10-Q 1 q12014form10q.htm 10-Q Q1 2014 Form 10Q
UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-Q
þ
QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
For the quarterly period ended March 31, 2014
OR
o
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.)
ONE BOSTON SCIENTIFIC PLACE, NATICK, MASSACHUSETTS 01760-1537
(Address of principal executive offices) (zip code)
(508) 650-8000
(Registrant’s telephone number, including area code)
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 þ No o
Indicate by check mark whether the registrant has submitted electronically and posted on its corporate website, if any, every Interactive Data File required to be submitted and posted 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 and post such files).Yes þ No o
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company. See the definitions of “large accelerated filer,” “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act.
Large accelerated filer þ
Accelerated filer o
Non-Accelerated filer o
Smaller reporting company o
 
 
(Do not check if a smaller reporting company)
 
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act). Yes o No þ
Indicate the number of shares outstanding of each of the issuer’s classes of common stock, as of the latest practicable date.

 
 
Shares outstanding
Class
 
as of April 30, 2014
Common Stock, $.01 par value
 
1,322,675,633



TABLE OF CONTENTS

 
 
Page No.
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Unregistered Sales of Equity Securities and Use of Proceeds
 
 
 
 
 
 
 


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
March 31,
in millions, except per share data
2014
 
2013
 
 
 
 
Net sales
$
1,774

 
$
1,761

Cost of products sold
537

 
578

Gross profit
1,237

 
1,183

 
 
 
 
Operating expenses:
 
 
 
Selling, general and administrative expenses
666

 
631

Research and development expenses
191

 
204

Royalty expense
40

 
41

Amortization expense
109

 
103

Goodwill impairment charges

 
423

Intangible asset impairment charges
55

 

Contingent consideration (benefit) expense
(22
)
 
(23
)
Restructuring charges
20

 
10

Litigation-related (credits) charges
(7
)
 
130

Gain on divestiture
(12
)
 
(6
)
 
1,040

 
1,513

Operating income (loss)
197

 
(330
)
 
 
 
 
Other (expense) income:
 
 
 
Interest expense
(54
)
 
(65
)
Other, net
3

 
1

Income (loss) before income taxes
146

 
(394
)
Income tax expense (benefit)
13

 
(40
)
Net income (loss)
$
133

 
$
(354
)
 
 
 
 
Net income (loss) per common share — basic
$
0.10

 
$
(0.26
)
Net income (loss) per common share — assuming dilution
$
0.10

 
$
(0.26
)
 
 
 
 
Weighted-average shares outstanding
 
 
 
Basic
1,321.7

 
1,351.9

Assuming dilution
1,349.2

 
1,351.9


See notes to the unaudited condensed consolidated financial statements.


3


BOSTON SCIENTIFIC CORPORATION AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME (LOSS) (UNAUDITED)

 
 
Three Months Ended
March 31,
(in millions)
 
2014
 
2013
Net income (loss)
 
$
133

 
$
(354
)
Other comprehensive income (loss):
 
 
 
 
Foreign currency translation adjustment
 
(6
)
 
3

Net change in unrealized gains and losses on derivative financial instruments, net of tax
 
(27
)
 
75

Net change in certain retirement plans
 
(1
)
 

Total other comprehensive income (loss)
 
(34
)
 
78

Total comprehensive income (loss)
 
$
99

 
$
(276
)

See notes to the unaudited condensed consolidated financial statements.



4


BOSTON SCIENTIFIC CORPORATION AND SUBSIDIARIES
CONDENSED CONSOLIDATED BALANCE SHEETS
 
As of
 
March 31,
 
December 31,
in millions, except share and per share data
2014
 
2013
 
(Unaudited)
 
 
ASSETS
 
 
 
Current assets:
 
 
 
Cash and cash equivalents
$
191

 
$
217

Trade accounts receivable, net
1,217

 
1,307

Inventories
926

 
897

Deferred income taxes
279

 
288

Prepaid expenses and other current assets
323

 
302

Total current assets
2,936

 
3,011

Property, plant and equipment, net
1,539

 
1,546

Goodwill
5,697

 
5,693

Other intangible assets, net
5,802

 
5,950

Other long-term assets
361

 
371

TOTAL ASSETS
$
16,335

 
$
16,571

 
 
 
 
LIABILITIES AND STOCKHOLDERS’ EQUITY
 
 
 
Current liabilities:
 
 
 
Current debt obligations
$
4

 
$
3

Accounts payable
241

 
246

Accrued expenses
1,275

 
1,348

Other current liabilities
199

 
227

Total current liabilities
1,719

 
1,824

Long-term debt
4,245

 
4,237

Deferred income taxes
1,439

 
1,402

Other long-term liabilities
2,398

 
2,569

 
 
 
 
Commitments and contingencies

 

 
 
 
 
Stockholders’ equity
 
 
 
Preferred stock, $.01 par value - authorized 50,000,000 shares, none issued and outstanding


 


Common stock, $.01 par value - authorized 2,000,000,000 shares and issued 1,570,033,861 shares as of March 31, 2014 and 1,560,302,634 shares as of December 31, 2013
16

 
16

Treasury stock, at cost - 247,566,270 shares as of March 31, 2014 and 238,006,570 shares as of December 31, 2013
(1,717
)
 
(1,592
)
Additional paid-in capital
16,599

 
16,579

Accumulated deficit
(8,436
)
 
(8,570
)
Accumulated other comprehensive income (loss), net of tax
72

 
106

Total stockholders’ equity
6,534

 
6,539

TOTAL LIABILITIES AND STOCKHOLDERS' EQUITY
$
16,335

 
$
16,571


See notes to the unaudited condensed consolidated financial statements.

5


BOSTON SCIENTIFIC CORPORATION AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS (UNAUDITED)

 
Three Months Ended
March 31,
in millions
2014
 
2013
 
 
 
 
Cash provided by operating activities
$
198

 
$
187

 
 
 
 
Investing activities:
 
 
 
Purchases of property, plant and equipment
(59
)
 
(53
)
Proceeds from sale of property, plant and equipment

 
53

Purchases of privately held securities
(6
)
 
(4
)
Proceeds from sales of publicly traded and privately held equity securities and collections of notes receivable
7

 

Payments for acquisitions of businesses, net of cash acquired
(8
)
 

Payments for investments in companies and acquisitions of certain technologies
(11
)
 
(7
)
Proceeds from business divestitures, net of costs
12

 

 
 
 
 
Cash used for investing activities
(65
)
 
(11
)
 
 
 
 
Financing activities:
 
 
 
Payment of contingent consideration
(12
)
 

Proceeds from borrowings on credit facilities
285

 
240

Payments on borrowings from credit facilities
(285
)
 
(240
)
Payments for acquisitions of treasury stock
(125
)
 
(100
)
Cash used to net share settle employee equity awards

(47
)
 
(24
)
Proceeds from issuances of shares of common stock
24

 
10

 
 
 
 
Cash used for financing activities
(160
)
 
(114
)
 
 
 
 
Effect of foreign exchange rates on cash
1

 
(1
)
 
 
 
 
Net increase (decrease) in cash and cash equivalents
(26
)
 
61

Cash and cash equivalents at beginning of period
217

 
207

Cash and cash equivalents at end of period
$
191

 
$
268

 
 
 
 
Supplemental Information
 
 
 
 
 
 
 
Non-cash operating activities:
 
 
 
Stock-based compensation expense
$
26

 
$
24

Fair value of contingent consideration recorded
$
3

 
$


See notes to the unaudited condensed consolidated financial statements.


6


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. 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 months ended March 31, 2014 are not necessarily indicative of the results that may be expected for the year ending December 31, 2014. For further information, refer to the consolidated financial statements and footnotes thereto included in Item 8 of our 2013 Annual Report filed on Form 10-K.
Additionally, certain prior year cash outflows from net share settling employee equity awards to satisfy their tax withholding requirement have been reclassified from an operating activity to a financing activity within our condensed consolidated statements of cash flows. Amounts reclassified from operating to financing activities on the cash flows were not material.
Subsequent Events
We evaluate events occurring after the date of our most recent accompanying unaudited condensed consolidated balance sheets for potential recognition or disclosure in our financial statements. We did not identify any material subsequent events requiring adjustment to our accompanying unaudited condensed consolidated financial statements (recognized subsequent events) for the three month period ended March 31, 2014. Those items requiring disclosure (unrecognized subsequent events) in the financial statements have been disclosed accordingly. Refer to Note B - Acquisitions and Note J - Commitments and Contingencies for more information.

NOTE B – ACQUISITIONS

We did not close any material acquisitions during the first quarters of 2014 and 2013.

On May 7, 2014, we completed the acquisition of the remaining fully diluted equity of IoGyn, Inc. (IoGyn). Prior to the acquisition, we held approximately 28 percent minority interest in IoGyn in addition to notes receivable of approximately $8 million. Total consideration was comprised of a net cash payment of $65 million at closing to acquire the remaining 72 percent of IoGyn equity and repay outstanding debt. IoGyn has developed the SymphionTM System, a next generation system for hysteroscopic intrauterine tissue removal including fibroids (myomas) and polyps. In March 2014, IoGyn received U.S. FDA approval for the system, and we expect to launch the system in the United States in the second half of 2014. We will integrate the operations of the IoGyn business into our Urology and Women’s Health division.

Contingent Consideration
Certain of our acquisitions involve contingent consideration arrangements. Payment of additional consideration is generally contingent on the acquired company reaching certain performance milestones, including attaining specified revenue levels, achieving product development targets and/or obtaining regulatory approvals. In accordance with U.S. GAAP, we recognize a liability equal to the fair value of the contingent payments we expect to make as of the acquisition date. We remeasure this liability each reporting period and record changes in the fair value through a separate line item within our consolidated statements of operations.
Changes in the fair value of our contingent consideration liability were as follows (in millions):
Balance as of December 31, 2013
$
(501
)
Amounts recorded related to new acquisitions
(3
)
Other amounts recorded related to prior acquisitions
(2
)
Net fair value adjustments
22

Payments made
12

Balance as of March 31, 2014
$
(472
)
As of March 31, 2014, the maximum amount of future contingent consideration (undiscounted) that we could be required to pay was approximately $2.2 billion.

7


Contingent consideration liabilities are remeasured to fair value each reporting period using projected revenues, discount rates, probabilities of payment and projected payment dates. The recurring Level 3 fair value measurements of our contingent consideration liability include the following significant unobservable inputs:
Contingent Consideration Liability
Fair Value as of March 31, 2014
Valuation Technique
Unobservable Input
Range
R&D, Regulatory and Commercialization-based Milestones
$87 million
Probability Weighted Discounted Cash Flow
Discount Rate
0.7%-1.4%
Probability of Payment
85% - 95%
Projected Year of Payment
2014 - 2015
Revenue-based Payments
$131 million
Discounted Cash Flow
Discount Rate
11.5% - 15%
Probability of Payment
0% - 100%
Projected Year of Payment
2014 - 2018
$254 million
Monte Carlo
Revenue Volatility
13% - 19%
Risk Free Rate
LIBOR Term Structure
Projected Year of Payment
2014-2018

Increases or decreases in the fair value of our contingent consideration liability can result from changes in discount periods and rates, as well as changes in the timing and amount of revenue estimates or in the timing or likelihood of achieving regulatory-, revenue- or commercialization-based milestones. Projected contingent payment amounts related to research and development, regulatory- and commercialization-based milestones and certain revenue-based milestones are discounted back to the current period using a discounted cash flow (DCF) model. Other revenue-based payments are valued using a Monte Carlo valuation model, which simulates future revenues during the earn-out period using management's best estimates. Projected revenues are based on our most recent internal operational budgets and long-range strategic plans. Increases in projected revenues and probabilities of payment may result in higher fair value measurements. Increases in discount rates and the time to payment may result in lower fair value measurements. Increases or decreases in any of those inputs in isolation may result in a significantly lower or higher fair value measurement.

NOTE C – DIVESTITURES
In January 2011, we closed the sale of our Neurovascular business to Stryker Corporation for a purchase price of $1.500 billion in cash. We received $1.450 billion during 2011, including an upfront payment of $1.426 billion, and $24 million which was placed into escrow and released throughout 2011 upon the completion of local closings in certain foreign jurisdictions. We received $10 million during 2012, $28 million during the second quarter of 2013 and we received the final $12 million of consideration in January 2014. Due to our continuing involvement in the operations of the Neurovascular business following the divestiture, the divestiture did not meet the criteria for presentation as a discontinued operation.
Revenue generated by the Neurovascular business was $2 million in the first quarter of 2014 and $36 million in the first quarter of 2013. Our sales related to our divested Neurovascular business have declined as the various transition services and supply agreements have terminated. 


8


NOTE D – 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 as of March 31, 2014 and December 31, 2013 are as follows:
 
 
As of
 
 
March 31, 2014
 
December 31, 2013
 
 
Gross Carrying
 
Accumulated
Amortization/
 
Gross Carrying
 
Accumulated
Amortization/
(in millions)
 
Amount
 
Write-offs
 
Amount
 
Write-offs
Amortizable intangible assets
 
 
 
 
 
 
 
 
Technology-related
 
$
8,232

 
$
(3,431
)
 
$
8,272

 
$
(3,342
)
Patents
 
521

 
(332
)
 
513

 
(326
)
Other intangible assets
 
846

 
(493
)
 
845

 
(479
)
 
 
$
9,599

 
$
(4,256
)
 
$
9,630

 
$
(4,147
)
Unamortizable intangible assets
 
 
 
 
 
 
 
 
Goodwill
 
$
15,597

 
$
(9,900
)
 
$
15,593

 
$
(9,900
)
Technology-related
 
197

 

 
197

 

 
 
$
15,794

 
$
(9,900
)
 
$
15,790

 
$
(9,900
)

In addition, we had $262 million and $270 million of in-process research and development intangible assets as of March 31, 2014 and December 31, 2013, respectively.
The following represents our goodwill balance by global reportable segment:
(in millions)
 
Cardiovascular
 
Rhythm Management
 
MedSurg
 
Total
Balance as of December 31, 2013
 
$
3,252

 
$
294

 
$
2,147

 
$
5,693

Purchase price adjustments
 

 
(2
)
 

 
(2
)
Goodwill acquired
 

 

 
6

 
6

Goodwill written off
 

 

 

 

Other changes in carrying amount *
 
7

 

 
(7
)
 

Balance as of March 31, 2014
 
$
3,259

 
$
292

 
$
2,146

 
$
5,697

* In the first quarter of 2014, we reallocated $7 million of goodwill between Cardiovascular and MedSurg as a result of the realignment of certain product lines from Endoscopy to Peripheral Interventions as of January 1, 2014.
Goodwill Impairment Testing and Charge
We test our goodwill balances during the second quarter of each year for impairment, or more frequently if indicators are present or changes in circumstances suggest that an impairment may exist. Refer to Note D - Goodwill and Other Intangible Assets contained in Item 8 of our 2013 Annual Report filed on Form 10-K for discussion of our most recent goodwill impairment test performed in the second quarter of 2013.

9


2013 Charge
Following our reorganization from regions to global business units and our reallocation of goodwill on a relative fair value basis as of January 1, 2013, we conducted the first step of the goodwill impairment test for all global reporting units. As of January 1, 2013, the fair value of each global reporting unit exceeded its carrying value, with the exception of the global Cardiac Rhythm Management (CRM) reporting unit. In accordance with ASC Topic 350, Intangibles—Goodwill and Other (Topic 350) and our accounting policies, we tested the global CRM intangible assets and goodwill for impairment and recorded a non-cash goodwill impairment charge of $423 million ($422 million after-tax) to write down the goodwill to its implied fair value as of January 1, 2013 as a result of this analysis. The primary driver of this impairment charge was our reorganization from geographic regions to global business units as of January 1, 2013, which changed the composition of our reporting units. As a result of the reorganization, any goodwill allocated to the global CRM reporting unit was no longer supported by the cash flows of other businesses. Under our former reporting unit structure, the goodwill allocated to our regional reporting units was supported by the cash flows from all businesses in each international region. The hypothetical tax structure of the global CRM business and the global CRM business discount rate applied were also contributing factors to the goodwill impairment charge. Refer to Note D - Goodwill and Other Intangible Assets contained in Item 8 of our 2013 Annual Report filed on Form 10-K for details on the 2013 goodwill impairment charge.
The following is a rollforward of accumulated goodwill write-offs by global reportable segment:
(in millions)
Cardiovascular
 
Rhythm Management
 
MedSurg
 
Total
Accumulated write-offs as of December 31, 2013
$
(1,479
)
 
$
(6,960
)
 
$
(1,461
)
 
$
(9,900
)
Goodwill written off

 

 

 

Accumulated write-offs as of March 31, 2014
$
(1,479
)
 
$
(6,960
)
 
$
(1,461
)
 
$
(9,900
)

Intangible Asset Impairment Testing

On a quarterly basis, we monitor for events or other potential indicators of an impairment that would warrant an interim impairment test of our intangible assets. Refer to Note D - Goodwill and Other Intangible Assets contained in Item 8 of our 2013 Annual Report filed on Form 10-K for a discussion of future events that would have a negative impact on the recoverability of our $4.305 billion of CRM-related amortizable intangible assets. Our CRM-related amortizable intangibles are at higher risk of potential failure of the first step of the amortizable intangible recoverability test in future reporting periods. An impairment of a material portion of our CRM-related amortizable intangibles carrying value would likely occur if the second step of the amortizable intangible test is required in a future reporting period. Refer to Critical Accounting Policies and Estimates within our Management's Discussion and Analysis of Financial Condition and Results of Operations contained in Item 7 of our 2013 Annual Report filed on Form 10-K for a discussion of key assumptions used in our testing.

During the first quarter of 2014, as a result of lower estimates of the resistant hypertension market following the announcement of data from a competitor's clinical trial, we performed an interim impairment test of our in-process research and development projects and core technology associated with our acquisition of Vessix Vascular, Inc. (Vessix). The impairment assessments were based upon probability-weighted cash flows of potential future scenarios. Based on our impairment assessment, which included an initial undiscounted recoverability cash flow test for core technology, and lower expected future cash flows associated with our Vessix-related intangible assets, we recorded pre-tax impairment charges of $55 million in the first quarter of 2014 to write down the balance of these intangible assets to their fair value. We recorded this amount in the intangible asset impairment charges caption in our accompanying unaudited condensed consolidated statements of operations.

The nonrecurring Level 3 fair value measurements of our intangible asset impairment analysis included the following significant unobservable inputs:
Intangible Asset
Valuation Date
Fair Value
Valuation Technique
Unobservable Input
Rate
In-Process R&D
March 31, 2014
$6 million
Income Approach - Excess Earnings Method
Discount Rate
20%
Core Technology
March 31, 2014
$64 million
Income Approach - Excess Earnings Method
Discount Rate
15%

10



NOTE E – FAIR VALUE MEASUREMENTS
Derivative Instruments and Hedging Activities
We develop, manufacture and sell medical devices globally and our earnings and cash flows are exposed to market risk from changes in foreign currency exchange rates and interest rates. We address these risks through a risk management program that includes the use of derivative financial instruments, and operate the program pursuant to documented corporate risk management policies. We recognize all derivative financial instruments in our consolidated financial statements at fair value in accordance with ASC Topic 815, Derivatives and Hedging (Topic 815). In accordance with Topic 815, for those derivative instruments that are designated and qualify as hedging instruments, the hedging instrument must be designated, based upon the exposure being hedged, as a fair value hedge, cash flow hedge, or a hedge of a net investment in a foreign operation. The accounting for changes in the fair value (i.e., gains or losses) of a derivative instrument depends on whether it has been designated and qualifies as part of a hedging relationship and, further, on the type of hedging relationship. Our derivative instruments do not subject our earnings or cash flows to material risk, as gains and losses on these derivatives generally offset losses and gains on the item being hedged. We do not enter into derivative transactions for speculative purposes and we do not have any non-derivative instruments that are designated as hedging instruments pursuant to Topic 815.
Currency Hedging
We are exposed to currency risk consisting primarily of foreign currency denominated monetary assets and liabilities, forecasted foreign currency denominated intercompany and third-party transactions and net investments in certain subsidiaries. We manage our exposure to changes in foreign currency exchange rates on a consolidated basis to take advantage of offsetting transactions. We use both derivative instruments (currency forward and option contracts), and non-derivative transactions (primarily European manufacturing and distribution operations) to reduce the risk that our earnings and cash flows associated with these foreign currency denominated balances and transactions will be adversely affected by foreign currency exchange rate changes.
Designated Foreign Currency Hedges
All of our designated currency hedge contracts outstanding as of March 31, 2014 and December 31, 2013 were cash flow hedges under Topic 815 intended to protect the U.S. dollar value of our forecasted foreign currency denominated transactions. We record the effective portion of any change in the fair value of foreign currency cash flow hedges in other comprehensive income (OCI) until the related third-party transaction occurs. Once the related third-party transaction occurs, we reclassify the effective portion of any related gain or loss on the foreign currency cash flow hedge to earnings. In the event the hedged forecasted transaction does not occur, or it becomes no longer probable that it will occur, we reclassify the amount of any gain or loss on the related cash flow hedge to earnings at that time. We had currency derivative instruments designated as cash flow hedges outstanding in the contract amount of $2.736 billion as of March 31, 2014 and $2.564 billion as of December 31, 2013.
We recognized net gains of $21 million in earnings on our cash flow hedges during the first quarter of 2014, as compared to net losses of $6 million during the first quarter of 2013. All currency cash flow hedges outstanding as of March 31, 2014 mature within 36 months. As of March 31, 2014, $112 million of net gains, net of tax, were recorded in accumulated other comprehensive income (AOCI) to recognize the effective portion of the fair value of any currency derivative instruments that are, or previously were, designated as foreign currency cash flow hedges, as compared to net gains of $139 million as of December 31, 2013. As of March 31, 2014, $69 million of net gains, net of tax, may be reclassified to earnings within the next twelve months.
The success of our hedging program depends, in part, on forecasts of transaction activity in various currencies (primarily Japanese yen, Euro, British pound sterling, Australian dollar and Canadian dollar). We may experience unanticipated currency exchange gains or losses to the extent that there are differences between forecasted and actual activity during periods of currency volatility. In addition, changes in foreign currency exchange rates related to any unhedged transactions may impact our earnings and cash flows.
Non-designated Foreign Currency Contracts
We use currency forward contracts as a part of our strategy to manage exposure related to foreign currency denominated monetary assets and liabilities. These currency forward contracts are not designated as cash flow, fair value or net investment hedges under Topic 815; are marked-to-market with changes in fair value recorded to earnings; and are entered into for periods consistent with currency transaction exposures, generally less than one year. We had currency derivative instruments not designated as hedges under Topic 815 outstanding in the contract amount of $2.157 billion as of March 31, 2014 and $1.952 billion as of December 31, 2013.

11


Interest Rate Hedging
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 by converting floating-rate debt into fixed-rate debt or fixed-rate debt into floating-rate debt.
We designate these derivative instruments either as fair value or cash flow hedges under Topic 815. We record changes in the value of fair value hedges in interest expense, which is generally offset by changes in the fair value of the hedged debt obligation. Interest payments made or received related to our interest rate derivative instruments are included in interest expense. We record the effective portion of any change in the fair value of derivative instruments designated as cash flow hedges as unrealized gains or losses in OCI, net of tax, until the hedged cash flow occurs, at which point the effective portion of any gain or loss is reclassified to earnings. We record the ineffective portion of our cash flow hedges in interest expense. In the event the hedged cash flow does not occur, or it becomes no longer probable that it will occur, we reclassify the amount of any gain or loss on the related cash flow hedge to interest expense at that time.
In the fourth quarter of 2013, we entered into interest rate derivative contracts having a notional amount of $450 million to convert fixed-rate debt into floating-rate debt, which we designated as fair value hedges, and had $450 million outstanding as of March 31, 2014. We assessed at inception, and re-assess on an ongoing basis, whether the interest rate derivative contracts are highly effective in offsetting changes in the fair value of the hedged fixed-rate debt. We recognized in interest expense a $10 million loss on our hedged debt and a $10 million gain on the related interest rate derivative contract during the first quarter of 2014.
In prior years, we terminated certain interest rate derivative contracts, including fixed-to-floating interest rate contracts, designated as fair value hedges, and floating-to-fixed treasury locks, designated as cash flow hedges. We are amortizing the gains and losses on these derivative instruments upon termination into earnings as a reduction of interest expense over the remaining term of the hedged debt, in accordance with Topic 815. The carrying amount of certain of our senior notes included unamortized gains of $52 million as of March 31, 2014 and $54 million as of December 31, 2013, and unamortized losses of $2 million as of March 31, 2014 and $2 million as of December 31, 2013, related to the fixed-to-floating interest rate contracts. In addition, we had pre-tax net gains within AOCI related to terminated floating-to-fixed treasury locks of $3 million as of March 31, 2014 and $3 million as of December 31, 2013. We recorded $2 million during the first quarter of 2014 as a reduction to interest expense, resulting from the amortization of previously terminated interest rate derivative contracts. As of March 31, 2014, $9 million of pre-tax net gains may be reclassified to earnings within the next twelve months as a reduction to interest expense from amortization of our previously terminated interest rate derivative contracts.
Counterparty Credit Risk
We do not have significant concentrations of credit risk arising from our derivative financial instruments, whether from an individual counterparty or a related group of counterparties. We manage our concentration of counterparty credit risk on our derivative instruments by limiting acceptable counterparties to a diversified group of major financial institutions with investment grade credit ratings, limiting the amount of credit exposure to each counterparty, and by actively monitoring their credit ratings and outstanding fair values on an on-going basis. Furthermore, none of our derivative transactions are subject to collateral or other security arrangements and none contain provisions that are dependent on our credit ratings from any credit rating agency.
We also employ master netting arrangements that reduce our counterparty payment settlement risk on any given maturity date to the net amount of any receipts or payments due between us and the counterparty financial institution. Thus, the maximum loss due to counterparty credit risk is limited to the unrealized gains in such contracts net of any unrealized losses should any of these counterparties fail to perform as contracted. Although these protections do not eliminate concentrations of credit risk, as a result of the above considerations, we do not consider the risk of counterparty default to be significant.

12


Fair Value of Derivative Instruments
The following presents the effect of our derivative instruments designated as cash flow hedges under Topic 815 on our accompanying unaudited condensed consolidated statements of operations during the first quarter of 2014 and 2013 (in millions):
 
Amount of Pre-tax
Gain (Loss)
Recognized in OCI
(Effective Portion)
 
Amount of Pre-tax Gain (Loss) Reclassified from AOCI into Earnings
(Effective Portion)
 
Location in Statement of
Operations
Three Months Ended March 31, 2014
 
 
 
 
 
Currency hedge contracts
(21
)
 
21

 
Cost of products sold
 
$
(21
)
 
$
21

 
 
Three Months Ended March 31, 2013
 
 
 
 
 
Currency hedge contracts
$
113

 
$
(6
)
 
Cost of products sold
 
$
113

 
$
(6
)
 
 

The amount of gain (loss) recognized in earnings related to the ineffective portion of hedging relationships was de minimis for all periods presented.

Net gains and losses on currency hedge contracts not designated as hedging instruments were offset by net losses and gains from foreign currency transaction exposures, as shown in the following table:
in millions
 
 
 
Three Months Ended
 
Location in Statement of Operations
 
March 31,
 
 
2014
 
2013
Gain (loss) on currency hedge contracts
 
Other, net
 
$
21

 
$
26

Gain (loss) on foreign currency transaction exposures
 
Other, net
 
(24
)
 
(28
)
Net foreign currency gain (loss)
 
Other, net
 
$
(3
)
 
$
(2
)
Topic 815 requires all derivative 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 instruments using the framework prescribed by ASC Topic 820, Fair Value Measurements and Disclosures (Topic 820), by considering the estimated amount we would receive or pay to transfer these instruments at the reporting date and by taking into account current interest rates, foreign currency exchange rates, the creditworthiness of the counterparty for assets, and our creditworthiness for liabilities. In certain instances, we may utilize financial models to measure fair value. Generally, 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. As of March 31, 2014, we have classified all of our derivative assets and liabilities within Level 2 of the fair value hierarchy prescribed by Topic 820, as discussed below, because these observable inputs are available for substantially the full term of our derivative instruments.

13


The following are the balances of our derivative assets and liabilities as of March 31, 2014 and December 31, 2013:
 
 
As of
 
 
March 31,
 
December 31,
(in millions)
Location in Balance Sheet (1)
2014
 
2013
Derivative Assets:
 
 
 
 
Designated Hedging Instruments
 
 
 
 
Currency hedge contracts
Prepaid and other current assets
$
106

 
$
117

Currency hedge contracts
Other long-term assets
88

 
120

Interest rate contracts
Prepaid and other current assets
4

 
1

Interest rate contracts
Other long-term assets
2

 

 
 
200

 
238

Non-Designated Hedging Instruments
 
 
 
 
Currency hedge contracts
Prepaid and other current assets
21

 
27

Total Derivative Assets
 
$
221

 
$
265

 
 
 
 
 
Derivative Liabilities:
 
 
 
 
Designated Hedging Instruments
 
 
 
 
Currency hedge contracts
Other current liabilities
$
13

 
$
13

Currency hedge contracts
Other long-term liabilities
19

 
19

Interest rate contracts
Other long-term liabilities

 
8

 
 
32

 
40

Non-Designated Hedging Instruments
 
 
 
 
Currency hedge contracts
Other current liabilities
24

 
23

Total Derivative Liabilities
 
$
56

 
$
63

(1)
We classify derivative assets and liabilities as current when the remaining term of the derivative contract is one year or less.

Other Fair Value Measurements
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 available. Where quoted market prices or other observable inputs are not available, we apply valuation techniques to estimate fair value. Topic 820 establishes a three-level valuation hierarchy for disclosure of fair value measurements. The categorization of financial assets and financial liabilities 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.

14


Assets and liabilities measured at fair value on a recurring basis consist of the following as of March 31, 2014 and December 31, 2013:
 
As of March 31, 2014
 
As of December 31, 2013
(in millions)
Level 1
 
Level 2
 
Level 3
 
Total
 
Level 1
 
Level 2
 
Level 3
 
Total
Assets
 
 
 

 
 
 
 
 
 
 
 

 
 
 
 
Money market and government funds
$
29

 
$

 
$

 
$
29

 
$
38

 
$

 
$

 
$
38

Currency hedge contracts

 
215

 

 
215

 

 
264

 

 
264

Interest rate contracts

 
6

 

 
6

 

 
1

 

 
1

 
$
29

 
$
221

 
$

 
$
250

 
$
38

 
$
265

 
$

 
$
303

Liabilities
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Currency hedge contracts
$

 
$
56

 
$

 
$
56

 
$

 
$
55

 
$

 
$
55

Accrued contingent consideration

 

 
472

 
472

 

 

 
501

 
501

Interest rate contracts

 

 

 

 

 
8

 

 
8

 
$

 
$
56

 
$
472

 
$
528

 
$

 
$
63

 
$
501

 
$
564

Our investments in money market and government funds are generally 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 $29 million invested in money market and government funds as of March 31, 2014, we had $9 million in short-term time deposits and $153 million in interest bearing and non-interest bearing bank accounts. In addition to $38 million invested in money market and government funds as of December 31, 2013, we had $31 million in short-term deposits and $148 million in interest bearing and non-interest bearing bank accounts.
Our recurring fair value measurements using significant unobservable inputs (Level 3) relate solely to our contingent consideration liabilities. Refer to Note B - Acquisitions for a discussion of the changes in the fair value of our contingent consideration liabilities.

Non-Recurring Fair Value Measurements
We hold certain assets and liabilities that are measured at fair value on a non-recurring basis in periods subsequent to initial recognition. The fair value of a cost method 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. The aggregate carrying amount of our cost method investments was $26 million as of March 31, 2014 and $20 million as of December 31, 2013.
During the three months ended March 31, 2014, we recorded $55 million of losses to adjust our intangible asset balances to their fair value. During the three months ended March 31, 2013, we recorded $423 million of losses to adjust our goodwill balances to their fair value. Refer to Note D - Goodwill and Other Intangible Assets, for further information related to these charges and significant unobservable inputs (Level 3).
The fair value of our outstanding debt obligations was $4.662 billion as of March 31, 2014 and $4.602 billion as of December 31, 2013, which was determined by using primarily quoted market prices for our publicly registered senior notes, classified as Level 1 within the fair value hierarchy. Refer to Note F – Borrowings and Credit Arrangements for a discussion of our debt obligations.


15


NOTE F – BORROWINGS AND CREDIT ARRANGEMENTS
We had total debt of $4.249 billion as of March 31, 2014 and $4.240 billion as of December 31, 2013. The debt maturity schedule for the significant components of our debt obligations as of March 31, 2014 is as follows:
 
 
 
 
(in millions)
2014
 
2015
 
2016
 
2017
 
2018
 
Thereafter
 
Total
Senior notes
$

 
$
400

 
$
600

 
$
250

 
$
600

 
$
1,950

 
$
3,800

Term loan

 

 
80

 
80

 
240

 

 
400

 
$

 
$
400

 
$
680

 
$
330

 
$
840

 
$
1,950

 
$
4,200

 
Note:
The table above does not include unamortized discounts associated with our senior notes, or amounts related to interest rate contracts used to hedge the fair value of certain of our senior notes.
Revolving Credit Facility
We maintain a $2.000 billion revolving credit facility, maturing in April 2017, with a global syndicate of commercial banks. Eurodollar and multicurrency loans under this revolving credit facility bear interest at LIBOR plus an interest margin of between 0.875 percent and 1.475 percent, based on our corporate credit ratings and consolidated leverage ratio (1.275 percent as of March 31, 2014). In addition, we are required to pay a facility fee based on our credit ratings, consolidated leverage ratio, and the total amount of revolving credit commitments, regardless of usage, under the agreement (0.225 percent as of March 31, 2014). There were no amounts borrowed under our revolving credit facility as of March 31, 2014 or December 31, 2013.
Our revolving credit facility agreement in place as of March 31, 2014 requires that we maintain certain financial covenants, as follows:
 
Covenant
Requirement
 
Actual as of
March 31, 2014
Maximum leverage ratio (1)
3.5 times
 
2.4 times
Minimum interest coverage ratio (2)
3.0 times
 
5.6 times
(1)
Ratio of total debt to consolidated EBITDA, as defined by the credit agreement, for the preceding four consecutive fiscal quarters.
(2)
Ratio of consolidated EBITDA, as defined by the credit agreement, to interest expense for the preceding four consecutive fiscal quarters.
The credit agreement provides for an exclusion from the calculation of consolidated EBITDA, as defined by the agreement, through the credit agreement 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 March 31, 2014, we had $206 million of the restructuring charge exclusion remaining. In addition, any cash litigation payments (net of any cash litigation receipts), as defined by the agreement, are excluded from the calculation of consolidated EBITDA and any new debt issued to fund any tax deficiency payments is excluded from consolidated total debt, as defined in the agreement, provided that the sum of any excluded net cash litigation payments and any new debt issued to fund any tax deficiency payments shall not exceed $2.300 billion in the aggregate. As of March 31, 2014, we had approximately $2.183 billion of the combined legal and debt exclusion remaining. As of and through March 31, 2014, we were in compliance with the required covenants.
Any inability to maintain compliance with these covenants could require us to seek to renegotiate the terms of our credit facilities or seek waivers from compliance with these covenants, 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.

16


Term Loan
We had $400 million outstanding under an unsecured term loan facility as of March 31, 2014 and December 31, 2013. Term loan borrowings under this facility bear interest at LIBOR plus an interest margin of between 1.0 percent and 1.75 percent (currently 1.5 percent), based on our corporate credit ratings and consolidated leverage ratio. The term loan borrowings are payable over a five-year period, with quarterly principal payments of $20 million commencing in the first quarter of 2016 and the remaining principal amount due at the final maturity date in August 2018, and are repayable at any time without premium or penalty. Our term loan facility requires that we comply with certain covenants, including financial covenants with respect to maximum leverage and minimum interest coverage, that are consistent with our revolving credit facility. The maximum leverage ratio requirement is 3.5 times and our actual leverage ratio as of March 31, 2014 is 2.4 times. The minimum interest coverage ratio requirement is 3.0 times and our actual interest coverage ratio as of March 31, 2014 is 5.6 times.
Senior Notes
We had senior notes outstanding of $3.800 billion as of March 31, 2014 and December 31, 2013. Our senior notes are publicly registered securities, are redeemable prior to maturity and are not subject to any sinking fund requirements. Our senior notes are unsecured, unsubordinated obligations and rank on parity with each other. These notes are effectively junior to borrowings under our credit and security facility and liabilities of our subsidiaries (see Other Arrangements below).
Other Arrangements
We also maintain a $300 million credit and security facility secured by our U.S. trade receivables maturing in June 2015, subject to further extension. The credit and security facility requires that we maintain a maximum leverage covenant consistent with our revolving credit facility. The maximum leverage ratio requirement is 3.5 times and our actual leverage ratio as of March 31, 2014 is 2.4 times. We had no borrowings outstanding under this facility as of March 31, 2014 and December 31, 2013.
We have accounts receivable factoring programs in certain European countries that we account for as sales under ASC Topic 860, Transfers and Servicing. These agreements provide for the sale of accounts receivable to third parties, without recourse, of up to approximately $312 million as of March 31, 2014. We have no retained interests in the transferred receivables, other than collection and administrative responsibilities and, once sold, the accounts receivable are no longer available to satisfy creditors in the event of bankruptcy. We de-recognized $158 million of receivables as of March 31, 2014 at an average interest rate of 3.6 percent, and $146 million as of December 31, 2013 at an average interest rate of 3.3 percent. Within Italy, Spain, Portugal and Greece, the number of days our receivables are outstanding has remained above historical levels. We believe we have adequate allowances for doubtful accounts related to our Italy, Spain, Portugal and Greece accounts receivable; however, we continue to monitor the European economic environment for any collectibility issues related to our outstanding receivables. During the first quarter of 2014, we received cash payments of approximately $80 million related to a government-funded settlement of long outstanding receivables in Spain. As of March 31, 2014, our net receivables in these countries greater than 180 days past due totaled $36 million, of which $17 million were past due greater than 365 days.
In addition, we have uncommitted credit facilities with a commercial Japanese bank that provide for borrowings, promissory notes discounting and receivables factoring of up to 21.000 billion Japanese yen (approximately $203 million as of March 31, 2014). We de-recognized $144 million of notes receivable as of March 31, 2014 at an average interest rate of 1.5 percent and $147 million of notes receivable as of December 31, 2013 at an average interest rate of 1.8 percent. De-recognized accounts and notes receivable are excluded from trade accounts receivable, net in the accompanying unaudited condensed consolidated balance sheets.
As of March 31, 2014 and December 31, 2013, we had outstanding letters of credit of $78 million, which consisted primarily of bank guarantees and collateral for workers' compensation insurance arrangements. As of March 31, 2014 and December 31, 2013, none of the beneficiaries had drawn upon the letters of credit or guarantees; accordingly, we did not recognize a related liability for our outstanding letters of credit in our consolidated balance sheets as of March 31, 2014 or December 31, 2013. We believe we will generate sufficient cash from operations to fund these payments and intend to fund these payments without drawing on the letters of credit.

NOTE G – RESTRUCTURING-RELATED ACTIVITIES
On an ongoing basis, we monitor the dynamics of the economy, the healthcare industry, and the markets in which we compete. We continue to assess opportunities for improved operational effectiveness and efficiency, and better alignment of expenses with revenues, while preserving our ability to make the investments in research and development projects, capital and our people that we believe are essential to our long-term success. As a result of these assessments, we have undertaken various restructuring initiatives in order to enhance our growth potential and position us for long-term success. These initiatives are described below.

17


2014 Restructuring Plan
On October 22, 2013, the Board of Directors approved, and we committed to, a restructuring initiative (the 2014 Restructuring plan). The 2014 Restructuring plan is intended to build on the progress we have made to address financial pressures in a changing global marketplace, further strengthen our operational effectiveness and efficiency and support new growth investments. Key activities under the plan include continued implementation of our ongoing Plant Network Optimization (PNO) strategy, continued focus on driving operational efficiencies and ongoing business and commercial model changes. The PNO strategy is intended to simplify our manufacturing plant structure by transferring certain production lines among facilities. Other activities involve rationalizing organizational reporting structures to streamline various functions, eliminate bureaucracy, increase productivity and better align resources to business strategies and marketplace dynamics. These activities were initiated in the fourth quarter of 2013 and are expected to be substantially completed by the end of 2015.

We estimate that the implementation of the 2014 Restructuring plan will result in total pre-tax charges of approximately $175 million to $225 million, and approximately $160 million to $210 million of these charges is estimated to result in cash outlays, of which we have made payments of $17 million to date. We have recorded related costs of $53 million since the inception of the plan, and recorded a portion of these expenses as restructuring charges and the remaining portion through other lines within our consolidated statements of operations.

The following table provides a summary of our estimates of costs associated with the 2014 Restructuring plan by major type of cost:
Type of cost
Total estimated amount expected to
be incurred
Restructuring charges:
 
Termination benefits
$100 million to $120 million
Other (1)
$5 million to $15 million
Restructuring-related expenses:
 
Other (2)
$70 million to $90 million
 
$175 million to $225 million
(1) Consists primarily of consultant fees and costs associated with contractual cancellations.
(2) Comprised of other costs directly related to the 2014 Restructuring plan, including program management, accelerated depreciation, and costs to transfer product lines among facilities.
2011 Restructuring Plan
On July 26, 2011, our Board of Directors approved, and we committed to, a restructuring initiative (the 2011 Restructuring plan) designed to strengthen operational effectiveness and efficiencies, increase competitiveness and support new investments, thereby increasing shareholder value. Key activities under the 2011 Restructuring plan included standardizing and automating certain processes and activities; relocating select administrative and functional activities; rationalizing organizational reporting structures; leveraging preferred vendors; and other efforts to eliminate inefficiency. Among these efforts, we expanded our ability to deliver best-in-class global shared services for certain functions and divisions at several locations in emerging markets. This action was intended to enable us to grow our global commercial presence in key geographies and take advantage of many cost-reducing and productivity-enhancing opportunities. In addition, we undertook efforts to streamline various corporate functions, eliminate bureaucracy, increase productivity and better align corporate resources to our key business strategies. On January 25, 2013, our Board of Directors approved, and we committed to, an expansion of the 2011 Restructuring plan (the Expansion). The Expansion was intended to further strengthen our operational effectiveness and efficiencies and support new investments. Activities under the 2011 Restructuring plan were initiated in the third quarter of 2011 and all activities, including those related to the Expansion, were substantially completed by the end of 2013.
The 2011 Restructuring plan, including the Expansion, is estimated to result in total pre-tax charges of approximately $289 million to $292 million, and approximately $280 million to $283 million of these charges is estimated to result in cash outlays, of which we have made payments of $280 million to date. We have recorded related costs of $289 million since the inception of the plan, and recorded a portion of these expenses as restructuring charges and the remaining portion through other lines within our consolidated statements of operations.

18


The following provides a summary of our expected total costs associated with the 2011 Restructuring plan, including the Expansion, by major type of cost:
Type of cost
Total estimated amount expected to
be incurred
Restructuring charges:
 
Termination benefits
$137 million to $140 million
Other (1)
$114 million
Restructuring-related expenses:
 
Other (2)
$38 million
 
$289 million to $292 million
(1)
Includes primarily consulting fees, gains and losses on disposals of fixed assets and costs associated with contractual cancellations.
(2)
Comprised of other costs directly related to the 2011 Restructuring plan, including the Expansion, such as program management, accelerated depreciation, retention and infrastructure-related costs.
Plant Network Optimization Program
In January 2009, our Board of Directors approved, and we committed to, a Plant Network Optimization program, intended to simplify our manufacturing plant structure by transferring certain production lines among facilities and by closing certain other facilities. The program was intended to improve our overall gross profit margins. Activities under the Plant Network Optimization program were initiated in the first quarter of 2009 and were substantially completed during 2012.
The Plant Network Optimization program resulted in total pre-tax charges of $126 million, and resulted in cash outlays of $103 million. We recorded a portion of these expenses as restructuring charges and the remaining portion through cost of products sold within our unaudited condensed consolidated statements of operations.
The following provides a summary of our costs associated with the Plant Network Optimization program by major type of cost:
Type of cost
Total amount incurred
Restructuring charges:
 
Termination benefits
$30 million
 
 
Restructuring-related expenses:
 
Accelerated depreciation
$22 million
Transfer costs (1)
$74 million
 
$126 million

(1)
Consists primarily of costs to transfer product lines among facilities, including costs of transfer teams, freight, idle facility and product line validations.
In the aggregate, we recorded net restructuring charges pursuant to our restructuring plans of $20 million and $10 million in the first quarter of 2014 and 2013, respectively. During the first quarter of 2013, our other restructuring charges were partially offset by a $19 million gain recognized on the sale of our Natick, Massachusetts headquarters. In addition, we recorded expenses within other lines of our accompanying unaudited condensed consolidated statements of operations related to our restructuring initiatives of $8 million in the first quarter of 2014 and $5 million in the first quarter of 2013.

19


The following presents these costs (credits) by major type and line item within our accompanying unaudited condensed consolidated statements of operations, as well as by program:

Three Months Ended March 31, 2014
 
 
 
 
 
 
 
 
 
 
 
(in millions)
Termination
Benefits
 
Accelerated
Depreciation
 
Transfer
Costs
 
Fixed Asset
Write-offs
 
Other
 
Total
Restructuring charges
$
11

 
$

 
$

 
$

 
$
9

 
$
20

Restructuring-related expenses:
 
 
 
 
 
 
 
 
 
 
 
Cost of products sold

 

 
2

 

 

 
2

Selling, general and administrative expenses

 
1

 

 

 
5

 
6

 

 
1

 
2

 

 
5

 
8

 
$
11

 
$
1

 
$
2

 
$

 
$
14

 
$
28

 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
(in millions)
Termination
Benefits
 
Accelerated
Depreciation
 
Transfer
Costs
 
Fixed Asset
Write-offs
 
Other
 
Total
2014 Restructuring plan
$
9

 
$
1

 
$
2

 
$

 
$
11

 
$
23

2011 Restructuring plan (including the Expansion)
2

 

 

 

 
3

 
5

 
$
11

 
$
1

 
$
2

 
$

 
$
14

 
$
28

 
 
 
 
 
 
 
 
 
 
 
 
Three Months Ended March 31, 2013
 
 
 
 
 
 
 
 
 
 
 
(in millions)
Termination
Benefits
 
Accelerated
Depreciation
 
Transfer
Costs
 
Net Gain on Fixed Asset Disposals
 
Other
 
Total
Restructuring charges
$
8

 
$

 
$

 
$
(17
)
 
$
19

 
$
10

Restructuring-related expenses:
 
 
 
 
 
 
 
 
 
 
 
Cost of products sold

 

 

 

 

 

Selling, general and administrative expenses

 
1

 

 

 
4

 
5

 

 
1

 

 

 
4

 
5

 
$
8

 
$
1

 
$

 
$
(17
)
 
$
23

 
$
15

 
 
 
 
 
 
 
 
 
 
 
 
(in millions)
Termination
Benefits
 
Accelerated
Depreciation
 
Transfer
Costs
 
Net Gain on Fixed Asset Disposals
 
Other
 
Total
2011 Restructuring plan (including the Expansion)
$
10

 
$
1

 
$

 
$
(17
)
 
$
23

 
$
17

Plant Network Optimization program
(2
)
 

 

 

 

 
(2
)
 
$
8

 
$
1

 
$

 
$
(17
)
 
$
23

 
$
15

 
 
 
 
 
 
 
 
 
 
 
 
Termination benefits represent amounts incurred pursuant to our on-going benefit arrangements and amounts for “one-time” involuntary termination benefits, and have been recorded in accordance with ASC Topic 712, Compensation – Non-retirement Postemployment Benefits and ASC Topic 420, Exit or Disposal Cost Obligations (Topic 420). We expect to record additional termination benefits related to our restructuring initiatives in 2014 when we identify with more specificity the job classifications, functions and locations of the remaining head count to be eliminated. Other restructuring costs, which represent primarily consulting fees, are being recorded as incurred in accordance with Topic 420. Accelerated depreciation is being recorded over the adjusted remaining useful life of the related assets, and production line transfer costs are being recorded as incurred.

20


As of March 31, 2014, we have incurred cumulative restructuring charges related to our 2014 Restructuring plan, 2011 Restructuring plan (including the Expansion), and Plant Network Optimization program of $324 million and restructuring-related costs of $144 million since we committed to each plan. The following presents these costs by major type and by plan:
The following presents these costs by major type and by plan:
(in millions)
2014
Restructuring
plan
 
2011
Restructuring
plan (including the Expansion)
 
Plant
Network
Optimization program
 
Total
Termination benefits
$
37

 
$
138

 
$
30

 
$
205

Fixed asset write-offs

 
(1
)
 

 
(1
)
Other
7

 
113

 

 
120

Total restructuring charges
44

 
250

 
30

 
324

Accelerated depreciation
1

 
5

 
22

 
28

Transfer costs
2

 

 
74

 
76

Other
6

 
34

 

 
40

Restructuring-related expenses
9

 
39

 
96

 
144

 
$
53

 
$
289

 
$
126

 
$
468


We made cash payments of $29 million in the first quarter of 2014 associated with restructuring initiatives pursuant to these plans, and as of March 31, 2014, we had made total cash payments of $400 million related to our 2014 Restructuring plan, 2011 Restructuring plan (including the Expansion), and Plant Network Optimization program since committing to each plan. These payments were made using cash generated from operations, and are comprised of the following:
(in millions)
2014
Restructuring
plan
 
2011
Restructuring
plan (including the Expansion)
 
Plant
Network
Optimization program
 
Total
Three Months Ended March 31, 2014
 
 
 
 
 
 
 
Termination benefits
$
6

 
$
7

 
$

 
$
13

Transfer costs
2

 

 

 
2

Other
9

 
5

 

 
14

 
$
17

 
$
12

 
$

 
$
29

 
 
 
 
 
 
 
 
Program to Date
 
 
 
 
 
 
 
Termination benefits
$
6

 
$
131

 
$
30

 
$
167

Transfer costs
2

 

 
73

 
75

Other
9

 
149

 

 
158

 
$
17

 
$
280

 
$
103

 
$
400

Our restructuring liability is primarily comprised of accruals for termination benefits. The following is a rollforward of the termination benefit liability associated with our 2014 Restructuring plan and 2011 Restructuring plan (including the Expansion), which is reported as a component of accrued expenses included in our accompanying unaudited condensed balance sheets:
(in millions)
 
2014
Restructuring
plan
 
2011
Restructuring
plan (including the Expansion)
 
Total
Accrued as of December 31, 2013
 
$
29

 
$
12

 
$
41

Charges (credits)
 
9

 
2

 
11

Cash payments
 
(6
)
 
(7
)
 
(13
)
Other adjustments
 

 

 

Accrued as of March 31, 2014
 
$
32

 
$
7

 
$
39



21


In addition to our accrual for termination benefits, we had an $8 million liability as of March 31, 2014 and December 31, 2013 for other restructuring-related items.

NOTE H – SUPPLEMENTAL BALANCE SHEET INFORMATION
Components of selected captions in our accompanying unaudited condensed consolidated balance sheets are as follows:
Trade accounts receivable, net
 
 
As of
(in millions)
 
March 31, 2014
 
December 31, 2013
Accounts receivable
 
$
1,322

 
$
1,419

Less: allowance for doubtful accounts
 
(75
)
 
(81
)
Less: allowance for sales returns
 
(30
)
 
(31
)
 
 
$
1,217

 
$
1,307

The following is a rollforward of our allowance for doubtful accounts for the first quarter of 2014 and 2013:
 
 
Three Months Ended
March 31,
(in millions)
 
2014
 
2013
Beginning balance
 
$
81

 
$
88

Charges to expenses
 
(2
)
 
3

Utilization of allowances
 
(4
)
 
(5
)
Ending balance
 
$
75

 
$
86

Inventories
 
 
As of
(in millions)
 
March 31, 2014
 
December 31, 2013
Finished goods
 
$
611

 
$
598

Work-in-process
 
116

 
90

Raw materials
 
199

 
209

 
 
$
926

 
$
897

Property, plant and equipment, net
 
 
As of
(in millions)
 
March 31, 2014
 
December 31, 2013
Land
 
$
81

 
$
81

Buildings and improvements
 
919

 
917

Equipment, furniture and fixtures
 
2,492

 
2,461

Capital in progress
 
234

 
211

 
 
3,726

 
3,670

Less: accumulated depreciation
 
2,187

 
2,124

 
 
$
1,539

 
$
1,546

Depreciation expense was $65 million for the first quarter of 2014 and $61 million for the first quarter of 2013.

22


Accrued expenses
 
 
As of
(in millions)
 
March 31, 2014
 
December 31, 2013
Payroll and related liabilities
 
$
370

 
$
488

Accrued contingent consideration
 
228

 
148

Legal reserves
 
98

 
84

Other
 
579

 
628

 
 
$
1,275

 
$
1,348

Other long-term liabilities
 
 
As of
(in millions)
 
March 31, 2014
 
December 31, 2013
Accrued income taxes
 
$
1,231

 
$
1,283

Accrued contingent consideration
 
244

 
353

Legal reserves
 
498

 
523

Other long-term liabilities
 
425

 
410

 
 
$
2,398

 
$
2,569


Accrued warranties
We offer warranties on certain of our product offerings. The majority of our warranty liability as of March 31, 2014 related to implantable devices offered by our CRM business, which include defibrillator and pacemaker systems. Our CRM products come with a standard limited warranty covering the replacement of these devices. We offer a full warranty for a portion of the period post-implant, and a partial warranty over the substantial remainder of the useful life of the product. We estimate the costs that we may incur under our warranty programs based on the number of units sold, historical and anticipated rates of warranty claims and cost per claim, and record a liability equal to these estimated costs as cost of products sold at the time the product sale occurs. We reassess the adequacy of our recorded warranty liabilities on a quarterly basis and adjust these amounts as necessary. The current portion of our warranty accrual is included in other accrued expenses in the table above and the non-current portion of our warranty accrual is included in other long-term liabilities in the table above. Changes in our product warranty accrual during the first three months of 2014 and 2013 consisted of the following (in millions):
 
 
Three Months Ended
March 31,
 
 
2014
 
2013
Beginning Balance
 
$
28

 
$
26

Provision
 
4

 
4

Settlements/reversals
 
(3
)
 
(3
)
Ending Balance
 
$
29

 
$
27


NOTE I – INCOME TAXES
Our effective tax rates from continuing operations for the three months ended March 31, 2014 and March 31, 2013, were 8.9% and 10.2%, respectively. The change in our reported tax rate for the first quarter of 2014, as compared to the same period in 2013, relates primarily to the impact of certain receipts and charges that are taxed at different rates than our effective tax rate and the impact of certain discrete tax items, including intangible asset impairment charges, acquisition- and divestiture-related items, and litigation- and restructuring-related items. In addition, our reported tax rate in the first quarter of 2013 was also impacted by discrete tax items that primarily related to the reinstatement of tax legislation that was retroactively applied, offset in part by the resolution of uncertain tax positions related to audit settlements.
As of March 31, 2014, we had $1.034 billion of gross unrecognized tax benefits, of which a net $922 million, if recognized, would affect our effective tax rate. As of December 31, 2013, we had $1.069 billion of gross unrecognized tax benefits, of which a net $939 million, if recognized, would affect our effective tax rate.

23


During the three months ended March 31, 2014, we received a Revenue Agent Report from the Internal Revenue Services (IRS) reflecting significant proposed audit adjustments for our 2008, 2009 and 2010 tax years based upon the same transfer pricing methodologies that are currently being contested in U.S. Tax Court for our tax years from 2001 to 2008. As with the prior years, we disagree with the transfer pricing methodologies being applied by the IRS and we expect to contest any adjustments received through applicable IRS and judicial procedures, as appropriate. We believe that our income tax reserves associated with these matters are adequate as of March 31, 2014; however, final resolution is uncertain and could have a material impact on our financial condition, results of operations, or cash flows. During the three months ended March 31, 2014, there were no other material changes to significant unresolved matters with the IRS or foreign tax authorities from what we disclosed in our 2013 Annual Report filed on Form 10-K.
We recognize interest and penalties related to income taxes as a component of income tax expense. We had $416 million accrued for gross interest and penalties as of March 31, 2014 and $402 million as of December 31, 2013. The increase in gross interest and penalties was $14 million, recognized in our unaudited condensed consolidated statements of operations. We recognized net tax expense related to interest of $9 million during the first quarter of 2014 and $9 million during the first quarter of 2013.
It is reasonably possible that within the next 12 months we will resolve multiple issues including transfer pricing and transactional-related issues with foreign, federal and state taxing authorities, in which case we could record a reduction in our balance of unrecognized tax benefits of up to approximately $15 million.

NOTE J – COMMITMENTS AND CONTINGENCIES

The medical device market in which we primarily 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 forces 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 legal 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 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 United States 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.

We record losses for claims in excess of the limits of purchased insurance in earnings at the time and to the extent they are probable and estimable. In accordance with ASC Topic 450, Contingencies, we accrue anticipated costs of settlement, damages, losses for general 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.


24


Our accrual for legal matters that are probable and estimable was $596 million as of March 31, 2014 and $607 million as of December 31, 2013, and includes estimated costs of settlement, damages and defense. The decrease in our legal accrual was primarily due to a net $7 million credit recorded during the first quarter of 2014. During the first quarter of 2013 we recorded $130 million of litigation-related charges. 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 our debt covenants.

In management's opinion, we are not currently involved in any legal proceedings other than those disclosed in our 2013 Annual Report filed on Form 10-K 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 estimated.

Patent Litigation

On May 16, 2013, Vascular Solutions, Inc. filed suit against us, alleging that our Guidezilla™ guide extension catheter infringes three U.S. patents owned by Vascular Solutions.  The suit was filed in the U.S. District Court for the District of Minnesota seeking monetary and injunctive relief.  On May 28, 2013, Vascular Solutions filed an amended complaint adding an allegation of copyright infringement.  On June 10, 2013, Vascular Solutions filed a motion requesting a preliminary injunction.  On July 11, 2013, we answered the amended complaint and filed a counterclaim against Vascular Solutions, alleging that its Guideliner™ guide extension catheter infringes a U.S. patent owned by us. On December 12, 2013, the District Court granted the motion for a preliminary injunction and on December 26, 2013, we filed an appeal. On April 15, 2014, the Court of Appeals for the Federal Circuit vacated the preliminary injunction.

On September 23, 2013, Kardiametrics, LLC filed a complaint in the United States District Court for the District of Delaware alleging that the sale of our FilterWire EZ Embolic Protection System, Sterling balloon catheters, Carotid NexStent and Carotid WallStent products infringe two patents owned by Kardiametrics. On January 24, 2014, we filed a motion to dismiss the case or, in the alternative, to stay the case pending an arbitration. On February 18, 2014, Kardiametrics dismissed its original complaint and filed a new complaint. On March 14, 2014, we filed a motion to dismiss the new case or, in the alternative, to stay the new case pending an arbitration.

On February 18, 2014, Atlas IP, LLC filed a complaint in the United States District Court for the Southern District of Florida alleging that the sale of our LATITUDE® Patient Management System and implantable devices that communicate with the LATITUDE® device infringe a patent owned by Atlas. 

Product Liability Litigation

Fewer than ten individual lawsuits remain pending in various state and federal jurisdictions against Guidant Corporation (Guidant) alleging personal injuries associated with defibrillators or pacemakers involved in certain 2005 and 2006 product communications. Further, we are aware of approximately 30 Guidant product liability lawsuits pending in international jurisdictions associated with defibrillators or pacemakers, including devices involved in the 2005 and 2006 product communications. Six of these suits are pending in Canada and were filed as class actions, four of which are stayed pending the outcome of two lead class actions. On April 10, 2008, the Justice of Ontario Court certified a class of persons in whom defibrillators were implanted in Canada and a class of family members with derivative claims. On May 8, 2009, the Justice of Ontario Court certified a class of persons in whom pacemakers were implanted in Canada and a class of family members with derivative claims. In each case, these matters generally seek monetary damages from us. The parties in the defibrillator class action have reached an agreement in principle to settle the matter for approximately $3 million. The presiding judge verbally approved the settlement at a hearing on March 24, 2014.

As of May 7, 2014, there were over 20,000 product liability cases or claims related to transvaginal surgical mesh products designed to treat stress urinary incontinence and pelvic organ prolapse pending against us. The cases are pending in various federal and state courts in the United States and include eight putative class actions. There were also over ten cases in Canada, inclusive of three putative class actions. Additionally, as of May 7, 2014, there were three claims in the United Kingdom. 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 1,700 of the cases have been 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. In addition, in October 2012, the Attorney General for the State of California informed us that their office and certain other state attorneys general offices intended to initiate a civil investigation into our sale of transvaginal surgical mesh products.

25


During the fourth quarter of 2013, we received written discovery requests from certain state attorneys general offices. We have responded to those requests. We have established a product liability accrual for known and estimated future cases and claims asserted against us as well as 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. We intend to vigorously contest the cases and claims asserted against us; however, the final resolution is uncertain and could have a material impact on our results of operations, financial condition and/or liquidity.

Governmental Investigations and Qui Tam Matters

On May 5, 2014, we were served with a subpoena from the U.S. Department of Health and Human Services, Office of the Inspector General.  The subpoena seeks information relating to the launch of the Cognis and Teligen line of devices in 2008, the performance of those devices from 2007 to 2009, and the operation of the Physician Guided Learning Program.  We are cooperating with this request.

Other Proceedings

On October 5, 2007, Dr. Tassilo Bonzel filed a complaint against Pfizer, Inc. and our Schneider subsidiaries and us in the District Court in Kassel, Germany alleging that a 1995 license agreement related to a catheter patent is invalid under German law and seeking monetary damages. In June 2009, the District Court dismissed all but one of Dr. Bonzel's claims and in October 2009, he added new claims. We opposed the addition of the new claims. The District Court ordered Dr. Bonzel to select the claims he would pursue and in January 2011, he made that selection. A hearing was held on March 28, 2014.

On April 24, 2014, Dr. Qingsheng Zhu and Dr. Julio Spinelli, acting jointly on behalf of the stockholder representative committee of Action Medical, Inc. (Action Medical), filed a lawsuit against us and our subsidiary, Cardiac Pacemakers, Inc. (CPI), in the U.S. District Court for the District of Delaware.  The stockholder representatives allege that we and CPI breached a contractual duty to pursue development and commercialization of certain patented heart pacing methods and devices and to return certain patents.

Refer to Note I - Income Taxes for information regarding our tax litigation.

Matters Concluded Since December 31, 2013

On February 1, 2008, Wyeth Corporation (Wyeth) and Cordis Corporation filed an amended complaint for patent infringement against Abbott Laboratories, adding us and Boston Scientific Scimed, Inc. as additional defendants to the complaint. The suit alleged that the PROMUS® coronary stent system, supplied to us by Abbott, infringes three U.S. patents owned by Wyeth and licensed to Cordis. The suit was filed in the U.S. District Court for the District of New Jersey seeking monetary and injunctive relief. Wyeth and Cordis subsequently withdrew their infringement claim as to one of the patents, and the District Court found the remaining two patents invalid. Wyeth and Cordis filed an appeal and, on June 26, 2013, the Court of Appeals for the Federal Circuit affirmed the District Court’s judgment in favor of Boston Scientific. On October 13, 2013, Wyeth’s motion for rehearing or rehearing en banc was denied. The deadline for further appeals lapsed on January 13, 2014.

On May 25, 2010, G. David Jang, M.D. filed suit against Boston Scientific Scimed, Inc. and us alleging breach of contract relating to certain patent rights covering stent technology. In October 2011, the U.S. District Court for the District of Delaware entered judgment in favor of us on the pleadings. Dr. Jang filed an appeal on August 28, 2012. On September 5, 2013, the Court of Appeals for the Third Circuit vacated the ruling and remanded the case to the District Court.  On March 31, 2014, the parties entered into a confidential settlement agreement.  On April 2, 2014, the case was dismissed.

NOTE K – WEIGHTED AVERAGE SHARES OUTSTANDING
 
 
Three Months Ended
March 31,
 
(in millions)
 
2014
 
2013
 
Weighted average shares outstanding - basic
 
1,321.7

 
1,351.9

 
Net effect of common stock equivalents
 
27.5

 

*
Weighted average shares outstanding - assuming dilution
 
1,349.2

 
1,351.9

 

* We generated a net loss in the first quarter of 2013. Our weighted-average shares outstanding for earnings per share calculations
exclude common stock equivalents of 12.8 million for the first quarter of 2013 due to our net loss position in this period.

26


Weighted average shares outstanding, assuming dilution, excludes the impact of 12 million stock options for the first quarter of 2014 and 48 million stock options for the first quarter of 2013, due to the exercise prices of these stock options being greater than the average fair market value of our common stock during the period.
We issued approximately 10 million shares of our common stock in the first quarters of 2014 and eight million shares of our common stock in the first quarter of 2013, following the exercise or vesting of underlying stock options or deferred stock units, or purchases under our employee stock purchase plans. We repurchased approximately 10 million shares of our common stock during the first quarter of 2014 for approximately $125 million and 13 million shares of our common stock during the first quarter of 2013 for approximately $100 million, pursuant to our authorized repurchase programs as discussed in Note L – Stockholders' Equity to our audited financial statements contained in Item 8 of our 2013 Annual Report filed on Form 10-K.

NOTE L – SEGMENT REPORTING
Effective as of January 1, 2013, we reorganized our business from geographic regions to fully operationalized global business units. Following the reorganization, based on information regularly reviewed by our chief operating decision maker, we have three reportable segments comprised of: Cardiovascular, Rhythm Management, and MedSurg. Our reportable segments represent an aggregate of operating segments.
Each of our reportable segments generates revenues from the sale of medical devices. We measure and evaluate our reportable segments based on segment net sales and operating income, excluding the impact of changes in foreign currency and sales from divested businesses. Sales generated from reportable segments and divested businesses, as well as operating results of reportable segments and corporate expenses, are based on internally-derived standard currency exchange rates, which may differ from year to year, and do not include intersegment profits. We restated segment information for the prior period based on standard currency exchange rates used for the current period in order to remove the impact of foreign currency exchange fluctuation and for the realignment of certain product lines from Endoscopy to Peripheral Interventions as of January 1, 2014. We exclude from segment operating income certain corporate-related expenses and certain transactions or adjustments that our chief operating decision maker considers to be non-recurring and/or non-operational, such as amounts related to goodwill and other intangible asset impairment charges; acquisition-, divestiture-, restructuring- and litigation-related charges and credits; and amortization expense. Although we exclude these amounts from segment operating income, they are included in reported consolidated operating income (loss) and are included in the reconciliation below.

27


A reconciliation of the totals reported for the reportable segments to the applicable line items in our accompanying unaudited condensed consolidated statements of operations is as follows:
 
 
Three Months Ended
March 31,
 
(in millions)
 
2014
 
2013
 
 
 
 
 
(restated)
 
Net sales
 
 
 
 
 
   Interventional Cardiology
 
$
501

 
$
498

 
   Peripheral Interventions
 
204

 
193

 
Cardiovascular
 
705

 
691

 
 
 
 
 
 
 
   Cardiac Rhythm Management
 
464

 
475

 
   Electrophysiology
 
58

 
34

 
Rhythm Management
 
522

 
509

 
 
 
 
 
 
 
   Endoscopy
 
316

 
300

 
   Urology and Women's Health
 
126

 
117

 
   Neuromodulation
 
109

 
89

 
MedSurg
 
551

 
506

 
Net sales allocated to reportable segments
 
1,778

 
1,706

 
Sales generated from divested businesses
 
2

 
36

 
Impact of foreign currency fluctuations
 
(6
)
 
19

 
 
 
$
1,774

 
$
1,761

 
 
 
 
 
 
 
Income (loss) before income taxes
 
 
 
 
 
Cardiovascular
 
$
171

 
$
158

 
Rhythm Management
 
66

 
57

 
MedSurg
 
168

 
140

 
Operating income allocated to reportable segments
 
405

 
355

 
Corporate expenses and currency exchange
 
(50
)
 
(42
)
 
Goodwill and other intangible asset impairment charges; and acquisition-, divestiture-, restructuring-, and litigation related charges or credits
 
(49
)
 
(540
)
 
Amortization expense
 
(109
)
 
(103
)
 
Operating income (loss)
 
197

 
(330
)
 
Other expense, net
 
(51
)
 
(64
)
 
Income (loss) before income taxes
 
$
146

 
$
(394
)
 


28


NOTE M – CHANGES IN OTHER COMPREHENSIVE INCOME

The following table provides the reclassifications out of other comprehensive income for the three months ended March 31, 2014 and March 31, 2013. Amounts in the chart below are presented net of tax.
Three Months Ended March 31, 2014
 
 
 
 
 
 
 
 
(in millions)
 
Foreign currency translation adjustments
 
Unrealized gains/losses on derivative financial instruments
 
Defined benefit pension items / Other
 
Total
Balance as of December 31, 2013
 
$(16)
 
$141
 
$(19)
 
$106
Other comprehensive income (loss) before reclassifications
 
(6)
 
(14)
 
(1)
 
(21)
Amounts reclassified from accumulated other comprehensive income
 
 
(13)
 
 
(13)
Net current-period other comprehensive income
 
(6)
 
(27)
 
(1)
 
(34)
Balance as of March 31, 2014
 
$(22)
 
$114
 
$(20)
 
$72
 
 
 
 
 
 
 
 
 
Three Months Ended March 31, 2013
 
 
 
 
 
 
 
 
(in millions)
 
Foreign currency translation adjustments
 
Unrealized gains/losses on derivative financial instruments
 
Defined benefit pension items / Other
 
Total
Balance as of December 31, 2012
 
$(26)
 
$34
 
$(41)
 
$(33)
Other comprehensive income (loss) before reclassifications
 
3
 
71
 
 
74
Amounts reclassified from accumulated other comprehensive income
 
 
4
 
 
4
Net current-period other comprehensive income
 
3
 
75
 
 
78
Balance as of March 31, 2013
 
$(23)
 
$109
 
$(41)
 
$45
The income tax impact of the amounts in other comprehensive income for unrealized gains/losses on derivative financial instruments before reclassifications was a benefit of $7 million in the first quarter of 2014 and an expense of $43 million in the first quarter of 2013. The gains and losses on derivative financial instruments reclassified were reduced by income tax impacts of $8 million in the first quarter of 2014 and $2 million in the first quarter of 2013. Refer to Note E – Fair Value Measurements for further detail on the reclassifications related to derivatives.

NOTE N – NEW ACCOUNTING PRONOUNCEMENTS
Standards Implemented
ASC Update No. 2013-11
In July 2013, the FASB issued ASC Update No. 2013-11, Income Taxes (Topic 740): Presentation of an Unrecognized Tax Benefit When a Net Operating Loss Carryforward, a Similar Tax Loss, or a Tax Credit Carryforward Exists. Update No. 2013-11 requires that entities present an unrecognized tax benefit, or portion of an unrecognized tax benefit, as a reduction to a deferred tax asset in the financial statements for a net operating loss carryforward, a similar tax loss, or a tax credit carryforward, with certain exceptions. We were required to adopt Update No. 2013-11 for our first quarter ending March 31, 2014. Update No. 2013-11 is related to presentation only and its adoption did not impact our results of operations or financial position.

29


Standards to be Implemented
ASC Update No. 2014-08
In April 2014, the FASB issued ASC Update No. 2014-08, Presentation of Financial Statements (Topic 205) and Property, Plant, and Equipment (Topic 360): Reporting Discontinued Operations and Disclosures of Disposals of Components of an Entity. Update No. 2014-08 changed the criteria for reporting discontinued operations and enhancing convergence of the FASB's and the International Accounting Standard Board's (IASB) reporting requirements for discontinued operations. We are required to apply this amendment, prospectively to: (1) all disposals (or classifications as held for sale) of components of an entity that occur within annual periods beginning on or after December 15, 2014 and interim periods within those years and (2) all businesses or nonprofit activities that, on acquisition, are classified as held for sale that occur within annual periods beginning on or after December 15, 2014 and interim periods within those years.

30


ITEM 2.
MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
Introduction
Boston Scientific Corporation is a worldwide 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 heart, digestive, pulmonary, vascular, urological, women's health, and chronic pain conditions. We continue to innovate in these areas and are intent on extending our innovations into new geographies and high-growth adjacency markets.
Financial Summary
Our net sales for the first quarter of 2014 were $1.774 billion, as compared to net sales of $1.761 billion for the first quarter of 2013, an increase of $13 million, or one percent. Excluding the impact of changes in foreign currency exchange rates, which had a $25 million negative impact on our first quarter 2014 net sales as compared to the same period in the prior year, and the change in net sales from divested businesses of $34 million, our net sales increased $72 million, or four percent.1 Refer to Quarterly Results and Business Overview for a discussion of our net sales by global business.
Our reported net income for the first quarter of 2014 was $133 million, or $0.10 per share. Our reported results for the first quarter of 2014 included an intangible asset impairment charge, acquisition- and divestiture-related net credits, litigation-related credits, restructuring-related charges, discrete tax items, and amortization expense totaling $135 million (after-tax), or $0.10 per share. Excluding these items, net income for the first quarter of 2014 was $268 million, or $0.20 per share.1 Our reported net loss for the first quarter of 2013 was $354 million, or $0.26 per share, driven primarily by a goodwill impairment charge related to our global Cardiac Rhythm Management (CRM) business unit. Our reported results for the first quarter of 2013 included a goodwill impairment charge, acquisition- and divestiture-related net credits, restructuring- and litigation-related charges, and amortization expense totaling $578 million (after-tax), or $0.42 per share. Excluding these items, net income for the first quarter of 2013 was $224 million, or $0.16 per share.1 














1 Sales growth rates that exclude the impact of sales from divested businesses and/or changes in foreign currency exchange rates and net income and net income per share excluding certain items required by GAAP are not prepared in accordance with U.S. GAAP. Refer to Additional Information for a discussion of management’s use of these non-GAAP financial measures.

31


The following is a reconciliation of results of operations prepared in accordance with U.S. GAAP to those adjusted results considered by management. Refer to Quarterly Results and Business Overview for a discussion of each reconciling item:
 
 
Three Months Ended March 31, 2014
 
 
 
 
 
Tax
 
 
 
Impact per
 
in millions, except per share data
 
Pre-Tax
 
Impact
 
After-Tax
 
share
 
GAAP net income (loss)
 
$
146

 
$
(13
)
 
$
133

 
$
0.10

 
Non-GAAP adjustments:
 
 
 
 
 
 
 
 
 
Intangible asset impairment charge
 
55

 
(6
)
 
49

 
0.04

 
Acquisition- and divestiture-related net credits
 
(27
)
 
(1
)
 
(28
)
 
(0.02
)
 
Restructuring and restructuring-related net charges
 
28

 
(7
)
 
21

 
0.01

 
Discrete tax items
 

 
2

 
2

 
0.00

 
Litigation-related credits
 
(7
)
 
1

 
(6
)
 
0.00

 
Amortization expense
 
109

 
(12
)
 
97

 
0.07

 
Adjusted net income
 
$
304

 
$
(36
)
 
$
268

 
$
0.20

 
 
 
 
 
 
 
 
 
 
 

 
 
Three Months Ended March 31, 2013
 
 
 
 
 
Tax
 
 
 
Impact per
 
in millions, except per share