repayment of other outstanding indebtedness and funding potential future acquisitions and investments.
We received $107 million in the first nine months of 2020 and $113 million in the first nine months of 2019 in proceeds from stock issuances related to our stock option and employee stock purchase plans. Proceeds from the exercise of employee stock options and employee stock purchases vary from period to period based upon, among other factors, fluctuations in the trading price of our common stock and in the exercise and stock purchase patterns of our employees.
We did not repurchase any shares of our common stock in the first nine months of 2020 or 2019. As of September 30, 2020, the remaining authorization to repurchase shares under our 2013 share repurchase program was $535 million.
Legal Matters
For a discussion of our material legal proceedings see Note H – Commitments and Contingencies to our unaudited condensed consolidated financial statements contained in Item 1 of this Quarterly Report on Form 10-Q and Note J – Commitments and Contingencies to our audited financial statements contained in Item 8 of our most recent Annual Report on Form 10-K.
Recent Accounting Pronouncements
Information regarding new accounting pronouncements implemented since December 31, 2019 is included in Note A – Basis of Presentation and information regarding new accounting pronouncements to be implemented is included in Note N – New Accounting Pronouncements to our unaudited condensed consolidated financial statements contained in Item 1 of this Quarterly Report on Form 10-Q.
Additional Information
Cybersecurity
We have established controls and procedures to escalate enterprise level issues, including cybersecurity matters, to the appropriate management levels within our organization and our Board of Directors, or members or committees thereof, as appropriate. Under our framework, cybersecurity issues are analyzed by subject matter experts and a crisis committee for potential financial, operational, and reputational risks, based on, among other factors, the nature of the matter and breadth of impact. Matters determined to present potential material impacts to the Company’s financial results, operations, and/or reputation are immediately reported by management to the Board of Directors, or individual members or committees thereof, as appropriate, in accordance with our escalation framework. In addition, we have established procedures to ensure that management responsible for overseeing the effectiveness of disclosure controls is informed in a timely manner of known cybersecurity risks and incidents that may materially impact our operations and that timely public disclosure is made as appropriate.
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Stock Trading Policy
Our directors and executive officers are subject to our Stock Trading Policy, which is designed to facilitate compliance with insider trading laws and governs transactions in our common stock and related derivative securities. Our policy designates certain regular periods, dictated by release of financial results, in which trading is restricted for individuals in information-sensitive positions, including directors and executive officers. In addition, additional periods of trading restriction may be imposed as determined by the President, General Counsel, or Chief Financial Officer in light of material pending developments. Further, during permitted windows, individuals in information-sensitive positions are required to seek pre-clearance for trades from the General Counsel, who assesses whether there are any important pending developments, including cybersecurity matters, which need to be made public before the individual may participate in the market.
Periodically, certain of our executive officers adopt written stock trading plans in accordance with Rule 10b5-1 under the Exchange Act and our own Stock Trading Policy. A Rule 10b5-1 Trading Plan is a written document that pre-establishes the amount, prices and dates (or formulas for determining the amounts, prices and dates) of future purchases or sales of our stock, including shares issued upon exercise of stock options or vesting of deferred stock units. These plans are entered into at a time when the person is not in possession of material non-public information about our Company. We disclose details regarding individual Rule 10b5-1 Trading Plans by our executive officers on the Investor Relations section of our website, under the Governance Overview section.
Use of Non-GAAP Financial Measures
To supplement our unaudited condensed consolidated financial statements presented on a GAAP basis, we disclose certain non-GAAP financial measures, including adjusted net income (loss), adjusted net income (loss) available to common stockholders and adjusted net income (loss) per share (EPS) that exclude certain amounts and operational net sales growth that exclude the impact of foreign currency fluctuations. These non-GAAP financial measures are not in accordance with generally accepted accounting principles in the United States and should not be considered in isolation from or as a replacement for the most directly comparable GAAP financial measures. Further, other companies may calculate these non-GAAP financial measures differently than we do, which may limit the usefulness of those measures for comparative purposes.
To calculate adjusted net income (loss), adjusted net income (loss) available to common stockholders and adjusted net income (loss) per share we exclude certain charges (credits) from GAAP net income and GAAP net income available to common stockholders. Amounts are presented after-tax using our effective tax rate, unless the amount is a significant unusual or infrequently occurring item in accordance with FASB ASC section 740-270-30, "General Methodology and Use of Estimated Annual Effective Tax Rate." Please refer to Part II, Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations in our most recent Annual Report filed on Form 10-K filed with the Securities and Exchange Commission (SEC) for an explanation of each of these adjustments and the reasons for excluding each item.
The GAAP financial measures most directly comparable to adjusted net income (loss), adjusted net income (loss) available to common stockholders and adjusted net income (loss) per share are GAAP net income (loss), GAAP net income (loss) available to common stockholders and GAAP net income (loss) per common share - assuming dilution, respectively.
To calculate operational net sales growth rates, which exclude the impact of foreign currency fluctuations, we convert actual net sales from local currency to U.S. dollars using constant foreign currency exchange rates in the current and prior period. The GAAP financial measure most directly comparable to operational growth rate percentages is growth rate percentages using net sales on a GAAP basis.
Reconciliations of each of these non-GAAP financial measures to the corresponding GAAP financial measure are included in the relevant sections of this Quarterly Report.
Management uses these supplemental non-GAAP financial measures to evaluate performance period over period, to analyze the underlying trends in our business, to assess our performance relative to our competitors and to establish operational goals and forecasts that are used in allocating resources. In addition, management uses these non-GAAP financial measures to further its understanding of the performance of our operating segments. The adjustments excluded from our non-GAAP financial measures are consistent with those excluded from our operating segments’ measures of net sales and profit or loss. These adjustments are excluded from the segment measures reported to our chief operating decision maker that are used to make operating decisions and assess performance.
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We believe that presenting adjusted net income (loss), adjusted net income (loss) available to common stockholders, adjusted net income (loss) per share that exclude certain amounts and operational net sales growth that exclude the impact of changes in foreign currency exchange rates, in addition to the corresponding GAAP financial measures, provides investors greater transparency to the information used by management for its operational decision-making and allows investors to see our results “through the eyes” of management. We further believe that providing this information assists our investors in understanding our operating performance and the methodology used by management to evaluate and measure such performance.
Safe Harbor for Forward-Looking Statements
Certain statements that we may make from time to time, including statements contained in this Quarterly Report on Form 10-Q and information incorporated by reference herein, constitute “forward-looking statements” within the meaning of Section 27A of the Securities Act of 1933, as amended, and Section 21E of the Securities Exchange Act of 1934, as amended. Forward-looking statements may be identified by words like “anticipate,” “expect,” “project,” “believe,” “plan,” “estimate,” “intend,” “aiming” and similar words. These forward-looking statements are based on our beliefs, assumptions and estimates using information available to us at the time and are not intended to be guarantees of future events or performance. If our underlying assumptions turn out to be incorrect, or if certain risks or uncertainties materialize, actual results could vary materially from the expectations and projections expressed or implied by our forward-looking statements.
The forward-looking statements in this Quarterly Report on Form 10-Q are based on certain risks and uncertainties, including the risk factors described in Part I, Item 1A. Risk Factors in our most recent Annual Report on Form 10-K and the specific risk factors discussed herein and in connection with forward-looking statements throughout this Quarterly Report on Form 10-Q, which could cause actual results to vary materially from the expectations and projections expressed or implied by our forward-looking statements. These risks and uncertainties, in some cases, have affected and in the future could affect our ability to implement our business strategy and may cause actual results to differ materially from those contemplated by the statements expressed in this Quarterly Report. As a result, readers are cautioned not to place undue reliance on any of our forward-looking statements. Risks and uncertainties that may cause such differences include, among other things: the impact of the COVID-19 pandemic on our operations and financial results, future U.S. and global economic, political, competitive, reimbursement and regulatory conditions, new product introductions and the market acceptance of those products, markets for our products, expected pricing environment, expected procedural volumes, the closing and integration of acquisitions, clinical trial results, demographic trends, intellectual property rights, litigation, financial market conditions, the execution and effect of our restructuring program, the execution and effect of our business strategy, including our cost-savings and growth initiatives and future business decisions made by us and our competitors. New risks and uncertainties may arise from time to time and are difficult to predict, including those that have emerged or have increased in significance or likelihood as a result of COVID-19. All of these factors are difficult or impossible to predict accurately and many of them are beyond our control. For a further list and description of these and other important risks and uncertainties that may affect our future operations, see Part I, Item 1A. Risk Factors in our most recent Annual Report on Form 10-K filed with the SEC, which we may update in Part II, Item 1A. Risk Factors in subsequent Quarterly Reports on Form 10-Q that we will file hereafter, and Part II, Item 1A. Risk Factors in this Quarterly Report on Form 10-Q. We disclaim any intention or obligation to publicly update or revise any forward-looking statement to reflect any change in our expectations or in events, conditions, or circumstances on which those expectations may be based, or that may affect the likelihood that actual results will differ from those contained in the forward-looking statements. This cautionary statement is applicable to all forward-looking statements contained in this Quarterly Report.
The following are some of the important risk factors that could cause our actual results to differ materially from our expectations in any forward-looking statements. For further discussion of these and other risk factors, see Part I, Item 1A. Risk Factors in our most recent Annual Report on Form 10-K and Part II, Item 1A. Risk Factors in this Quarterly Report on Form 10-Q.
Our Businesses
•The impact of the COVID-19 pandemic on the U.S. and global economies and financial markets,
•The impact of the COVID-19 pandemic upon the scheduling of elective and semi-emergent procedures,
•The impact of natural disasters, public health crises, including the COVID-19 pandemic, and other catastrophic events,
•The impact of COVID-19 on our global manufacturing and distribution system including the quality of our products,
•Our ability to recover and increase net sales, expand the market, capture market share and adapt to market volatility,
•Competitive offerings and related declines in average selling prices for our products,
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•The ongoing impact on our business of physician alignment to hospitals, governmental investigations and audits of hospitals and other market and economic conditions on the overall number of procedures performed,
•The performance of, and physician and patient confidence in, our products and technologies or those of our competitors,
•The impact and outcome of ongoing and future clinical trials and market studies undertaken by us, our competitors or other third parties or perceived product performance of our or our competitors' products,
•Variations in clinical results, reliability or product performance of our and our competitors' products,
•Our ability to acquire or develop, launch and supply new or next-generation products and technologies worldwide and in line with our commercialization strategies in a timely and successful manner and with respect to our recent acquisitions,
•The effect of consolidation and competition in the markets in which we do business or plan to do business,
•Disruption in the manufacture or supply of certain components, materials or products, or the failure to secure in a timely manner alternative manufacturing or additional or replacement components, materials or products,
•Our ability to achieve our projected level or mix of product sales, as some of our products are more profitable than others,
•Our ability to retain and attract key personnel, including those associated with recent acquisitions,
•The inability of certain of our employees to return to work full time following reduced work schedules, or our inability to recruit personnel into direct labor roles,
•The impact of enhanced requirements to obtain regulatory approval in the U.S. and around the world, including EU MDR and the associated timing and cost of product approval, and
•The impact of increased pressure on the availability and rate of third-party reimbursement for our products and procedures in the U.S. and around the world, including with respect to the timing and costs of creating and expanding markets for new products and technologies.
Regulatory Compliance, Litigation and Data Protection
•The impact of healthcare policy changes and legislative or regulatory efforts in the U.S., the EU and around the world to modify product approval or reimbursement processes, including a trend toward demonstrating clinical outcomes, comparative effectiveness and cost efficiency, as well as the impact of other healthcare reform legislation,
•Risks associated with our regulatory compliance and quality systems and activities in the U.S., the EU and around the world, including meeting regulatory standards applicable to manufacturing and quality processes,
•Our ability to minimize or avoid future field actions or FDA warning letters relating to our products and processes and the ongoing inherent risk of potential physician advisories related to our or our competitors' products,
•The impact of increased scrutiny of and heightened global regulatory enforcement facing the medical device industry arising from political and regulatory changes, economic pressures or otherwise, including under U.S. Anti-Kickback Statute, U.S. False Claims Act and similar laws in other jurisdictions, U.S. Foreign Corrupt Practices Act (FCPA) and similar laws in other jurisdictions, and U.S. and foreign export control, trade embargo and customs laws,
•Costs and risks associated with current and future asserted litigation,
•The effect of our litigation and risk management practices, including self-insurance and compliance activities on our loss contingencies, legal provision and cash flows,
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•The impact of, diversion of management attention as a result of, and costs to cooperate with, litigate and/or resolve governmental investigations and our class action, product liability, contract and other legal proceedings,
•The possibility of failure to protect our intellectual property rights and the outcome of patent litigation,
•Our ability to operate properly our information systems that support our business operations and protect our data integrity and products from a cyber-attack or other breach that has a material adverse effect on our business, reputation or results of operations, and
•The potential impact to internal control over financial reporting relating to potential restrictions to access to consigned inventory at customer locations for our inventory count procedures.
Innovation and Certain Growth Initiatives
•The timing, size and nature of our strategic growth initiatives and market opportunities, including with respect to our internal research and development platforms and externally available research and development platforms and technologies and the ultimate cost and success of those initiatives and opportunities,
•Our ability to complete planned clinical trials successfully, obtain regulatory approvals and launch new and next generation products in a timely manner consistent with cost estimates, including the successful completion of projects from in-process research and development,
•Our ability to identify and prioritize our internal research and development project portfolio and our external investment portfolio on profitable net sales growth opportunities as well as to maintain the estimated timing and costs of such projects and expected revenue levels for the resulting products and technologies,
•Our ability to develop, manufacture and market new products and technologies successfully and in a timely manner and the ability of our competitors and other third parties to develop products or technologies that render our products or technologies noncompetitive or obsolete,
•Our ability to execute appropriate decisions to discontinue, write-down or reduce the funding of any of our research and development projects, including projects from in-process research and development from our acquisitions, in our growth adjacencies or otherwise,
•Our dependence on acquisitions, alliances or investments to introduce new products or technologies and to enter new or adjacent growth markets and our ability to fund them or to fund contingent payments with respect to those acquisitions, alliances and investments, and
•The potential failure to successfully integrate and realize the expected benefits, including cost synergies, from the strategic acquisitions, alliances and investments we have consummated or may consummate in the future.
International Markets
•Our dependency on international net sales to achieve growth, including in emerging markets,
•The timing and collectability of customer payments, as well as our ability to continue factoring customer receivables where we have factoring arrangements,
•The impact on pricing due to national tenders,
•Geopolitical and economic conditions, including civil unrest, terrorist activity, governmental changes, restrictions on the ability to transfer capital across borders, tariffs and other protectionist measures,
•The United Kingdom’s departure from the European Union,
•Protection of our intellectual property,
•Our ability to comply with established and developing U.S. and foreign legal and regulatory requirements, including FCPA, MDR, and similar laws in other jurisdictions,
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•Our ability to comply with U.S. and foreign export control, trade embargo and customs laws,
•The impact of changes in reimbursement practices and policies,
•The impact of significant developments or uncertainties stemming from the U.S. administration and the November 3, 2020 presidential and congressional elections, including changes in U.S. trade policies, tariffs and the reaction of other countries thereto, particularly China,
•Our ability to maintain or expand our worldwide market positions in the various markets in which we compete or seek to compete, including through investments in product diversification and emerging markets such as Brazil, Russia, India and China,
•Our ability to execute and realize anticipated benefits from our investments in emerging markets, and
•The potential effect of foreign currency fluctuations and interest rate fluctuations on our net sales, expenses and resulting margins.
Liquidity
•Our ability to generate sufficient cash flow to fund operations, capital expenditures, global expansion initiatives, any litigation settlements and judgments, share repurchases and strategic investments and acquisitions as well as maintaining our investment grade ratings and managing our debt levels and financial covenant compliance, particularly in light of the COVID-19 pandemic and lower demand for our products,
•Our ability to access the public and private capital markets when desired and to issue debt or equity securities on terms reasonably acceptable to us,
•The unfavorable resolution of open tax matters, exposure to additional tax liabilities and the impact of changes in U.S. and international tax laws,
•The impact of examinations and assessments by domestic and international taxing authorities on our tax provision, financial condition or results of operations,
•The issuance of new or revised accounting standards by the Financial Accounting Standards Board or the Securities and Exchange Commission,
•The possibility of counterparty default on our derivative financial instruments,
•The impact of potential intangible asset impairment charges, including on our results of operations, and
•Our ability to collect outstanding and future receivables and/or sell receivables under our factoring programs.
Cost Reduction and Optimization Initiatives
•Risks associated with changes made or expected to be made to our organizational and operational structure, pursuant to our restructuring plans as well as any further restructuring or optimization plans we may undertake in the future and our ability to recognize benefits and cost reductions from such programs and
•Business disruption and employee distraction as we execute our global compliance program, restructuring and optimization plans and divestitures of assets or businesses and implement our other strategic and cost reduction initiatives.
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ITEM 3.QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
We develop, manufacture and sell medical devices globally and our earnings and cash flows are exposed to market risk from changes in currency exchange rates and interest rates. We address these risks through a risk management program that includes the use of derivative financial instruments. We operate the program pursuant to documented corporate risk management policies. We do not enter derivative transactions for speculative purposes. Gains and losses on derivative financial instruments substantially offset losses and gains on underlying hedged exposures. Furthermore, we manage our exposure to counterparty risk on derivative instruments by entering into contracts with a diversified group of major financial institutions and by actively monitoring outstanding positions.
Our currency risk consists primarily of foreign currency denominated firm commitments, forecasted foreign currency denominated intercompany and third-party transactions and net investments in certain subsidiaries. We use both nonderivative (primarily European manufacturing operations) and derivative instruments to manage our earnings and cash flow exposure to changes in currency exchange rates. We had currency derivative instruments outstanding in the contract amount of $9.392 billion as of September 30, 2020 and $9.221 billion as of December 31, 2019. A ten percent appreciation in the U.S. dollar’s value relative to the hedged currencies would increase the derivative instruments’ fair value by $338 million as of September 30, 2020 as compared to $337 million as of December 31, 2019. A ten percent depreciation in the U.S. dollar’s value relative to the hedged currencies would decrease the derivative instruments’ fair value by $414 million as of September 30, 2020 as compared to $412 million as of December 31, 2019. Any increase or decrease in the fair value of our currency exchange rate sensitive derivative instruments would be substantially offset by a corresponding decrease or increase in the fair value of the hedged underlying asset, liability or forecasted transaction, resulting in minimal impacts on our unaudited condensed consolidated statements of operations.
Our interest rate risk relates primarily to U.S. dollar borrowings partially offset by U.S. dollar cash investments. We have historically used interest rate derivative instruments to manage our earnings and cash flow exposure to changes in interest rates. We had no interest rate derivative instruments outstanding as of September 30, 2020 and December 31, 2019. As of September 30, 2020, $9.404 billion in aggregate principal amount of our outstanding debt obligations were at fixed interest rates, representing approximately 100 percent of our total debt, on an amortized cost basis. As of September 30, 2020, our outstanding debt obligations at fixed interest rates were comprised of senior notes.
Refer to Note D – Hedging Activities and Fair Value Measurements to our unaudited condensed consolidated financial statements contained in Item 1 of this Quarterly Report on Form 10-Q for further information regarding our derivative financial instruments.
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ITEM 4.CONTROLS AND PROCEDURES
Evaluation of Disclosure Controls and Procedures
Our management, with the participation of our Chief Executive Officer (CEO) and our Chief Financial Officer (CFO), evaluated the effectiveness of our disclosure controls and procedures as of September 30, 2020 pursuant to Rule 13a-15(b) of the Securities Exchange Act of 1934, as amended (the Exchange Act). Disclosure controls and procedures are designed to ensure that material information required to be disclosed by us in the reports that we file or submit under the Exchange Act is recorded, processed, summarized and reported within the time periods specified in the SEC’s rules and forms and that such material information is accumulated and communicated to our management, including our CEO and CFO, as appropriate, to allow timely decisions regarding required disclosure. Based on their evaluation, our CEO and CFO concluded that, as of September 30, 2020, our disclosure controls and procedures were effective.
Changes in Internal Control Over Financial Reporting
There were no changes in our internal control over financial reporting in the three-month period ended September 30, 2020 that have materially affected, or are reasonably likely to materially affect, our internal control over financial reporting. While there are a number of business risks that have emerged associated with COVID-19 (Refer to Risk Factors contained in Part I. Item 1A of this Quarterly Report), we are continuing to monitor these risks and have implemented business continuity measures as described within Management’s Discussion and Analysis. Additionally, the Company has provided regular updates to the Board of Directors on risk mitigation strategies to ensure transparent decision making and appropriate Board oversight.
Further, while many of our employees worked remotely to adhere to COVID-19 social distancing requirements, this did not affect our ability to maintain financial reporting systems, internal controls over financial reporting or disclosure controls and procedures. Prior to the COVID-19 pandemic, we were leveraging electronic tools to facilitate our global close process and to connect our physically dispersed team of finance professionals in offices around the world. While the quarterly close cycles were performed remotely, fundamentally, the work performed, and the processes and controls executed did not change. As we approach year-end, we are evaluating the potential impact, if any, to internal control over financial reporting relating to potential restrictions to access to consigned inventory at customer locations for our inventory count procedures.
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PART II
OTHER INFORMATION
ITEM 1. LEGAL PROCEEDINGS
See Note G – Income Taxes and Note H – Commitments and Contingencies to our unaudited condensed consolidated financial statements contained in Item 1 of this Quarterly Report on Form 10-Q, which is incorporated herein by reference.
ITEM 1A. RISK FACTORS
In addition to the information set forth below and other information contained elsewhere in this report, you should carefully consider the factors discussed in Part I, Item 1A. Risk Factors in our most recent Annual Report filed on Form 10-K, which could materially affect our business, financial condition or future results.
The ongoing global COVID-19 pandemic and related impacts are having a material adverse effect on our operations, financial performance and cash flows. We are unable to predict the extent to which the pandemic and related impacts will continue to adversely impact our business operations, financial performance, results of operations, financial position and the achievement of our strategic objectives.
Our operations, financial performance and cash flows have been negatively impacted by the ongoing COVID-19 pandemic that has caused, and is expected to continue to cause, the global slowdown of economic activity (including the decrease in demand for a broad variety of goods and services), disruptions in global supply chains and significant volatility, disruption of financial markets, a U.S. economic recession and, potentially, a global economic recession. Because the severity, magnitude, and duration of the COVID-19 pandemic and its economic consequences are uncertain, rapidly changing, and difficult to predict, the pandemic’s impact on our operations and financial performance, as well as its impact on our ability to execute our business strategies and initiatives successfully, remains uncertain and difficult to predict. Further, the ultimate impact of the COVID-19 pandemic on our operations and financial performance depends on many factors that are not within our control, including, but not limited, to: governmental, business and individuals’ actions that have been and continue to be taken in response to the pandemic (including restrictions on travel, transport and workforce pressures, and voluntary or mandated deferrals or postponements of elective procedures); the impact of the pandemic and actions taken in response on global and regional economies, travel, and economic activity; the availability of federal, state, local or non-U.S. funding programs; general economic uncertainty in key global markets and financial market volatility; global economic conditions and levels of economic growth; and the timing and pace of recovery when the COVID-19 pandemic subsides, which could be impacted by a number of factors, including limited provider capacity to perform procedures using our products that were deferred as a result of the pandemic.
The COVID-19 pandemic has subjected, and is expected to continue to subject, our operations, financial performance and financial condition to a number of risks, including, but not limited to those discussed below:
•Operations-related risks: Across all of our businesses, we are facing increased operational challenges from the need to protect employee health and safety. Some of these challenges include site shutdowns, workplace disruptions and restrictions on the movement of people, raw materials and goods, both at our own facilities and at customers and suppliers. We are also experiencing, and expect to continue experiencing, lower demand and volume for certain products and services, customer requests for potential payment deferrals or other contract modifications, delays of deliveries and other factors related directly and indirectly to the COVID-19 pandemic that adversely impact our businesses. We expect that the longer the period of economic and global supply chain and disruption continues, the more material the cumulative adverse impact will be on our business operations, financial performance and results of operations. Our ability to manufacture our products is highly dependent on our ability to maintain the safety and health of our employees. The ability of our employees to work may be significantly impacted by one or more employee contracting or being exposed to COVID-19. Additionally, when the economic recovery following the COVID-19 pandemic occurs, we may experience unpredictable increases in demand for certain of our products, which could exceed our capacity to meet such demand on a timely basis or at all, which could have a material adverse impact on our business operations, financial performance and results of operations.
•Customer-related risks: In particular, as a result of impacts associated with preventive and precautionary measures that we, other businesses and governments are taking to quell the spread of COVID-19 and protect our customers, employees, and the patients receiving our products, we have experienced significant and unpredictable reductions in demand for certain of our products as health care customers re-prioritize the treatment of patients. For example, in the United States in mid-March, governmental authorities began recommending, and in certain cases required, that elective procedures be suspended or canceled to avoid non-essential patient exposure to medical environments and potential
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infection with COVID-19 and to focus limited resources and personnel capacity toward the treatment of COVID-19. These measures and challenges significantly reduced our net sales in the second and third quarters and the situation remains challenging. In certain jurisdictions, however, the timing of the pandemic and public health measures have resulted in lower levels of COVID-19 cases and some hospitals have developed protocols such that elective procedures may be conducted safely and are approaching pre-COVID-19 pandemic levels. Further, once the pandemic subsides, we anticipate there may be some continued reluctance upon the part of some patients to seek medical attention in a hospital setting. In addition, for the majority of patients who do seek appointments with physicians and surgeries to be performed at hospitals and ambulatory surgery centers relating to a variety of medical conditions, we anticipate there may be a substantial backlog. As a result, patients seeking to schedule or reschedule elective or deferrable procedures utilizing our products may have to navigate potentially limited healthcare provider capacity. We believe this likely patient reluctance and potential healthcare provider capacity could have an adverse effect on our sales following the end of the pandemic.
•Employee-related risks: In an attempt to proactively address the changed business environment caused by COVID-19, in order to preserve employees’ jobs and ensure we are able to quickly respond to increased customer demand, when deferrable procedures resume as permitted by development or conclusion of the pandemic, we made temporary work hour reductions, and corresponding salary reductions, where appropriate, for many of our employees. However, because the severity, magnitude, and duration of the COVID-19 pandemic and its economic consequences are uncertain, rapidly changing, and difficult to predict, we may, in the future, have to consider taking additional actions including further reductions to salary and work hours, furloughs, restructuring, layoffs or extensions of remote work arrangements, which may negatively impact our workforce and our business. These negative impacts could include inhibiting our ability to quickly respond to increased customer demand and to take advantage of more favorable economic and market conditions after the pandemic subsides as well as lower productivity and higher employee attrition.
•Accounting-related risks: Generally accepted accounting principles and the related authoritative guidance are complex and involve subjective judgments. In particular, the accounting for revenue, inventory, goodwill, intangible assets, income taxes and other assets and liabilities requires reliance on forward looking estimates of sales and/or earnings. Due to the uncertainty surrounding the COVID-19 pandemic, estimating the future performance of our business is extremely challenging and the range of deviation from internal estimates could be more significant in this environment. Changes in the underlying estimates, assumptions or judgments could have a material adverse impact on our future results of operations, financial position and cash flows.
•Leverage- and market-related risks: The current financial market dynamics and volatility pose heightened risks to our previously announced timelines for decreasing our leverage, which we expect to be delayed as we seek to maintain appropriate liquidity to compensate for lower cash flows from operations or as variables impacting our leverage ratios fluctuate with extreme market volatility.
•Liquidity- and funding-related risks: While we have significant sources of cash and liquidity and access to committed credit lines, a prolonged period of generating lower cash from operations could adversely affect our financial condition and the achievement of our strategic objectives. Additionally, there can also be no assurance that we will not face credit rating downgrades as a result of weaker than anticipated performance of our businesses, slower progress in decreasing our leverage or other factors. Future downgrades could further adversely affect our cost of funds and related margins, liquidity, competitive position and access to capital markets, and a significant downgrade could have an adverse commercial impact on our business. Conditions in the financial and credit markets may also limit the availability of funding or increase the cost of funding (including for receivables monetization or supply chain finance programs, as well as increased borrowing costs and higher interest rates), which could adversely affect our business, financial position and results of operations. Although the U.S. federal and other governments have instituted and/or announced a number of funding programs to support businesses, our ability or willingness to access funding under such programs may be limited by regulations or other guidance, or by further change or uncertainty related to the terms of these programs.
As the COVID-19 pandemic continues to adversely affect our operating and financial results, it may also have the effect of heightening many of the other risks described in the risk factors in our Annual Report on Form 10-K for the year ended December 31, 2019. Further, the COVID-19 pandemic may also affect our operating and financial results in a manner that is not presently known to us or that we currently do not expect to present significant risks to our operations or financial results, particularly if the COVID-19 pandemic and its associated impacts reoccur in successive waves in the coming months.
ITEM 6. EXHIBITS (* documents filed or furnished with this report, # compensatory plans or arrangements)
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| 31.1* | ||||||||
| 31.2* | ||||||||
| 32.1* | ||||||||
| 32.2* | ||||||||
| 101.SCH* | XBRL Taxonomy Extension Schema Document. | |||||||
| 101.CAL* | XBRL Taxonomy Extension Calculation Linkbase Document. | |||||||
| 101.DEF* | XBRL Taxonomy Extension Definition Linkbase Document. | |||||||
| 101.LAB* | XBRL Taxonomy Extension Label Linkbase Document. | |||||||
| 101.PRE* | XBRL Taxonomy Extension Presentation Linkbase Document. | |||||||
| 104 | Cover Page Interactive Data File (embedded within the Inline XBRL document and contained in Exhibit 101) | |||||||
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SIGNATURE
Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized on November 5, 2020.
BOSTON SCIENTIFIC CORPORATION | |||||||||||
| By: | /s/ Daniel J. Brennan | ||||||||||
| Name: | Daniel J. Brennan | ||||||||||
| Title: | Executive Vice President and Chief Financial Officer | ||||||||||
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