10-Q 1 q12018form10-q.htm 10-Q Q1 2018 Document

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, 2018
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.)
300 BOSTON SCIENTIFIC WAY, MARLBOROUGH, MASSACHUSETTS 01752-1234
(Address of principal executive offices) (zip code)
(508) 683-4000
(Registrant’s telephone number, including area code)
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, smaller reporting company, or an emerging growth company. See the definitions of “large accelerated filer,” “accelerated filer,” “smaller reporting company,” and "emerging growth company" in Rule 12b-2 of the Exchange Act.
Large accelerated filer þ
Accelerated filer o
Non-Accelerated filer o (Do not check if a smaller reporting company)
Smaller reporting company o
 
Emerging growth company o
If an emerging growth company, indicate by check mark if the registrant has elected not to use the extended transition period for complying with any new or revised financial accounting standards provided pursuant to Section 13(a) of the Exchange Act. o
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 25, 2018
Common Stock, $0.01 par value
 
1,379,810,502


TABLE OF CONTENTS

 
 
Page No.
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 

2

PART I
FINANCIAL INFORMATION

ITEM 1. CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

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

 
Three Months Ended
March 31,
in millions, except per share data
2018
 
2017
 
 
 
 
Net sales
$
2,379

 
$
2,160

Cost of products sold
672

 
650

Gross profit
1,707

 
1,510

 
 
 
 
Operating expenses:
 
 
 
Selling, general and administrative expenses
860

 
794

Research and development expenses
261

 
235

Royalty expense
18

 
17

Amortization expense
141

 
143

Intangible asset impairment charges
1

 
—

Contingent consideration expense (benefit)
5

 
(50
)
Restructuring charges (credits)
13

 
4

Litigation-related net charges (credits)
—

 
3

 
1,300

 
1,146

Operating income (loss)
407

 
364

 
 
 
 
Other income (expense):
 
 
 
Interest expense
(61
)
 
(57
)
Other, net
(23
)
 
(2
)
Income (loss) before income taxes
323

 
305

Income tax expense (benefit)
26

 
15

Net income (loss)
$
298

 
$
290

 
 
 
 
Net income (loss) per common share — basic
$
0.22

 
$
0.21

Net income (loss) per common share — assuming dilution
$
0.21

 
$
0.21

 
 
 
 
Weighted-average shares outstanding
 
 
 
Basic
1,376.5

 
1,365.4

Assuming dilution
1,396.8

 
1,390.2







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)
2018
 
2017
Net income (loss)
$
298

 
$
290

Other comprehensive income (loss), net of tax:
 
 
 
Foreign currency translation adjustment
10

 
8

Net change in derivative financial instruments
(80
)
 
(55
)
Total other comprehensive income (loss)
(69
)
 
(47
)
Total comprehensive income (loss)
$
228

 
$
243











































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
2018
 
2017
 
(unaudited)
 
 
ASSETS
 
 
 
Current assets:
 
 
 
Cash and cash equivalents
$
287

 
$
188

Trade accounts receivable, net
1,580

 
1,548

Inventories
1,113

 
1,078

Prepaid income taxes
50

 
66

Other current assets
1,048

 
942

Total current assets
4,080

 
3,822

Property, plant and equipment, net
1,700

 
1,697

Goodwill
6,984

 
6,998

Other intangible assets, net
5,713

 
5,837

Other long-term assets
725

 
688

TOTAL ASSETS
$
19,202

 
$
19,042

 
 
 
 
LIABILITIES AND STOCKHOLDERS’ EQUITY
 
 
 
Current liabilities:
 
 
 
Current debt obligations
$
962

 
$
1,801

Accounts payable
404

 
530

Accrued expenses
2,447

 
2,456

Other current liabilities
1,174

 
867

Total current liabilities
4,988

 
5,654

Long-term debt
4,803

 
3,815

Deferred income taxes
128

 
191

Other long-term liabilities
2,254

 
2,370

 
 
 
 
Commitments and contingencies

 

 
 
 
 
Stockholders’ equity
 
 
 
Preferred stock, $0.01 par value - authorized 50,000,000 shares,
none issued and outstanding


 


Common stock, $0.01 par value - authorized 2,000,000,000 shares -
issued 1,627,188,009 shares as of March 31, 2018 and
1,621,062,898 shares as of December 31, 2017
16

 
16

Treasury stock, at cost - 247,566,270 shares as of March 31, 2018
and December 31, 2017
(1,717
)
 
(1,717
)
Additional paid-in capital
17,184

 
17,161

Accumulated deficit
(8,326
)
 
(8,390
)
Accumulated other comprehensive income (loss), net of tax
(128
)
 
(59
)
Total stockholders’ equity
7,030

 
7,012

TOTAL LIABILITIES AND STOCKHOLDERS' EQUITY
$
19,202

 
$
19,042



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)
2018
 
2017
 
 
 
(restated)†
Cash provided by (used for) operating activities
$
193

 
$
(7
)
 
 
 
 
Investing activities:
 
 
 
Purchases of property, plant and equipment
(60
)
 
(112
)
Payments for acquisitions of businesses, net of cash acquired
(9
)
 
—

Payments for investments and acquisitions of certain technologies
(103
)
 
(28
)
Cash provided by (used for) investing activities
(173
)
 
(140
)
 
 
 
 
Financing activities:
 
 
 
Payment of contingent consideration amounts previously established in purchase accounting
—

 
(18
)
Payments on long-term borrowings
(602
)
 
(250
)
Proceeds from long-term borrowings, net of debt issuance and extinguishment costs
990

 
—

Net increase (decrease) in commercial paper
(316
)
 
—

Proceeds from borrowings on credit facilities
70

 
1,016

Payments on borrowings from credit facilities
—

 
(735
)
Cash used to net share settle employee equity awards
(50
)
 
(61
)
Proceeds from issuances of shares of common stock
38

 
33

Cash provided by (used for) financing activities
130

 
(15
)
 
 
 
 
Effect of foreign exchange rates on cash
1

 
1

 
 
 
 
Net increase (decrease) in cash, cash equivalents, restricted cash and restricted cash equivalents
151

 
(161
)
Cash, cash equivalents, restricted cash and restricted cash equivalents at beginning of period
1,017

 
487

Cash, cash equivalents, restricted cash and restricted cash equivalents at end of period
$
1,168

 
$
327

 
 
 
 
Supplemental Information
 
 
 
Stock-based compensation expense
$
36

 
$
30


†Certain prior year balances related to restricted cash have been reclassified to reflect our adoption of Financial Accounting Standards Board (FASB) Accounting Standards Codification (ASC) Update No. 2016-18, Statement of Cash Flows (Topic 230) - Restricted Cash in the fourth quarter of 2017. Please refer to our most recent annual report on Form 10-K for additional details.














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, 2018 are not necessarily indicative of the results that may be expected for the year ending December 31, 2018. For further information, refer to the consolidated financial statements and footnotes thereto included in Item 8 of our most recent Annual Report on Form 10-K.

Amounts reported in millions within this report are computed based on the amounts in thousands. As a result, the sum of the components reported in millions may not equal the total amount reported in millions due to rounding. Certain columns and rows within tables may not add due to the use of rounded numbers. Percentages presented are calculated from the underlying numbers in dollars. Prior year balances were subject to rounding.

Revision of Reportable Segments

Effective January 1, 2018, following organizational changes to align the company's business and organization structure focused on active implantable devices, we revised our reportable segments, in accordance with FASB ASC Topic 280, Segment Reporting. The revision reflects a reclassification of our Neuromodulation business from our Medical Surgical (MedSurg) segment to our newly created Rhythm and Neuro segment. We have revised prior year amounts to conform to the current year’s presentation (as denoted with an asterisk throughout *). There was no revision to operating segments or reporting units as a result of the organizational change. See Note C – Goodwill and Other Intangible Assets and Note K – Segment Reporting for further details.

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 months ended March 31, 2018. Those items requiring disclosure (unrecognized subsequent events) in the financial statements have been disclosed accordingly. Refer to Note B – Acquisitions and Strategic Investments and Note I – Commitments and Contingencies for more information.

Accounting Standards Implemented Since December 31, 2017

ASC Update No. 2014-09

In May 2014, the FASB issued ASC Update No. 2014-09, Revenue from Contracts with Customers (Topic 606), which was subsequently updated. We adopted the standard as of January 1, 2018, using the modified retrospective method. Under this method, we applied FASB ASC Topic 606 to contracts that were not complete as of January 1, 2018 and recognized the cumulative effect of initially applying the standard as an adjustment to the opening balance of retained earnings. Results for reporting periods beginning after January 1, 2018 are presented in accordance with FASB ASC Topic 606. Prior period amounts are not adjusted and are reported in accordance with legacy GAAP requirements in FASB ASC Topic 605, Revenue Recognition.

Due to the adoption of FASB ASC Topic 606, we recorded a net reduction to opening retained earnings of $177 million on January 1, 2018, primarily related to cost of providing non-contractual post-implant support to certain customers, which we deemed immaterial in the context of the arrangement. Upon the adoption of FASB ASC Topic 606, when we sell a device with an implied non-contractual post-implant support obligation, we forward accrue the cost of the service within Selling, general and administrative expenses and recognize it at the point in time the associated revenue is earned. We release the accrual over the related service period. These costs were previously expensed as incurred due to such service obligation being non-contractual.

The impact of adopting FASB ASC Topic 606 on our unaudited condensed consolidated balance sheets as of March 31, 2018, resulted in an increase in Other current liabilities of $59 million and an increase in Other long-term liabilities of $206 million, as a result of accruing for our post-implant support obligation. We also recorded deferred tax assets primarily related to post-implant support, resulting in an increase in Other long-term assets of $12 million and a reduction in Deferred income taxes of

7

$41 million. The remaining impact of adopting FASB ASC Topic 606 was not material to our financial position or results of operations.

Refer to Note L – Revenue for additional details.

ASC Update No. 2016-01

In January 2016, the FASB issued ASC Update No. 2016-01, Financial Instruments - Overall (Subtopic 825-10): Recognition and Measurement of Financial Assets and Financial Liabilities. The purpose of Update No. 2016-01 is to improve financial reporting for financial instruments by reducing the number of items recorded to other comprehensive income. We adopted Update No. 2016-01 in the first quarter of 2018, using both the modified retrospective and prospective methods. For publicly-held securities, we used the modified retrospective approach. Unrealized gains and losses previously recorded to other comprehensive income were reclassified to retained earnings and all future fair value changes will be recorded to net income. For privately-held securities, we elected the measurement alternative approach which is applied prospectively upon adoption. This approach requires entities to measure their investments at cost minus impairment, if any, plus or minus changes resulting from observable price changes in orderly transactions for the identical or a similar investment of the same issuer. The adoption of the standard did not have a material impact on our financial position or results of operations. The actual impact to future periods resulting from fair value changes of our equity investments is difficult to predict as it will depend on their future performance.

ASC Update No. 2016-16

In October 2016, the FASB issued ASC Update No. 2016-16, Income Taxes (Topic 740): Intra-Entity Transfers of Assets Other Than Inventory. The purpose of Update No. 2016-16 is to allow an entity to recognize the income tax consequences of an intra-entity transfer of an asset other than inventory when the transfer occurs, as opposed to waiting until the asset is sold to a third party, or impaired. Update No. 2016-16 was effective for annual periods beginning after December 15, 2017, including interim periods within those annual periods. We adopted Update No. 2016-16 prospectively in the first quarter of 2018 and recognized a net reduction to opening retained earnings of $55 million for income tax consequences not previously recognized for intra-entity transfers of assets other than inventories. All future income tax consequences of intra-entity transfers of assets other than inventories will be recognized through income tax expense.

ASC Update No. 2017-12

In August 2017, the FASB issued ASC Update No. 2017-12, Derivatives and Hedging (Topic 815): Targeted Improvements to Accounting for Hedging Activities. The purpose of Update No. 2017-12 is to simplify the application of hedge accounting and better align financial reporting of hedging relationships with risk management objectives. Update No. 2017-12 was effective for annual periods beginning after December 15, 2018, including interim periods within those annual periods. We early adopted Update No. 2017-12 in the first quarter of 2018. The adoption of the standard had no impact on our financial position or results of operations.

NOTE B – ACQUISITIONS AND STRATEGIC INVESTMENTS

We did not close any material acquisitions during the first quarter of 2018 or 2017.

On April 30, 2018, we announced the closing of our acquisition of NxThera, Inc. (NxThera), a privately-held company based in Maple Grove, Minnesota. NxThera developed the Rezûm® System, a minimally invasive therapy in a growing category of treatment options for patients with benign prostatic hyperplasia (BPH). The transaction consists of an upfront cash payment of $306 million, and up to an additional $100 million in potential commercial milestone payments over the next four years. We have an existing minority investment in NxThera which is expected to result in a net upfront payment of approximately $240 million upon closing, and milestone payments of up to $85 million. NxThera will be integrated into our Urology and Pelvic Health business.

On April 16, 2018, we announced the closing of our acquisition of nVision Medical Corporation (nVision), a privately-held company focused on women’s health. nVision developed the first and only device cleared by the U.S. Food and Drug Administration (FDA) to collect cells from the fallopian tubes, offering a potential platform for earlier diagnosis of ovarian cancer. The transaction consists of an upfront cash payment of $150 million, and up to an additional $125 million in potential clinical and commercial milestones over four years. nVision will be integrated into our Urology and Pelvic Health business.


8

Contingent Consideration

We recorded a net expense related to the changes in fair value of our contingent consideration liabilities of $5 million during the first quarter of 2018 and a net benefit related to the changes in fair value of our contingent consideration liabilities of $50 million during the first quarter of 2017. We made $28 million of contingent payments during the first quarter of 2017.

Changes in the fair value of our contingent consideration liabilities were as follows (in millions):
Balance as of December 31, 2017
$
169

Amounts recorded related to prior acquisitions
(22
)
Fair value adjustment
5

Balance as of March 31, 2018
$
152


As of March 31, 2018, the maximum amount of future contingent consideration (undiscounted) that we could be required to pay was approximately $1.320 billion.

The recurring Level 3 fair value measurements of our contingent consideration liabilities include the following significant unobservable inputs:
Contingent Consideration Liabilities
Fair Value as of March 31, 2018
Valuation Technique
Unobservable Input
Range
R&D and Commercialization-based Milestones
$105 million
Discounted Cash Flow
Discount Rate
3%
Probability of Payment
17% - 100%
Projected Year of Payment
2018 - 2022
Revenue-based Payments
$48 million
Discounted Cash Flow
Discount Rate
11% - 15%
Projected Year of Payment
2018 - 2026

Projected contingent payment amounts related to some of our R&D, commercialization-based and revenue-based milestones are discounted back to the current period using a discounted cash flow (DCF) model. 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 together, or in isolation, may result in a significantly lower or higher fair value measurement.

Strategic Investments

On January 24, 2018, we closed an investment and entered into an acquisition option agreement with Millipede, Inc. (Millipede), a privately-held company that has developed the IRIS Transcatheter Annuloplasty Ring System for the treatment of severe mitral regurgitation. Under the terms of the agreements, we have purchased a portion of the outstanding shares of Millipede along with newly issued shares of the company for a total consideration of $90 million. We also have the option to acquire the remaining shares of the company at any time prior to the completion of a first in human clinical study that meets certain parameters. Upon the completion of the clinical study, Millipede has the option to compel us to acquire the remaining shares of the company. Each company’s option period expires by the end of 2019. Completion of this acquisition would result in an additional $325 million payment by us at closing with a further $125 million becoming payable upon achievement of a commercial milestone.

The aggregate carrying amount of our strategic investments were comprised of the following categories:


 
As of
(in millions)
 
March 31, 2018
 
December 31, 2017
Equity method investments
 
$
304

 
$
209

Measurement alternative investments
 
84

 
81

Publicly-held securities
 
12

 
15

Notes receivable
 
43

 
47

 
 
$
442

 
$
353



9

These investments are classified as other long-term assets within our accompanying unaudited condensed consolidated balance sheets, in accordance with U.S. GAAP and our accounting policies.

As of March 31, 2018, the book value of our equity method investments exceeded our share of the book value of the investees’ underlying net assets by approximately $335 million, which represents amortizable intangible assets and in-process research and development, corresponding deferred tax liabilities and goodwill.

NOTE C – GOODWILL AND OTHER INTANGIBLE ASSETS

The gross carrying amount of goodwill and other intangible assets and the related accumulated amortization for intangible assets subject to amortization and accumulated write-offs of goodwill are as follows:
 
As of March 31, 2018
 
As of December 31, 2017
(in millions)
Gross Carrying
Amount
 
Accumulated
Amortization/
Write-offs
 
Gross Carrying
Amount
 
Accumulated
Amortization/
Write-offs
Amortizable intangible assets
 
 
 
 
 
 
 
Technology-related
$
9,396

 
$
(4,984
)
 
$
9,386

 
$
(4,880
)
Patents
517

 
(381
)
 
517

 
(379
)
Other intangible assets
1,636

 
(868
)
 
1,633

 
(838
)
 
$
11,549

 
$
(6,233
)
 
$
11,536

 
$
(6,097
)
Unamortizable intangible assets
 
 
 
 
 
 
 
Goodwill
$
16,884

 
$
(9,900
)
 
$
16,898

 
$
(9,900
)
In-process research and development (IPR&D)
278

 
—

 
278

 
—

Technology-related
120

 
—

 
120

 
—

 
$
17,281

 
$
(9,900
)
 
$
17,295

 
$
(9,900
)

The following represents our goodwill balance by global reportable segment:
(in millions)
MedSurg*
 
Rhythm and Neuro*
 
Cardiovascular
 
Total
Balance as of December 31, 2017
$
2,877

 
$
417

 
$
3,704

 
$
6,998

Impact of reportable segment revisions
(1,379
)
 
1,379

 
—

 
—

Impact of foreign currency fluctuations and other changes in carrying amount
1

 
(22
)
 
3

 
(17
)
Goodwill acquired
3

 
—

 
—

 
3

Balance as of March 31, 2018
$
1,503

 
$
1,774

 
$
3,707

 
$
6,984


We did not have any goodwill impairments in the three months ended March 31, 2018 or 2017. 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 impairment may exist. We assess goodwill for impairment at the reporting unit level, which is defined as an operating segment or one level below an operating segment, referred to as a component. We have seven reporting units: Endoscopy, Urology and Pelvic Health, Cardiac Rhythm Management, Electrophysiology, Neuromodulation, Interventional Cardiology and Peripheral Interventions. As such, the first quarter change in our reportable segments, where Neuromodulation was reclassified from our MedSurg segment to our newly created Rhythm and Neuro segment did not trigger a goodwill impairment assessment or impact our total goodwill carrying value.

NOTE D – HEDGING ACTIVITIES AND FAIR VALUE MEASUREMENTS

Derivative Instruments and Hedging Activities

We address market risk from changes in foreign currency exchange rates and interest rates through risk management programs which include the use of derivative financial instruments. We operate these programs pursuant to documented corporate risk management policies and do not enter into derivative transactions for speculative purposes. Our derivative instruments do not subject our earnings or cash flows to material risk, as the gains or losses on these derivatives generally offset losses or gains recognized on the hedged item.


10

We manage concentration of counterparty credit risk by limiting acceptable counterparties to major financial institutions with investment grade credit ratings, limiting the amount of credit exposure to individual counterparties and by actively monitoring counterparty credit ratings and the amount of individual credit exposure. We also employ master netting arrangements that limit the risk of counterparty non-payment on a particular settlement date to the net gain that would have otherwise been received from the counterparty. Although not completely eliminated, we do not consider the risk of counterparty default to be significant as a result of these protections. Further, none of our derivative instruments are subject to collateral or other security arrangements, nor do they contain provisions that are dependent on our credit ratings from any credit rating agency.
Our risk from changes in currency exchange rates consists primarily of monetary assets and liabilities, forecast intercompany and third-party transactions and net investments in certain subsidiaries. We manage currency exchange rate risk at a consolidated level to reduce the cost of hedging by taking advantage of offsetting transactions. We employ derivative instruments, primarily forward currency contracts, to reduce the risk to our earnings and cash flows associated with changes in currency exchange rates.

The success of our currency risk management program depends, in part, on forecast transactions denominated primarily in British pound sterling, Euro and Japanese yen. We may experience unanticipated currency exchange gains or losses to the extent the actual activity is different than forecast. In addition, changes in currency exchange rates related to any unhedged transactions may impact our earnings and cash flows.

Certain of our currency derivative instruments are designated as cash flow hedges under FASB ASC Topic 815, Derivatives and Hedging and are intended to protect the U.S. dollar value of forecasted transactions. The gain or loss on a derivative instrument designated as a cash flow hedge is recorded in other comprehensive income (OCI) and is included in the Accumulated other comprehensive income (loss), net of tax (AOCI) caption of our unaudited condensed consolidated balance sheets until the underlying third-party transaction occurs. When the related third-party transaction occurs we recognize the gain or loss to earnings within the Cost of products sold caption of our unaudited condensed consolidated statements of operations. In the event the hedging relationship is no longer effective, or if the hedged forecast transaction becomes no longer probable of occurring, we reclassify the amount of gains or losses on the derivative instrument designated as a cash flow hedge to earnings at that time.

We also use forward currency contracts that are not part of designated hedging relationships under FASB ASC Topic 815 as a part of our strategy to manage our exposure to currency exchange rate risk related to monetary assets and liabilities and related forecast transactions. These non-designated currency forward contracts have an original time to maturity consistent with the hedged currency transaction exposures, generally less than one year, and are marked-to-market with changes in fair value recorded to earnings and reflected within the Other, net caption of our unaudited condensed consolidated statements of operations.

Our interest rate risk relates primarily to U.S. dollar borrowings partially offset by U.S. dollar cash investments. We use interest rate derivative instruments to manage our earnings and cash flow exposure to changes in interest rates. Under these agreements we and the counterparty, at specified intervals, exchange the difference between fixed and floating interest amounts calculated by reference to an agreed-upon notional principal amount. We designate these derivative instruments either as fair value or cash flow hedges under FASB ASC Topic 815.

The changes in the fair value of interest rate derivatives designated as fair value hedges and the changes in the fair value of the underlying hedged debt instrument generally offset and are recorded within the Interest expense caption of our unaudited condensed consolidated statements of operations. We record the changes in the fair value of interest rate derivatives designated as cash flow hedges within OCI and is included within the AOCI caption of our unaudited condensed consolidated balance sheets until the underlying hedged transaction occurs, at which time we recognize the gain or loss within Interest expense. In the event the hedging relationship is no longer effective, or if the hedged forecast transaction becomes no longer probable of occurring, we reclassify the amount of gains or losses on the interest rate derivative designated as a cash flow hedge to earnings at that time.

We are amortizing the realized gains or losses from interest rate derivative instruments previously designated as fair value or cash flow hedges into earnings as a component of Interest expense over the remaining term of the hedged item in accordance with FASB ASC Topic 815, so long as the hedge relationship remains effective. Prior to the adoption of ASC Update No. 2017-12, Derivatives and Hedging (Topic 815), the ineffective portion, if any, of our interest rate derivatives designated as either fair value or cash flow hedges was recognized in earnings in the period in which the hedging relationship exhibited ineffectiveness.


11

The following table presents the contractual amounts of our derivative instruments outstanding:
(in millions)
FASB ASC Topic 815 Designation
As of
March 31, 2018
 
December 31, 2017
Forward currency contracts
Cash flow hedge
$
3,595

 
$
3,252

Forward currency contracts
Non-designated
2,565

 
2,671

Total Notional Outstanding
 
$
6,161

 
$
5,923


The remaining time to maturity as of March 31, 2018 is within 60 months for all designated forward currency contracts and generally less than one year for all non-designated forward currency contracts.

We had no interest rate derivative instruments outstanding as of March 31, 2018 and December 31, 2017.

The following presents the effect of our derivative instruments designated as cash flow hedges under FASB ASC Topic 815 on our accompanying unaudited condensed consolidated statements of operations:
(in millions)
 
Location in Unaudited Condensed Consolidated Statements of Operations
Total Amounts Presented in Unaudited Condensed Consolidated Statements of Operations
 
Effective Amount
Recognized in OCI
 
Effective Amount Reclassified from AOCI into Earnings
 
 
Pre-Tax Gain (Loss)
Tax Benefit (Expense)
Gain (Loss) Net of Tax
 
Pre-Tax (Gain) Loss
Tax (Benefit) Expense
(Gain) Loss
Net of Tax
Three Months Ended March 31, 2018
 
 
 
 
 
 
 
 
 
 
 
Forward currency contracts
 
Cost of products sold
$
672

 
$
(118
)
$
27

$
(91
)
 
$
15

$
(3
)
$
12

 
 
 
 
 
$
(118
)
$
27

$
(91
)
 
$
15

$
(3
)
$
12

Three Months Ended March 31, 2017
 
 
 
 
 
 
 
 
 
 
 
Forward currency contracts
 
Cost of products sold
$
650

 
$
(58
)
$
21

$
(37
)
 
$
(28
)
$
10

$
(18
)
 
 
 
 
 
$
(58
)
$
21

$
(37
)
 
$
(28
)
$
10

$
(18
)

As of March 31, 2018, pre-tax net gains or losses for our derivative instruments designated, or previously designated, as currency hedge contracts under FASB ASC Topic 815 that may be reclassified to earnings within the next twelve months are presented below:
(in millions)
Designated Derivative Instrument
 
FASB ASC Topic 815 Designation
 
Location in
Unaudited Condensed Consolidated Statements of Operations
Total Amounts
Presented in
Unaudited Condensed Consolidated
Statements of Operations
 
Amount of
Pre-Tax
Gain (Loss)
that may be Reclassified to Earnings
 
 
 
Interest rate derivative contracts
 
Fair value hedge
 
Interest expense
$
(61
)
 
$
12

Interest rate derivative contracts
 
Cash flow hedge
 
Interest expense
(61
)
 
1

Forward currency contracts
 
Cash flow hedge
 
Cost of products sold

672

 
(55
)

Net gains and losses on currency hedge contracts not designated as hedging instruments offset by net gains and losses from currency transaction exposures are presented below:
 
 
Location in
Unaudited Condensed Consolidated Statements of Operations
 
 
 
 
 
 
 
Three Months Ended March 31,
(in millions)
 
 
2018
 
2017
Net gain (loss) on currency hedge contracts
 
Other, net
 
$
(23
)
 
$
(17
)
Net gain (loss) on currency transaction exposures
 
Other, net
 
16

 
17

Net currency exchange gain (loss)
 
 
 
$
(8
)
 
$
—



12

Fair Value Measurements

FASB ASC 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 FASB ASC Topic 820, Fair Value Measurements and Disclosures, by considering the estimated amount we would receive or pay to transfer these instruments at the reporting date when taking into account current currency exchange rates, interest rates, the creditworthiness of the counterparty for unrealized gain positions and our own creditworthiness for unrealized loss positions. In certain instances, we may utilize financial models to measure fair value of our derivative instruments. In doing so, we use inputs that include quoted prices for similar assets or liabilities in active markets, quoted prices for identical or similar assets or liabilities in markets that are not active, other observable inputs for the asset or liability and inputs derived principally from, or corroborated by, observable market data by correlation or other means.

The following are the balances of our derivative assets and liabilities:
 
Location in
Unaudited Condensed Consolidated
Balance Sheets (1)
As of
 
March 31,
 
December 31,
(in millions)
2018
 
2017
Derivative Assets:
 
 
 
 
Designated Derivative Instruments
 
 
 
 
Forward currency contracts
Other current assets
$
3

 
$
7

Forward currency contracts
Other long-term assets
15

 
57

 
 
17

 
64

Non-Designated Derivative Instruments
 
 
 
 
Forward currency contracts
Other current assets
15

 
18

Total Derivative Assets
 
$
32

 
$
82

 
 
 
 
 
Derivative Liabilities:
 
 
 
 
Designated Derivative Instruments
 
 
 
Forward currency contracts
Other current liabilities
$
54

 
$
37

Forward currency contracts
Other long-term liabilities
69

 
33

 
 
123

 
69

Non-Designated Derivative Instruments
 
 
 
 
Forward currency contracts
Other current liabilities
31

 
21

Total Derivative Liabilities
 
$
154

 
$
90


(1)
We classify derivative assets and liabilities as current when the remaining term of the derivative contract is one year or less.
Recurring Fair Value Measurements
On a recurring basis, we measure certain financial assets and financial liabilities at fair value based upon quoted market prices. Where quoted market prices or other observable inputs are not available, we apply valuation techniques to estimate fair value. FASB ASC Topic 820 establishes a three-level valuation hierarchy for disclosure of fair value measurements. The category of a financial asset or a financial liability within the valuation hierarchy is based upon the lowest level of input that is significant to the measurement of fair value. The three levels of the hierarchy are defined as follows:
•
Level 1 – Inputs to the valuation methodology are quoted market prices for identical assets or liabilities.
•
Level 2 – Inputs to the valuation methodology are other observable inputs, including quoted market prices for similar assets or liabilities and market-corroborated inputs.
•
Level 3 – Inputs to the valuation methodology are unobservable inputs based on management’s best estimate of inputs market participants would use in pricing the asset or liability at the measurement date, including assumptions about risk.

13

Assets and liabilities measured at fair value on a recurring basis consist of the following:
 
As of
 
March 31, 2018
 
December 31, 2017
(in millions)
Level 1
 
Level 2
 
Level 3
 
Total
 
Level 1
 
Level 2
 
Level 3
 
Total
Assets
 
 
 

 
 
 
 
 
 
 
 

 
 
 
 
Money market and government funds
$
42

 
$
—

 
$
—

 
$
42

 
$
21

 
$
—

 
$
—

 
$
21

Publicly-held securities
12

 
—

 
—

 
12

 
15

 
—

 
—

 
15

Forward currency contracts
—

 
32

 
—

 
32

 
—

 
82

 
—

 
82

 
$
54

 
$
32

 
$
—

 
$
86

 
$
36

 
$
82

 
$
—

 
$
118

Liabilities
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Forward currency contracts
$
—

 
$
154

 
$
—

 
$
154

 
$
—

 
$
90

 
$
—

 
$
90

Accrued contingent consideration
—

 
—

 
152

 
152

 
—

 
—

 
169

 
169

 
$
—

 
$
154

 
$
152

 
$
306

 
$
—

 
$
90

 
$
169

 
$
259


Our investments in money market and government funds are classified within Level 1 of the fair value hierarchy because they are valued using quoted market prices. These investments are classified as cash and cash equivalents within our accompanying unaudited condensed consolidated balance sheets, in accordance with U.S. GAAP and our accounting policies. In addition to $42 million invested in money market and government funds as of March 31, 2018, we had $245 million in interest bearing and non-interest bearing bank accounts. In addition to $21 million invested in money market and government funds as of December 31, 2017, we had $167 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 liability. Refer to Note B – Acquisitions and Strategic Investments for a discussion of the changes in the fair value of our contingent consideration liability.
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 measurement alternative investment is not estimated if there are no identified events or changes in circumstances that may have a significant adverse effect on the fair value of the investment. Refer to Note B – Acquisitions and Strategic Investments for a discussion of our strategic investments.

Refer to Note C – Goodwill and Other Intangible Assets for a discussion of the fair values and annual impairment tests of goodwill and our indefinite lived intangible assets.

The fair value of our outstanding debt obligations was $6.040 billion as of March 31, 2018 and $5.945 billion as of December 31, 2017. We determined fair value by using quoted market prices for our publicly registered senior notes, classified as Level 1 within the fair value hierarchy, amortized cost for commercial paper and face value for term loans and credit facility borrowings outstanding. Refer to Note E – Borrowings and Credit Arrangements for a discussion of our debt obligations.


14

NOTE E – BORROWINGS AND CREDIT ARRANGEMENTS

We had total debt of $5.765 billion as of March 31, 2018 and $5.616 billion as of December 31, 2017. The debt maturity schedule for the significant components of our long-term debt obligations is presented below:
(in millions, except interest rates)
Issuance Date
Maturity Date
As of
 
Semi-annual Coupon Rate
March 31, 2018
 
December 31, 2017
 
October 2018 Notes
August 2013
October 2018
—

 
†

 
2.650
%
January 2020 Notes
December 2009
January 2020
850

 
850

 
6.000
%
May 2020 Notes
May 2015
May 2020
600

 
600

 
2.850
%
May 2022 Notes
May 2015
May 2022
500

 
500

 
3.375
%
October 2023 Notes
August 2013
October 2023
450

 
450

 
4.125
%
May 2025 Notes
May 2015
May 2025
750

 
750

 
3.850
%
March 2028 Notes
February 2018
March 2028
1,000

 
—

 
4.000
%
November 2035 Notes
November 2005
November 2035
350

 
350

 
7.000
%
January 2040 Notes
December 2009
January 2040
300

 
300

 
7.375
%
Unamortized Debt Issuance Discount
 
2020 - 2040
(14
)
 
(6
)
 
 
Unamortized Deferred Financing Costs
 
2020 - 2040
(19
)
 
(18
)
 
 
Unamortized Gain on Fair Value Hedges
 
2020 - 2023
35

 
38

 
 
Capital Lease Obligation
 
Various
1

 
1

 
 
Long-term debt
 
 
$
4,803

 
$
3,815

 
 
†As of December 31, 2017, $600 million under the October 2018 Notes was outstanding and classified as short-term debt.
Note:
The table above does not include unamortized amounts related to interest rate contracts designated as cash flow hedges.

Revolving Credit Facility
As of March 31, 2018 and December 31, 2017, we maintained a $2.250 billion revolving credit facility (the 2017 Facility) with a global syndicate of commercial banks that matures on August 4, 2022. This facility provides backing for the commercial paper program described below. There were no amounts borrowed under our revolving credit facility as of March 31, 2018 and December 31, 2017.
The 2017 Facility requires that we maintain certain financial covenants, as follows:
 
Covenant Requirement
 
Actual
 
as of March 31, 2018
 
as of March 31, 2018
Maximum leverage ratio (1)
3.5 times
 
2.2 times

(1)
Ratio of total debt to consolidated EBITDA, as defined by the credit agreement, for the preceding four consecutive fiscal quarters.

The 2017 Facility provides for an exclusion from the calculation of consolidated EBITDA, as defined by the agreement, through maturity, of any non-cash charges and up to $500 million in restructuring charges and restructuring-related expenses related to our current or future restructuring plans. As of March 31, 2018, we had $415 million of the restructuring charge exclusion remaining. In addition, any cash litigation payments (net of any cash litigation receipts), as defined by the 2017 Facility, are excluded from the calculation of consolidated EBITDA, as defined in the 2017 Facility, provided that the sum of any excluded net cash litigation payments does not exceed $2.624 billion in the aggregate. As of March 31, 2018, we had $1.690 billion of the legal exclusion remaining.

Any inability to maintain compliance with these covenants could require us to seek to renegotiate the terms of our credit facility 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 on terms acceptable to us. In this case, all credit facility commitments would terminate and any amounts borrowed under the facility would become immediately due and payable. Furthermore, any termination of our credit facility may negatively impact the credit ratings assigned to our commercial paper program which may impact our ability to refinance any then outstanding commercial paper as it becomes due and payable.

15

Commercial Paper
As of March 31, 2018, we had $886 million of commercial paper outstanding and $1.197 billion outstanding as of December 31, 2017. Our commercial paper program is backed by the 2017 Facility, which allows us to have a maximum of $2.250 billion in commercial paper outstanding. Outstanding commercial paper directly reduces borrowing capacity available under the 2017 Facility. As of March 31, 2018, the commercial paper issued and outstanding had a weighted average maturity of 22 days and a weighted average yield of 2.46 percent. As of December 31, 2017, the commercial paper issued and outstanding had a weighted average maturity of 38 days and a weighted average yield of 1.85 percent.

Senior Notes

We had senior notes outstanding of $4.800 billion as of March 31, 2018 and $4.400 billion as of December 31, 2017.

In February 2018, we completed an offering of $1.000 billion in aggregate principal amount of 4.000% senior notes, due March 2028. We used a portion of the net proceeds from the offering to repay the $600 million plus accrued interest of our 2.650% senior notes due in October 2018. The remaining proceeds were used to repay a portion of our outstanding commercial paper.

Our senior notes were issued in public offerings, are redeemable prior to maturity and are not subject to sinking fund requirements. Our senior notes are unsecured, unsubordinated obligations and rank on parity with each other. These notes are effectively junior to borrowings under our credit and security facility, and to the extent borrowed by our subsidiaries, to liabilities of our subsidiaries (see Other Arrangements below).

Other Arrangements

As of March 31, 2018 and December 31, 2017, we maintained a $400 million credit and security facility secured by our U.S. trade receivables maturing in February 2019. We had outstanding borrowings of $70 million as of March 31, 2018 and no outstanding borrowings as of December 31, 2017 under our credit and security facility.

We have accounts receivable factoring programs in certain European countries that we account for as sales under FASB ASC Topic 860, Transfers and Servicing. These agreements provide for the sale of accounts receivable to third parties, of up to approximately $463 million as of March 31, 2018. 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 $178 million of receivables as of March 31, 2018 at an average interest rate of 2.1 percent and $171 million as of December 31, 2017 at an average interest rate of 1.8 percent.

In March 2018, we entered into a factoring agreement with a commercial Japanese bank. The agreement provides for the sale of accounts receivable and promissory notes of up to 30.000 billion Japanese yen (approximately $282 million as of March 31, 2018). 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 $95 million of receivables as of March 31, 2018 at an average interest rate of 0.5 percent.

In addition, we have uncommitted credit facilities with a commercial Japanese bank that provide for accounts receivable factoring and promissory notes discounting of up to 22.000 billion Japanese yen (approximately $207 million as of March 31, 2018). 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 $124 million of notes receivable as of March 31, 2018 at an average interest rate of 1.5 percent and $157 million of notes receivable as of December 31, 2017 at an average interest rate of 1.3 percent. De-recognized accounts and notes receivable are excluded from trade accounts receivable, net in the accompanying unaudited condensed consolidated balance sheets.

As of and through March 31, 2018, we were in compliance with all the required covenants related to our debt obligations. For additional information regarding the terms of our debt agreements, refer to Note E - Borrowings and Credit Arrangements of the consolidated financial statements in our most recent Annual Report on Form 10-K.

NOTE F – RESTRUCTURING-RELATED ACTIVITIES

2016 Restructuring Plan

On June 6, 2016, our Board of Directors approved and we committed to a restructuring initiative (the 2016 Restructuring Plan). The 2016 Restructuring Plan is intended to develop global commercialization, technology and manufacturing capabilities in key

16

growth markets and build on our Plant Network Optimization (PNO) strategy, which is intended to simplify our manufacturing plant structure by transferring certain production lines among facilities and expanding operational efficiencies in support of our operating income margin goals. Key activities under the 2016 Restructuring Plan include strengthening global infrastructure through evolving global real estate assets and workplaces, developing global commercial and technical competencies, enhancing manufacturing and distribution expertise in certain regions and continuing implementation of our PNO strategy. These activities were initiated in the second quarter of 2016 and are expected to be substantially complete by the end of 2018. We revised the original estimate for the costs and savings associated with the program in the first quarter of 2018, as approved by the Board of Directors.

The following table provides a summary of our estimates of costs associated with the 2016 Restructuring Plan by major type of cost:
Type of cost
Total Estimated Amount Expected to be Incurred
Restructuring charges:
 
Termination benefits
$100 million to $110 million
Other (1)
$25 million to $50 million
Restructuring-related expenses:
 
Other (2)
$150 million to $165 million
 
$275 million to $325 million

(1) Consists primarily of consulting fees and costs associated with contract cancellations.
(2) Comprised of other costs directly related to the 2016 Restructuring Plan, including program management, accelerated depreciation and costs to transfer product lines among facilities.

Approximately $250 million to $300 million of these charges are estimated to result in cash outlays.

The following presents these costs (credits) by major type and line item within our accompanying unaudited condensed consolidated statements of operations.
Three Months Ended March 31, 2018
 
 
 
 
 
 
 
(in millions)
Termination
Benefits
 
Transfer
Costs
 
Other
 
Total
Restructuring charges
$
12

 
$
—

 
$
1

 
$
13

Restructuring-related expenses:
 
 
 
 
 
 
 
Cost of products sold
—

 
7

 
—

 
7

Selling, general and administrative expenses
—

 
—

 
8

 
8

 
—

 
7

 
8

 
15

 
$
12

 
$
7

 
$
8

 
$
28

 
 
 
 
 
 
 
 
Three Months Ended March 31, 2017
 
 
 
 
 
 
 
 
 
(in millions)
Termination
Benefits
 
Accelerated
Depreciation
 
Transfer
Costs
 
Other
 
Total
Restructuring charges
$
3

 
$
—

 
$
—

 
$
1

 
$
4

Restructuring-related expenses:
 
 
 
 
 
 
 
 
 
Cost of products sold
—

 
—

 
12

 
—

 
12

Selling, general and administrative expenses
—

 
2

 
—

 
1

 
3

 
—

 
2

 
12

 
1

 
15

 
$
3

 
$
2

 
$
12

 
$
2

 
$
19



17

The following table presents cumulative restructuring and restructuring-related charges as of March 31, 2018, related to our 2016 Restructuring Plan by major type:
(in millions)
2016 Restructuring Plan
Termination benefits
$
61

Other (1)
16

Total restructuring charges
77

Accelerated depreciation
9

Transfer costs
68

Other (2)
15

Restructuring-related expenses
92

 
$
169

(1) Consists primarily of consulting fees and costs associated with contract cancellations.
(2) Comprised of other costs directly related to our Restructuring Plan, including program management, accelerated depreciation and costs to transfer product lines among facilities.

Cash payments associated with our 2016 Restructuring Plan were made using cash generated from operations and are comprised of the following:
(in millions)
2016 Restructuring Plan
Three Months Ended March 31, 2018
 
Termination benefits
$
8

Transfer costs
7

Other
9

 
$
25

 
 
Program to Date
 
Termination benefits
$
36

Transfer costs
67

Other
19

 
$
122


Our restructuring liability is primarily comprised of accruals for termination benefits. The following is a rollforward of the termination benefit liability associated with our 2016 Restructuring Plan, which is reported as a component of accrued expenses included in our accompanying unaudited condensed consolidated balance sheets:
(in millions)
2016 Restructuring Plan
Accrued as of December 31, 2017
$
22

Charges (credits)
12

Cash payments
(8
)
Accrued as of March 31, 2018
$
27



18

NOTE G – SUPPLEMENTAL BALANCE SHEET INFORMATION

Components of selected captions in our accompanying unaudited condensed consolidated balance sheets are as follows:

Cash, cash equivalents, restricted cash and restricted cash equivalents
 
 
As of
(in millions)
 
March 31, 2018
 
December 31, 2017
Cash and cash equivalents
 
$
287

 
$
188

Restricted cash included in Other current assets
 
850

 
803

Restricted cash included in Other long-term assets
 
31

 
26

Total cash, cash equivalents and restricted cash
 
$
1,168

 
$
1,017


Trade accounts receivable, net
 
 
As of
(in millions)
 
March 31, 2018
 
December 31, 2017
Accounts receivable
 
$
1,650

 
$
1,645

Allowance for doubtful accounts
 
(67
)
 
(68
)
Allowance for sales returns
 
—

 
(30
)
Other sales reserves
 
(3
)
 
—

 
 
$
1,580

 
$
1,548


Note: Due to the adoption of FASB ASC Topic 606 effective January 1, 2018, the allowance for sales returns has been prospectively reclassified from Trade accounts receivable, net to Other current liabilities within the unaudited condensed consolidated balance sheets. Prior period balances remain unchanged.

The following is a rollforward of our allowance for doubtful accounts:
 
 
Three Months Ended
March 31,
(in millions)
 
2018
 
2017
Beginning balance
 
$
68

 
$
73

Net charges to expenses
 
4

 
3

Utilization of allowances
 
(5
)
 
(1
)
Ending balance
 
$
67

 
$
75


Inventories
 
 
As of
(in millions)
 
March 31, 2018
 
December 31, 2017
Finished goods
 
$
717

 
$
685

Work-in-process
 
105

 
110

Raw materials
 
291

 
284

 
 
$
1,113

 
$
1,078



19

Property, plant and equipment, net
 
 
As of
(in millions)
 
March 31, 2018
 
December 31, 2017
Land
 
$
103

 
$
102

Buildings and improvements
 
1,132

 
1,120

Equipment, furniture and fixtures
 
3,246

 
3,183

Capital in progress
 
215

 
219

 
 
4,696

 
4,625

Accumulated depreciation
 
(2,996
)
 
(2,928
)
 
 
$
1,700

 
$
1,697


Depreciation expense was $68 million for the first quarter of 2018 and $63 million for the first quarter of 2017.

Accrued expenses
 
 
As of
(in millions)
 
March 31, 2018
 
December 31, 2017
Legal reserves
 
$
1,255

 
$
1,176

Payroll and related liabilities
 
488

 
591

Accrued contingent consideration
 
62

 
36

Other
 
643

 
653

 
 
$
2,447

 
$
2,456


Other long-term liabilities
 
 
As of
(in millions)
 
March 31, 2018
 
December 31, 2017
Accrued income taxes
 
$
1,119

 
$
1,275

Legal reserves
 
256

 
436

Accrued contingent consideration
 
92

 
133

Other
 
787

 
525

 
 
$
2,254

 
$
2,370


NOTE H – INCOME TAXES

Our effective tax rate from continuing operations is presented below:
 
 
Three Months Ended March 31,
 
2018
 
2017
Effective tax rate from continuing operations
 
8.0
%
 
4.9
%

The change in our reported tax rates for the first quarter of 2018, as compared to the same period in 2017, relates primarily to the impact of certain receipts and charges that are taxed at different rates than our effective tax rate, including intangible asset impairment charges, acquisition-related items, restructuring items, litigation-related items, as well as certain discrete tax items including impacts of the Tax Cuts and Jobs Act (TCJA), enacted on December 22, 2017.

As of March 31, 2018, we had $1.240 billion of gross unrecognized tax benefits, of which a net $1.157 billion, if recognized, would affect our effective tax rate. As of December 31, 2017, we had $1.238 billion of gross unrecognized tax benefits, of which a net $1.150 billion, if recognized, would affect our effective tax rate.

We have received Notices of Deficiency from the Internal Revenue Service (IRS) reflecting proposed audit adjustments for Guidant Corporation for its 2001 through 2006 tax years and for Boston Scientific Corporation for its 2006 and 2007 tax years. The total

20

incremental tax liability asserted by the IRS for the applicable periods is $1.162 billion plus interest. The primary issue in dispute for all years is the transfer pricing associated with the technology license agreements between domestic and foreign subsidiaries of Guidant. In addition, the IRS has proposed adjustments in connection with the financial terms of our Transaction Agreement with Abbott Laboratories pertaining to the sale of Guidant's vascular intervention business to Abbott Laboratories in April 2006. During 2014, we received a Revenue Agent Report from the IRS reflecting significant proposed audit adjustments to our 2008, 2009 and 2010 tax years based upon the same transfer pricing methodologies that the IRS applied to our 2001 through 2007 tax years.

We do not agree with the transfer pricing methodologies applied by the IRS or its resulting assessment. We have filed petitions with the U.S. Tax Court contesting the Notices of Deficiency for the 2001 through 2007 tax years in challenge and submitted a letter to the IRS Office of Appeals protesting the Revenue Agent Report for the 2008 through 2010 tax years and requesting an administrative appeal hearing. The issues in dispute were scheduled to be heard in U.S. Tax Court in July 2016. On July 19, 2016, we entered into a Stipulation of Settled Issues with the IRS intended to resolve all of the aforementioned transfer pricing issues, as well as the issues related to our transaction with Abbott Laboratories, for the 2001 through 2007 tax years. The Stipulation of Settled Issues was contingent upon the IRS Office of Appeals applying the same basis of settlement to all transfer pricing issues for the Company’s 2008, 2009 and 2010 tax years as well as review by the United States Congress Joint Committee on Taxation (JCT). In October 2016, we reached an agreement in principle with the IRS Office of Appeals as to the resolution of transfer pricing issues in 2008, 2009 and 2010 tax years, subject to additional calculations of tax as well as documentation to memorialize our agreement. The IRS has recalculated our final tax liabilities under this agreement for all of our tax years from 2001 through 2010 and the JCT has completed its review of the recalculations for the 2001 through 2010 tax years.

In the event that the conditions in the Stipulation of Settled Items are satisfied, we expect to make net tax payments of approximately $275 million, plus interest through the date of payment with respect to the settled issues. If finalized, payments related to the resolution are expected in the next six months. We believe that our income tax reserves associated with these matters are adequate as of March 31, 2018 and we do not expect to recognize any additional charges related to resolution of this controversy. However, the final resolution of these issues remains contingent and if the Stipulation of Settled Issues is not finalized, it could have a material impact on our financial condition, results of operations, or cash flows.

We recognize interest and penalties related to income taxes as a component of income tax expense. We had $675 million accrued for gross interest and penalties as of March 31, 2018 and $655 million as of December 31, 2017. We recognized net tax expense related to interest and penalties of $17 million during the first quarter of 2018 and $13 million in the first quarter of 2017.

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 $897 million.

There are a number of key provisions under the TCJA that impact us and we continue to monitor and analyze the ramification of the new law as the implementation is executed. The final impact of the TCJA may differ from the estimates reported due to, among other things, changes in interpretations and assumptions made by us, additional guidance that may be issued by the U.S. Department of the Treasury and actions that we may take as a result. The TCJA reduces the US Federal corporate income tax rate from 35 percent to 21 percent, requires companies to pay a one-time transition tax on earnings of certain foreign subsidiaries that were previously tax deferred, and creates new taxes on certain foreign sourced earnings. Due to insufficient guidance, as well as the availability of information to accurately analyze the impact of the TCJA, we have made a reasonable estimate of the effects, as described below and in other cases we have not been able to make a reasonable estimate and continue to account for those items based on our existing accounting under FASB ASC Topic 740, Income Taxes and the provisions of the tax laws that were in effect immediately prior to enactment. In the first quarter of 2018, we recognized an additional tax benefit of $9 million, resulting in a total provisional estimate of $852 million related to the TCJA.

We are required to record deferred tax assets and liabilities based on the enacted tax rates at which they are expected to reverse in the future. Therefore, any U.S. related deferred taxes were re-measured from 35 percent down to 21 percent based on the recorded balances as of December 31, 2017. The analysis included a preliminary assessment on the deductibility of certain amounts for which deferred tax assets may have been recorded. However, we are still analyzing certain aspects of the TCJA and refining our calculations based on the available information, which could potentially affect the measurement of these balances or give rise to new deferred tax amounts. As of March 31, 2018, we have not adjusted our provisional estimate related to re-measurement of our deferred tax balances. As of December 31, 2017, we recorded an estimated tax benefit of approximately $99 million.

We are required to calculate a one-time transition tax based on our total post-1986 foreign earnings and profits (E&P) that we previously deferred from U.S. income taxes. In the first quarter of 2018, we recognized an additional tax benefit of $9 million, which results in a revised provisional amount of approximately $1.035 billion. We anticipate offsetting this liability against existing

21

tax attributes reducing the required payment to approximately $454 million which will be remitted over an eight year period. We have not yet completed our calculation of the total post-1986 E&P for these foreign subsidiaries and we continue to refine the analysis. Additionally, no income taxes have been provided for any remaining undistributed foreign earnings that are not subject to the transition tax or any additional outside basis difference inherent in these entities, as we expect these amounts will remain indefinitely reinvested in foreign operations. Determining the amount of unrecognized deferred tax liability related to any remaining undistributed foreign earnings not subject to the transition tax and additional outside basis difference in these entities is not practicable.

We are subject to a territorial tax system under the TCJA, in which we are required to provide for tax on Global Intangible Low Taxed Income (GILTI) earned by certain foreign subsidiaries. Additionally, we are required to make an accounting policy election to either recognize deferred taxes for temporary basis differences expected to reverse as GILTI in future years or provide for the tax expense related to GILTI in the year the tax is incurred as a period expense. As of March 31, 2018, we are still evaluating the effects of the GILTI provisions as guidance and interpretations continue to emerge. Therefore, we have not determined our accounting policy on the GILTI provisions. However, the standard requires that we reflect the impact of the GILTI provisions as a period expense until the accounting policy is finalized. Therefore, we have included the provisional estimate of GILTI related to current-year operations in our estimated annual effective tax rate only and will be updating the impact and accounting policy as the analysis related to the GILTI provisions is completed.

NOTE I – 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 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 U.S. and other countries in which we operate. From time to time we are the subject of qui tam actions and governmental investigations often involving regulatory, marketing and other business practices. These qui tam actions and governmental investigations could result in the commencement of civil and criminal proceedings, substantial fines, penalties and administrative remedies and have a material adverse effect on our financial position, results of operations and/or liquidity.

In accordance with FASB ASC Topic 450, Contingencies, we accrue anticipated costs of settlement, damages, losses for product liability claims and, under certain conditions, costs of defense, based on historical experience or to the extent specific losses are probable and estimable. Otherwise, we expense these costs as incurred. If the estimate of a probable loss is a range and no amount within the range is more likely, we accrue the minimum amount of the range.


22

Our accrual for legal matters that are probable and estimable was $1.511 billion as of March 31, 2018 and $1.612 billion as of December 31, 2017 and includes certain estimated costs of settlement, damages and defense. As of March 31, 2018 and December 31, 2017, a portion of our legal accrual is funded and included in our restricted cash balance as disclosed in Note G – Supplemental Balance Sheet Information. 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 most recent Annual Report 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 November 9, 2015, Edwards Lifesciences, LLC filed an invalidity claim against one of our subsidiaries, Sadra Medical, Inc. (Sadra), in the High Court of Justice, Chancery Division Patents Court in the United Kingdom, alleging that a European patent owned by Sadra relating to a repositionable heart valve is invalid. On January 15, 2016, we filed our defense and counterclaim for a declaration that our European patent is valid and infringed by Edwards. On February 25, 2016, we amended our counterclaim to allege infringement of a second patent related to adaptive sealing technology. A trial was held from January 18 to January 27, 2017. On March 3, 2017, the court found one of our patents valid and infringed and some claims of the second patent invalid and the remaining claims not infringed. Both parties have filed an appeal. On March 28, 2018, the Court of Appeals affirmed the decision of the High Court.

On April 19, 2016, a subsidiary of Boston Scientific filed suit against Edwards Lifesciences Corporation in the U.S. District Court for the District of Delaware for patent infringement. We allege that Edwards’ SAPIEN™ 3 Valve infringes a patent related to adaptive sealing technology. On June 9, 2016, Edwards filed a counterclaim alleging that our Lotus™ Valve System infringes three patents owned by Edwards. On October 12, 2016, Edwards filed a petition for inter partes review of our patent with the U.S. Patent and Trademark Office (USPTO), Patent Trial and Appeal Board. On March 29, 2017, the USPTO granted the inter partes review request. On April 18, 2017, Edwards filed a second petition for inter partes review of our patent with the USPTO. On March 23, 2018, the USPTO found the patent invalid. The Company plans to appeal that decision.

On April 26, 2016, Edwards Lifesciences PVT, Inc. filed a patent infringement action against us and one of our subsidiaries, Boston Scientific Medizintechnik GmbH, in the District Court of Düsseldorf, Germany alleging a European patent (Spenser '550) owned by Edwards is infringed by our Lotus Transcatheter Heart Valve System. The trial began on February 7, 2017. On March 9, 2017, the court found that we infringed the Spenser '550 patent. The Company filed an appeal. The appeal hearing is scheduled for May 17, 2018. On April 13, 2018, the ‘550 patent was revoked by the European Patent Office.

On December 22, 2016, Edwards Lifesciences PVT, Inc. and Edwards Lifesciences SA (AG) filed a plenary summons against Boston Scientific Limited and Boston Scientific Group Public Company in the High Court of Ireland alleging that a European patent (Spenser) owned by Edwards is infringed by our Lotus Valve System. On April 13, 2018, the ‘550 patent was revoked by the European Patent Office.

On November 20, 2017, The Board of Regents, University of Texas System (UT) and TissueGen. Inc. (TissueGen), served a lawsuit against us in the Western District of Texas. The complaint against us alleges patent infringement of two U.S. patents owned by UT, relating to “Drug Releasing Biodegradable Fiber Implant” and “Drug Releasing Biodegradable Fiber for Delivery of Therapeutics,” and affects the manufacture, use and sale of our Synergy™ Stent System. On March 12, 2018, the court dismissed the action and transferred it to the United States District Court for the District of Delaware.


23

Product Liability Litigation

As of April 24, 2018, approximately 49,500 product liability cases or claims related to transvaginal surgical mesh products designed to treat stress urinary incontinence and pelvic organ prolapse have been asserted against us. The pending cases are in various federal and state courts in the United States and include eight putative class actions. There were also approximately 20 cases in Canada, inclusive of one certified and three putative class actions and fewer than 25 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 3,100 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 United States District Court for the Southern District of West Virginia and transferred the federal court transvaginal surgical mesh cases to MDL-2326 for coordinated pretrial proceedings. During the fourth quarter of 2013, we received written discovery requests from certain state attorneys general offices regarding our transvaginal surgical mesh products. We have responded to those requests. As of April 24, 2018, we have entered into master settlement agreements in principle or are in final stages of entering one with certain plaintiffs' counsel to resolve an aggregate of approximately 47,500 cases and claims. These master settlement agreements provide that the settlement and distribution of settlement funds to participating claimants are conditional upon, among other things, achieving minimum required claimant participation thresholds. Of the approximately 47,500 cases and claims, approximately 21,000 have met the conditions of the settlement and are final. All settlement agreements were entered into solely by way of compromise and without any admission or concession by us of any liability or wrongdoing.

We have established a product liability accrual for known and estimated future cases and claims asserted against us as well as with respect to the actions that have resulted in verdicts against us and the costs of defense thereof associated with our transvaginal surgical mesh products. While we believe that our accrual associated with this matter is adequate, changes to this accrual may be required in the future as additional information becomes available. While we continue to engage in discussions with plaintiffs’ counsel regarding potential resolution of pending cases and claims and intend to vigorously contest the cases and claims asserted against us, that do not settle, the final resolution of the cases and claims is uncertain and could have a material impact on our results of operations, financial condition and/or liquidity. Initial trials involving our transvaginal surgical mesh products have resulted in both favorable and unfavorable judgments for us. We do not believe that the judgment in any one trial is representative of potential outcomes of all cases or claims related to our transvaginal surgical mesh products.

Other Proceedings

Refer to Note H – Income Taxes for information regarding our tax litigation.

NOTE J – WEIGHTED AVERAGE SHARES OUTSTANDING
 
 
Three Months Ended
March 31,
(in millions)
 
2018

2017
Weighted average shares outstanding - basic
 
1,376.5

 
1,365.4

Net effect of common stock equivalents
 
20.2

 
24.8

Weighted average shares outstanding - assuming dilution
 
1,396.8

 
1,390.2


The impact of stock options outstanding with exercise prices greater than the average fair market value of our common stock was immaterial for all periods presented.

We issued approximately six million shares of our common stock in the first quarter of 2018 and seven million shares of our common stock in the first quarter of 2017, following the exercise of underlying stock options, vesting of deferred stock units or purchases under our employee stock purchase plan. We did not repurchase any shares of our common stock during the first three months of 2018 or 2017.

NOTE K – SEGMENT REPORTING

We have three reportable segments comprised of MedSurg, Rhythm and Neuro, and Cardiovascular, which represent an aggregation of our 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 intersegment profits. In 2017, we updated our presentation

24

of segment net sales and operating income to the impact of foreign currency fluctuations, since our chief operating decision maker (CODM) reviews operating results both including and excluding the impact of foreign currency fluctuations and the following presentation more closely aligns to our consolidated financial statements. We exclude from segment operating income certain corporate-related expenses and certain transactions or adjustments that our CODM considers to be non-operational, such as amounts related to amortization expense, intangible asset impairment charges, acquisition-related items, restructuring and restructuring-related items and litigation-related items. 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.

Effective January 1, 2018, following organizational changes to align the company's business and organization structure focused on active implantable devices, we revised our reportable segments, in accordance with FASB ASC Topic 280, Segment Reporting. The revision reflects a reclassification of our Neuromodulation business from our Medical Surgical (MedSurg) segment to our newly created Rhythm and Neuro segment. We have revised prior year amounts to conform to the current year’s presentation (as denoted with an asterisk throughout *). There was no revision to operating segments or reporting units as a result of the organizational change.

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)
 
2018
 
2017
 
 
 
 
 
Net sales
 
 
 
 
MedSurg*
 
$
711

 
$
641

Rhythm and Neuro*
 
736

 
668

Cardiovascular
 
933

 
851

 
 
$
2,379

 
$
2,160

 
 
 
 
 
Income (loss) before income taxes
 
 
 
 
MedSurg*
 
$
259

 
$
215

Rhythm and Neuro*
 
153

 
109

Cardiovascular
 
290

 
233

Operating income allocated to reportable segments
 
703

 
557

Corporate expenses, including hedging activities
 
(100
)
 
(61
)
Intangible asset impairment charges, acquisition-related, restructuring- and restructuring-related and litigation-related net credits (charges)
 
(54
)
 
11

Amortization expense
 
(141
)
 
(143
)
Operating income (loss)
 
407

 
364

Other expense, net
 
(84
)
 
(59
)
Income (loss) before income taxes
 
$
323

 
$
305


 
 
Three Months Ended
March 31,
Operating income as a percentage of segment net sales
 
2018
 
2017
MedSurg*
 
36.4
%
 
33.5
%
Rhythm and Neuro*
 
20.8
%
 
16.3
%
Cardiovascular
 
31.1
%
 
27.3
%

NOTE L – REVENUE

We generate revenue primarily from the sale of single-use medical devices and present revenue net of sales taxes in our unaudited condensed consolidated statements of operations. The following tables disaggregate our revenue from contracts with customers by business and geographic region:

25

 
 
Three Months Ended March 31,
Businesses (in millions)
 
2018
 
2017
Endoscopy
 
 
 
 
U.S.
 
$
231

 
$
215

International
 
187

 
164

Worldwide
 
418

 
379

 
 
 
 
 
Urology and Pelvic Health
 
 
 
 
U.S.
 
197

 
183

International
 
96

 
79

Worldwide
 
293

 
262

 
 
 
 
 
Cardiac Rhythm Management
 
 
 
 
U.S.
 
290

 
283

International
 
203

 
180

Worldwide
 
493

 
463

 
 
 
 
 
Electrophysiology
 
 
 
 
U.S.
 
35

 
32

International
 
39

 
32

Worldwide
 
75

 
64

 
 
 
 
 
Neuromodulation
 
 
 
 
U.S.
 
131

 
116

International
 
38

 
25

Worldwide
 
169

 
141

 
 
 
 
 
Interventional Cardiology
 
 
 
 
U.S.
 
281

 
278

International
 
364

 
312

Worldwide
 
645

 
590

 
 
 
 
 
Peripheral Interventions
 
 
 
 
U.S.
 
145

 
142

International
 
142

 
119

Worldwide
 
288

 
261

 
 
 
 
 
Total Company
 
 
 
 
U.S.
 
1,310

 
1,249

International
 
1,069

 
911

Net Sales
 
$
2,379

 
$
2,160



26

 
 
Three Months Ended March 31,
Geographic Regions (in millions)
 
2018
 
2017
U.S.
 
$
1,310

 
$
1,249

EMEA (Europe, Middle East and Africa)
 
563

 
454

APAC (Asia-Pacific)
 
415

 
371

LACA (Latin America and Canada)
 
91

 
84

 
 
$
2,379

 
$
2,160

 
 
 
 
 
Emerging Markets (1)
 
$
255

 
$
208

(1) Emerging Markets is defined as certain countries that we believe have strong growth potential based on their economic conditions, healthcare sectors and our global capabilities. Currently, we include 20 countries in our definition of Emerging Markets.

We sell our products primarily through a direct sales force. In certain international markets, we sell our products through independent distributors. We consider revenue to be earned when all of the following criteria are met: we have a contract with a customer that creates enforceable rights and obligations; promised products or services are identified; the transaction price, or the amount we expect to receive, is determinable and we have transferred control of the promised items to the customer. Transfer of control is evidenced upon passage of title and risk of loss to the customer unless we are required to provide additional services. We treat shipping and handling costs performed after a customer obtains control of the good as a fulfillment cost and record these costs as a selling expense when incurred. We recognize revenue from consignment arrangements based on product usage, or implant, which indicates that the sale is complete. We recognize a receivable at the point in time we have an unconditional right to payment. Payment terms are typically 30 days in the U.S., but may be longer in international markets.

Deferred Revenue

We record a contract liability, or deferred revenue, when we have an obligation to provide a product or service to the customer and payment is received or due in advance of our performance. When we sell a device with a future service obligation, we defer revenue on the unfulfilled performance obligation and recognize this revenue over the related service period. Many of our Cardiac Rhythm Management (CRM) product offerings combine the sale of a device with our LATITUDE™ Patient Management System, which represents a future service obligation. Generally, we do not have observable evidence of the standalone selling price related to our future service obligations; therefore we estimate the selling price using an expected cost plus a margin approach. We allocate the transaction price using the relative standalone selling price method. The use of alternative estimates could result in a different amount of revenue deferral.

Contract liabilities are classified as other current liabilities and other long-term liabilities on the balance sheet. Our deferred revenue balance as of March 31, 2018 was $393 million and $411 million as of January 1, 2018. Our contractual liabilities are primarily composed of deferred revenue related to the LATITUDE™ Patient Management System. Revenue is recognized over the average service period which is based on device and patient longevity. During the first quarter of 2018, we recognized $26 million of revenue that was included in the above January 1, 2018 contract liability balance. We have elected not to disclose the transaction price allocated to unsatisfied performance obligations when the original expected contract duration is one year or less. In addition, we have not identified material unfulfilled performance obligations for which revenue is not currently deferred.

Variable Consideration

We generally allow our customers to return defective, damaged and, in certain cases, expired products for credit. We base our estimate for sales returns upon historical trends and record the amount as a reduction to revenue when we sell the initial product. In addition, we may allow customers to return previously purchased products for next­ generation product offerings. For these transactions, we defer recognition of revenue on the sale of the earlier generation product based upon an estimate of the amount of product to be returned when the next­-generation products are shipped to the customer. Uncertain timing of next-generation product approvals, variability in product launch strategies, product recalls and variation in product utilization all affect our estimates related to sales returns and could cause actual returns to differ from these estimates.

We also offer sales rebates and discounts to certain customers. We treat sales rebates and discounts as a reduction of revenue and classify the corresponding liability as current. We estimate rebates for products where there is sufficient historical information available to predict the volume of expected future rebates. If we are unable to estimate the expected rebates reasonably, we record a liability for the maximum rebate percentage offered. We have entered certain agreements with group purchasing organizations

27

to sell our products to participating hospitals at negotiated prices. We recognize revenue from these agreements following the same revenue recognition criteria discussed above.

Capitalized Contract Costs

We capitalize commission fees related to contracts with customers when the associated revenue is expected to be earned over a period that exceeds one year. Deferred commissions are primarily related to the sale of devices enabled with our LATITUDE Patient Management System. We have elected to expense commission costs when incurred for contracts with an expected duration of one year or less. Capitalized commission fees are amortized over the period the associated products or services are transferred. Similarly, we capitalize certain recoverable costs related to the delivery of the LATITUDE Remote Monitoring Service. These fulfillment costs are amortized over the average service period. Our total capitalized contract costs are immaterial to our consolidated financial statements.

NOTE M – CHANGES IN OTHER COMPREHENSIVE INCOME

The following table provides the reclassifications out of other comprehensive income, net of tax.
Three Months Ended March 31, 2018
 
 
 
 
 
 
 
 
 
 
(in millions)
 
Foreign Currency Translation Adjustments
 
Unrealized Gains/Losses on Derivative Financial Instruments
 
Unrealized Gains/Losses on Available-for-Sale Securities
 
Defined Benefit Pension Items/Other
 
Total
Balance as of December 31, 2017
 
$
(32
)
 
$
1

 
$
(1
)
 
$
(27
)
 
$
(59
)
Other comprehensive income (loss) before reclassifications
 
10

 
(91
)
 
—

 
—

 
(81
)
(Income) loss amounts reclassified from accumulated other comprehensive income
 
—

 
12

 
1

 
—

 
13

Net current-period other comprehensive income (loss)
 
10

 
(80
)
 
—

 
—

 
(69
)
Balance as of March 31, 2018
 
$
(22
)
 
$
(79
)
 
$
—

 
$
(27
)
 
$
(128
)

Three Months Ended March 31, 2017
 
 
 
 
 
 
 
 
 
 
(in millions)
 
Foreign Currency Translation Adjustments
 
Unrealized Gains/Losses on Derivative Financial Instruments
 
Unrealized Gains/Losses on Available-for-Sale Securities
 
Defined Benefit Pension Items/Other
 
Total
Balance as of December 31, 2016
 
$
(79
)
 
$
107

 
$
(6
)
 
$
(21
)
 
$
1

Other comprehensive income (loss) before reclassifications
 
8

 
(37
)
 
—

 
(3
)
 
(32
)
(Income) loss amounts reclassified from accumulated other comprehensive income
 
—

 
(18
)
 
—

 
3

 
(15
)
Net current-period other comprehensive income (loss)
 
8

 
(55
)
 
—

 
—

 
(47
)
Balance as of March 31, 2017
 
$
(71
)
 
$
52

 
$
(6
)
 
$
(21
)
 
$
(46
)

Refer to Note D – Hedging Activities and Fair Value Measurements for further detail on the reclassifications related to derivatives.

We adopted Update No. 2016-01 in the first quarter of 2018, as a result of adopting the standard, we recorded a cumulative effect adjustment to retained earnings for unrealized gains and losses for available-for-sale securities previously recorded to accumulated other comprehensive income.

The gains and losses on defined benefit and pension related items before reclassifications and gains and losses on defined benefit and pension items reclassified from accumulated other comprehensive income were reduced by immaterial income tax impacts in the first three months of 2018 and 2017.


28

NOTE N – NEW ACCOUNTING PRONOUNCEMENTS

Periodically, new accounting pronouncements are issued by the FASB or other standard setting bodies. Recently issued standards typically do not require adoption until a future effective date. Prior to their effective date, we evaluate the pronouncements to determine the potential effects of adoption on our unaudited condensed consolidated financial statements.

Standards to be Implemented

ASC Update No. 2016-02

In February 2016, the FASB issued ASC Update No. 2016-02, Leases (Topic 842). The purpose of Update No. 2016-02 is to increase the transparency and comparability among organizations by recognizing lease assets and lease liabilities on the balance sheet, including those previously classified as operating leases under current U.S. GAAP and disclosing key information about leasing arrangements. Update No. 2016-02 is effective for annual periods beginning after December 15, 2018, including interim periods within those annual periods. Early adoption is permitted and a modified retrospective approach is required for adoption. While we are still in the process of determining the effect that the new standard will have on our financial position and results of operations, we expect to recognize additional assets and corresponding liabilities on our consolidated balance sheets, as a result of our operating lease portfolio as it exists at the date we adopt the new standard. Please refer to Note F - Lease and Other Purchase Obligations in our most recent Annual Report on Form 10-K for information regarding our most current lease activity. Additionally, we are in the process of implementing a new lease administration and lease accounting system, and updating our controls and procedures for maintaining and accounting for our lease portfolio under the new standard. As a result, we anticipate adopting the new standard on January 1, 2019.

ASC Update No. 2016-13

In June 2016, the FASB issued ASC Update No. 2016-13, Financial Instruments - Credit Losses (Topic 326): Measurement of Credit Losses on Financial Instruments. The purpose of Update No. 2016-13 is to replace the current incurred loss impairment methodology for financial assets measured at amortized cost with a methodology that reflects expected credit losses and requires consideration of a broader range of reasonable and supportable information, including forecasted information, to develop credit loss estimates. Update No. 2016-13 is effective for annual periods beginning after December 15, 2019, including interim periods within those annual periods. Early adoption is permitted for annual periods beginning after December 15, 2018. We are in the process of determining the effect that the adoption will have on our financial position and results of operations.

No other new accounting pronouncements, issued or effective, during the period had, or are expected to have, a material impact on our condensed consolidated financial statements.

29

ITEM 2.
MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

Introduction

Boston Scientific Corporation is a global developer, manufacturer and marketer of medical devices that are used in a broad range of interventional medical specialties. Our mission is to transform lives through innovative medical solutions that improve the health of patients around the world. Our products and technologies are used to diagnose or treat a wide range of medical conditions, including cardiovascular, digestive, respiratory, urological, pelvic health and neurological conditions. We continue to innovate in these areas and are intent on extending our innovations into new geographies and high-growth adjacency markets. When used in this report, the terms, "we," "us," "our," and "the Company" mean Boston Scientific Corporation and its divisions and subsidiaries.

Financial Summary

Three Months Ended March 31, 2018

Our net sales for the first quarter of 2018 were $2.379 billion, as compared to net sales of $2.160 billion for the first quarter of 2017, an increase of $219 million, or 10.1 percent. Our operational net sales, which exclude a 390 basis point impact of foreign currency fluctuations, increased $136 million, or 6.2 percent as compared to the same period in the prior year.1 This increase in the first quarter of 2018 included operational net sales of $21 million, with no prior year period related net sales, due to the acquisition of Symetis SA (Symetis) during the second quarter of 2017. 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 2018 was $298 million, or $0.21 per share. Our reported results for the first quarter of 2018 included certain charges and/or credits totaling $157 million (after-tax), or $0.11 per share. Adjusted net income, which excludes these items, for the first quarter of 2018, was $455 million, or $0.33 per share.1  

Our reported net income for the first quarter of 2017 was $290 million, or $0.21 per share. Our reported results for the first quarter of 2017 included certain charges and/or credits totaling $107 million (after-tax), or $0.08 per share. Excluding these items, net income for the first quarter of 2017, was $397 million, or $0.29 per share.1 
























1Operational net sales, which exclude the impact of foreign currency fluctuations, and adjusted net income and adjusted net income per share, which exclude certain items required by generally accepted accounting principles in the United States (U.S. GAAP), are not prepared in accordance with U.S. GAAP and should not be considered in isolation from, or as a replacement for, the most directly comparable GAAP measure. Refer to Additional Information for a discussion of management’s use of these non-GAAP financial measures.

30

The following is a reconciliation of our results of operations prepared in accordance with U.S. GAAP to those adjusted results considered by management. Refer to Quarterly Results and Business Overview for a discussion of each reconciling item:
 

Three Months Ended March 31, 2018
in millions, except per share data

Net income (loss)
 
Impact per share
GAAP net income (loss)

$
298

 
$
0.21

Non-GAAP adjustments:

 
 
 
Amortization expense
 
119

 
0.08

Intangible asset impairment charges

1

 
0.00

Acquisition-related net charges (credits)

20

 
0.01

Restructuring and restructuring-related net charges (credits)

22

 
0.02

Investment impairment charges
 
5

 
0.00

Tax Cuts and Jobs Act net charges
 
(9
)
 
(0.01
)
Adjusted net income

$
455

 
$
0.33

 
 
 
 
 

 
 
Three Months Ended March 31, 2017
in millions, except per share data
 
Net income (loss)
 
Impact per share
GAAP net income (loss)
 
$
290

 
$
0.21

Non-GAAP adjustments:
 
 
 
 
Amortization expense
 
122

 
0.09

Acquisition-related net charges (credits)
 
(32
)
 
(0.02
)
Restructuring and restructuring-related net charges (credits)
 
15

 
0.01

Litigation-related net charges (credits)
 
2

 
0.00

Adjusted net income
 
$
397

 
$
0.29

 
 
 
 
 

Cash provided by operating activities was $193 million for the first three months of 2018. As of March 31, 2018, we had total debt of $5.765 billion, cash and cash equivalents of $287 million and a working capital deficit of $908 million. Refer to Liquidity and Capital Resources for further discussion.