10-K 1 form10-k_14949.htm FORM 10-K DATED DECEMBER 31, 2006 WWW.EXFILE.COM, INC. -- 14949 -- BOSTON SCIENTIFIC CORP. -- FORM 10-K


UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549

FORM 10-K

ANNUAL REPORT PURSUANT TO
SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934

For the fiscal year ended December 31, 2006
Commission File No. 1-11083

BOSTON SCIENTIFIC CORPORATION
(Exact Name Of Company As Specified In Its Charter)

DELAWARE
04-2695240
(State of Incorporation)
(I.R.S. Employer Identification No.)

ONE BOSTON SCIENTIFIC PLACE, NATICK, MASSACHUSETTS 01760-1537
(Address Of Principal Executive Offices)

(508) 650-8000
(Company’s Telephone Number)

Securities registered pursuant to Section 12(b) of the Act:

COMMON STOCK, $.01 PAR VALUE PER SHARE
NEW YORK STOCK EXCHANGE
(Title Of Class)
(Name of Exchange on Which Registered)

Securities registered pursuant to Section 12(g) of the Act:
NONE
________________
 
Indicate by check mark if the Company is a well-known seasoned issuer, as defined in Rule 405 of the Securities Act.

Yes: R    No £

Indicate by check mark if the Company is not required to file reports pursuant to Section 13 or Section 15(d) of the Act.

Yes: £    No R

Indicate by check mark whether the Company (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 Company was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.

Yes: R    No £

Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K is not contained herein, and will not be contained, to the best of the Company’s knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K. £

Indicate by check mark whether the registrant is an accelerated filer (as defined in Rule 12b-2 of the Act).

Yes: R    No £

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).

Yes: £    No R

The aggregate market value of the Company’s common stock held by non-affiliates of the Company was approximately $21.8 billion based on the closing price of the Company’s common stock on June 30, 2006, the last business day of the Company’s most recently completed second fiscal quarter.

The number of shares outstanding of the Company’s common stock as of January 31, 2007, was 1,480,340,219.
 


 
 
 
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EX-10.2 FORM OF OMNIBUS AMENDMENT
EX-10.16 FORM OF DEFERRED STOCK UNIT AWARD AGREEMENT
EX-10.21 FIFTH AMENDMENT TO 401(K) RETIREMENT SAVINGS PLAN
EX-10.23 2006 GLOBAL EMPLOYEE STOCK OWNERSHIP PLAN
EX-10.24 FIRST AMENDMENT TO 2006 GLOBAL EMPLOYEE STOCK OWNERSHIP PLAN
EX-10.46 GUIDANT CORPORATION 1994 STOCK PLAN, AS AMENDED
EX-10.47 GUIDANT CORPORATION 1996 NONEMPLOYEE DIRECTOR STOCK PLAN, AS AMENDED
EX-10.48 GUIDANT CORPORATION 1998 STOCK PLAN, AS AMENDED
EX-10.49 FORM OF GUIDANT CORPORATION OPTION GRANT
EX-10.50 FORM OF GUIDANT CORPORATION RESTRICTED STOCK GRANT
EX-10.51 GUIDANT CORPORATION EMPLOYEE SAVINGS AND STOCK OWNERSHIP PLAN
EX-10.52 FIRST AMENDMENT TO GUIDANT CORPORATION EMPLOYEE SAVINGS AND STOCK OWNERSHIP PLAN
EX-10.53 SECOND AMENDMENT TO GUIDANT CORPORATION EMPLOYEE SAVINGS AND STOCK OWNERSHIP PLAN
EX-10.54 THIRD AMENDMENT TO GUIDANT CORPORATION EMPLOYEE SAVINGS AND STOCK OWNERSHIP PLAN
EX-10.55 FOURTH AMENDMENT TO GUIDANT CORPORATION EMPLOYEE SAVINGS AND STOCK OWNERSHIP PLAN
EX-10.56 FIFTH AMENDMENT TO GUIDANT CORPORATION EMPLOYEE SAVINGS AND STOCK OWNERSHIP PLAN
EX-12 STATEMENT REGARDING COMPUTATION OF RATIOS OF EARNINGS TO FIXED CHARGES
EX-21 LIST OF SUBSIDIARIES AS OF 2/28/2007
EX-23 CONSENT OF ERNST & YOUNG, LLP
EX-31.1 SECTION 302 CEO CERTIFICATION
EX-31.2 SECTION 302 CFO CERTIFICATION
EX-32.1 SECTION 906 CEO CERTIFICATION
EX-32.2 SECTION 906 CFO CERTIFICATION
 
 
 
 
The Company
 
Boston Scientific Corporation is a worldwide developer, manufacturer and marketer of medical devices that are used in a broad range of interventional medical specialties including interventional cardiology, cardiac rhythm management, peripheral interventions, cardiac surgery, vascular surgery, electrophysiology, neurovascular intervention, oncology, endoscopy, urology, gynecology and neuromodulation. When used in this report, the terms we,“us,” “our” and the “Company” mean Boston Scientific Corporation and its divisions and subsidiaries.
 
Since we were formed in 1979, we have advanced the practice of less-invasive medicine by helping physicians and other medical professionals treat a variety of diseases and improve patients quality of life by providing alternatives to surgery and other medical procedures that are typically traumatic to the body. Some of our medical products are used for enlarging narrowed blood vessels to prevent heart attack and stroke; clearing passages blocked by plaque to restore blood flow; detecting and managing fast, slow or irregular heart rhythms; mapping electrical problems in the heart; opening obstructions and bringing relief to patients suffering from various forms of cancer; performing biopsies and intravascular ultrasounds; placing filters to prevent blood clots from reaching the lungs, heart or brain; treating urological, gynecological, renal, pulmonary, neurovascular and gastrointestinal diseases; and modulating nerve activity to treat deafness and chronic pain.
 
Our history began in the late 1960s when our co-founder, John Abele, acquired an equity interest in Medi-tech, Inc., a research and development company focused on developing alternatives to surgery. Medi-tech’s initial products, a family of steerable catheters, were introduced in 1969 and were used in some of the first less-invasive procedures performed. In 1979, John Abele joined with Pete Nicholas to form Boston Scientific Corporation, which indirectly acquired Medi-tech. This acquisition began a period of active and focused marketing, new product development and organizational growth. Since then, our net sales have increased substantially, growing from $1.8 million in 1979 to approximately $7.8 billion in 2006.
 
Our growth has been fueled in part by strategic acquisitions and alliances designed to improve our ability to take advantage of growth opportunities in the medical device industry. In 2006, we experienced a transforming event with our acquisition of Guidant Corporation, a world leader in the treatment of cardiac disease. This acquisition enabled us to become a major provider in the more than $9 billion global Cardiac Rhythm Management (CRM) business,  enhancing our overall competitive position and long-term growth potential and further diversifying our product portfolio. With this acquisition, we have become one of the world’s largest cardiovascular device companies and a global leader in microelectronic therapies. This and other acquisitions have helped us add promising new technologies to our pipeline and to offer one of the broadest product portfolios in the world for use in less-invasive procedures. We believe that the depth and breadth of our product portfolio has also enabled us to compete more effectively in, and better absorb the pressures of, the current healthcare environment of cost containment, managed care, large buying groups and hospital consolidation.
 
 
The Drug-Eluting Stent Opportunity
 
Our broad, innovative product offerings have enabled us to become a leader in the interventional cardiology market. This leadership is in large part due to our coronary stent product offerings. Coronary stents are tiny, mesh tubes used in the treatment of coronary artery disease and implanted in patients to prop open arteries and facilitate blood flow from the heart. We have further enhanced the outcomes associated with the use of coronary stents, particularly the processes that lead to restenosis (the growth of neointimal tissue within an artery after angioplasty and stenting), through dedicated internal and external product development and scientific research of drug-eluting stent systems.
 
Use of our products in the United States and abroad has demonstrated that drug-eluting stents reduce the need for repeat procedures—or more expensive surgical procedures—and reduce healthcare costs, as well as overall patient risk, trauma, procedure time and the need for aftercare. Since its U.S. launch in March 2004 and its launch in our Europe and Inter-Continental markets in 2003, our proprietary polymer-based paclitaxel-eluting stent technology for reducing coronary restenosis, the TAXUS® Express2™ paclitaxel-eluting coronary stent system, has become the worldwide leader in the drug-eluting coronary stent market. In 2006, approximately 30 percent of our net sales were derived from sales of our TAXUS stent system.
 
We are continuing to enhance our product offerings in the coronary drug-eluting stent market. We recently launched our next-generation coronary stent, the TAXUS® Liberté™ paclitaxel-eluting coronary stent system, in our Europe and Inter-Continental markets, and we expect to launch the product in the U.S., subject to regulatory approval. The Liberté™ coronary stent is designed to further enhance deliverability and conformability, particularly in challenging lesions. Also, prior to our acquisition of Guidant, Abbott Laboratories acquired Guidant’s vascular intervention and endovascular solutions businesses and shares the drug-eluting technology it acquired from Guidant with us. This arrangement gives us access to a second drug-eluting stent program which complements our existing TAXUS coronary stent program. In the fourth quarter of 2006, we launched our PROMUS™ everolimus-eluting stent system in certain European countries and expect to launch the PROMUS stent system in certain other European markets in the first quarter of 2007, certain Inter-Continental markets in the second quarter of 2007 and in the U.S. in 2008, subject to regulatory approval.
 
Our U.S. TAXUS stent system sales decreased in 2006 relative to 2005, due in part to a decline in the U.S. market size due to recent uncertainty regarding the risk of late stent thrombosis following the use of drug-eluting stents. Late stent thrombosis is the formation of a clot, or thrombus, within the stented area one year or more after implantation of the stent. In the fourth quarter of 2006, the FDA held a special advisory panel meeting to discuss drug-eluting stents. Members of the panel concluded that drug-eluting stents remain safe and effective when used as indicated, and that the benefits outweigh the risks.
 
The Cardiac Rhythm Management Opportunity
 
As a result of our acquisition of Guidant in April 2006, we now develop, manufacture and market products that focus on the treatment of cardiac arrhythmias and heart failure. Natural electrical impulses stimulate the heart’s chambers to pump blood. In healthy individuals, the electrical current causes the heart to beat at an appropriate rate and in synchrony. We make a variety of implantable devices that can monitor the heart and deliver electricity to treat cardiac abnormalities, including:

·  
Implantable defibrillator systems used to detect and treat abnormally fast heart rhythms (tachycardia) that could result in sudden cardiac death, including implantable cardiac resynchronization therapy defibrillator systems used to treat heart failure; and
·  
Implantable pacemaker systems used to manage slow or irregular heart rhythms (bradycardia), including implantable cardiac resynchronization therapy pacemaker systems used to treat heart failure.
 
Tachycardia (abnormally fast or chaotic heart rhythms) can prevent the heart from pumping blood efficiently and can lead to sudden cardiac death. Implantable cardioverter defibrillator systems (defibrillators, leads, programmers, our LATITUDE® Patient Management System and accessories) monitor the heart and can deliver electrical energy, restoring a normal rhythm. Our defibrillators can deliver tiered therapy—a staged progression from lower intensity pacing pulses designed to correct the abnormal rhythm to more aggressive shocks to restore a heartbeat.

Heart failure (the heart’s inability to pump effectively) is a debilitating, progressive condition, with symptoms including shortness of breath and extreme fatigue. After a person is diagnosed with heart failure, the one-year mortality rate is high, with one in five people dying. Moreover, once diagnosed, sudden cardiac death occurs at six to nine times the rate of the general population. The condition is pervasive, with approximately five million people in the U.S. affected.

Bradycardia (slow or irregular heart rhythms) often results in a heart rate insufficient to provide adequate blood flow throughout the body, creating symptoms such as fatigue, dizziness and fainting. Cardiac pacemaker systems (pulse generators, leads, programmers and accessories) deliver electrical energy to stimulate the heart to beat more frequently and regularly. Pacemakers range from conventional single-chamber devices to more sophisticated adaptive-rate, dual-chamber devices.
 
Our remote monitoring system, the LATITUDE® Patient Management System, can be placed in a patient’s home (at their bedside) and reads implantable device information at times specified by the patient’s physician. The communicator can then transmit the data to a secure Internet server where the physician (or other third party) can access this medical information anytime, anywhere. In addition to automatic device data uploads, the communicator enables a daily confirmation of the patient’s device status, providing assurance the device is operating properly. Available as an optional component to the system is the LATITUDE Weight Scale and Blood Pressure Monitor. Weight and blood pressure data is captured by the communicator and sent to the secure server for review by the patient’s physician (or other technician). In addition, this weight and blood information is immediately available to patients in their home to assist their compliance with the day-to-day and home-based heart failure instructions prescribed by their physician.
 
Business Strategy
 
Our mission is to improve the quality of patient care and the productivity of healthcare delivery through the development and advocacy of less-invasive medical devices and procedures. We believe that the pursuit of this mission will likewise enhance shareholder value.
 
We intend to accomplish our mission through the continuing refinement of existing products and procedures and the investigation and development of new technologies that can reduce risk, trauma, cost, procedure time and the need for aftercare. Our approach to innovation combines internally developed products and technologies with those we obtained externally through strategic acquisitions and alliances. Building relationships with development-stage companies and inventors allows us to deepen our current franchises as well as expand into complementary businesses.
 
Key elements of our overall business strategy include the following:
 
Product Quality
 
Our commitment to quality and the success of our quality objectives are designed to build customer trust and loyalty. This commitment to provide quality products to our customers runs throughout our organization and is one of our most critical business objectives. During 2005, in order to strengthen our quality controls, we established Project Horizon, a cross-functional initiative to further improve and harmonize our overall quality processes and systems. Under Project Horizon, we have made an overarching effort to elevate quality thinking in all that we do. To that end, in 2006, we have made significant improvements to our quality systems, including in the areas of field action decision-making, corrective and preventative actions, management controls, process validations and complaint management systems. In 2006, our Board of Directors created a Compliance and Quality Committee to monitor our compliance and quality initiatives. Our quality policy, applicable to all employees, is “I improve the quality of patient care and all things Boston Scientific.”
 
Innovation
 
We are committed to harnessing technological innovation through a mixture of tactical and strategic initiatives that are designed to offer sustainable growth in the near and long term. Combining internally developed products and technologies with those obtained through acquisitions and alliances allows us to focus on and deliver products currently in our own research and development pipeline as well as to strengthen our technology portfolio by accessing third-party technologies.
 
Clinical Excellence
 
Our commitment to innovation is further demonstrated by our clinical capabilities. Our clinical groups focus on driving innovative therapies that can transform the practice of medicine. Our clinical teams are organized by therapeutic specialty to better support our research and development pipeline and marketing and sales efforts. During 2006, our clinical organizations planned, initiated and conducted an expanding series of focused clinical trials that support regulatory and reimbursement requirements and demonstrate the safe and effective clinical performance of critical products and technologies. In October, we announced positive results from our TAXUS OLYMPIA registry, supporting the safety and efficacy of our TAXUS Liberté stent system in real-world patient subsets considered high risk for bare-metal stenting, including diabetics, small vessels and long lesions. We are currently enrolling patients in our SYNTAX clinical trial, which will compare the performance of drug-eluting stents with cardiac surgery in the most complex subsets: those with coronary artery disease in all three coronary arteries, in the left main coronary artery, or both.
 
Product Diversity
 
We offer products in numerous product categories, which are used by physicians throughout the world in a broad range of diagnostic and therapeutic procedures. The
 
breadth and diversity of our product lines permit medical specialists and purchasing organizations to satisfy many of their less-invasive medical device requirements from a single source.
 
Operational Excellence
 
We are focused on continuously improving our supply chain effectiveness, strengthening our manufacturing processes and optimizing our plant network in order to increase operational efficiencies within our organization. By shifting global manufacturing along product lines, we are able to leverage our existing resources and concentrate on new product development, including the enhancement of existing products and their commercial launch. We are committing additional resources to support our growth and implementing new systems designed to provide improved quality and reliability, service, greater efficiency and lower supply chain costs. We have substantially increased our focus on process controls and validations, supplier controls, distribution controls and providing our operations teams with the training and tools necessary to drive continuous improvement in product quality. In 2007, we are also focused on examining our operations and general business activities to identify cost-improvement opportunities in order to enhance our operational effectiveness.
 
Focused Marketing
 
We consistently strive to understand and exceed the expectations of our customers. Each of our business groups maintains dedicated sales forces and marketing teams focusing on physicians who specialize in the diagnosis and treatment of different medical conditions. We believe that this focused disease state management enables us to develop highly knowledgeable and dedicated sales representatives and to foster close professional relationships with physicians. In recent years, we have expanded our direct sales presence worldwide so as to be in a position to take advantage of expanding market opportunities.
 
Active Participation in the Medical Community
 
We believe that we have excellent working relationships with physicians and others in the medical industry, which enable us to gain a detailed understanding of new therapeutic and diagnostic alternatives and to respond quickly to the changing needs of physicians and patients. Active participation in the medical community contributes to physician understanding and adoption of less-invasive techniques and the expansion of these techniques into new therapeutic and diagnostic areas.
 
Corporate Culture
 
We believe that success and leadership evolve from a motivating corporate culture that rewards achievement, respects and values individual employees and customers, and focuses on quality, patient care, integrity, technology and service. This high performance culture has embraced an intense increase in quality focus, and now places quality at the top of its priorities. We believe that our success is attributable in large part to the high caliber of our employees and our commitment to respecting the values on which our success has been based.
 
Research and Development
 
Our investment in research and development is critical to drive our future growth. We have directed our development efforts toward regulatory compliance and innovative technologies designed to expand current markets or enter new markets. Enhancements to existing products that are typically originated and developed within our research and development, manufacturing and marketing operations contribute to each year’s sales growth. We believe that streamlining,
 
prioritizing and coordinating our technology pipeline and new product development activities are essential to our ability to stimulate growth and maintain leadership positions in our markets. Our approach to new product design and development is through focused, cross-functional teams. We believe that our formal process for technology and product development aids in our ability to offer innovative and manufacturable products in a consistent and timely manner. Involvement of the research and development, clinical, quality, regulatory, manufacturing and marketing teams early in the process is the cornerstone of our product development cycle. This collaboration allows these teams to concentrate resources on the most viable and game-changing new products and technologies and get them to market in a timely manner. In addition to internal development, we work with hundreds of leading research institutions, universities and clinicians around the world to develop, evaluate and clinically test our products.
 
We believe our future success will depend upon the strength of these development efforts. In 2006, we expended over $1.0 billion on research and development, representing approximately 13 percent of our 2006 net sales. Our investment in research and development reflects:
 
·  
spending on new product development programs;
 
·  
regulatory compliance and clinical research, particularly relating to our next-generation stent and CRM platforms and other development programs acquired in connection with our business combinations; and
 
·  
sustaining engineering efforts which factor customer (or “post market”) feedback into continuous improvement efforts for currently marketed products.
 
Strategic Initiatives
 
Since 1995, we have undertaken a strategic acquisition program to assemble the lines of business necessary to achieve the critical mass that allows us to continue to be a leader in the medical device industry. In 2006, in addition to our acquisition of Guidant, we invested approximately $500 million in approximately 25 new and existing strategic alliances and acquisitions. These initiatives are intended to further expand our product offerings by adding new or complementary technologies to our already diverse technology portfolio.
 
Many of our alliances involve complex arrangements with third parties and include, in many instances, the option to purchase these companies at pre-established future dates, generally upon the attainment of performance, regulatory and/or revenue milestones. These arrangements allow us to evaluate new technologies prior to acquiring them.
 
We expect that we will continue to focus selectively on strategic acquisitions and alliances in order to provide new products and technology platforms to our customers, including making additional investments in several of our existing strategic relationships.
 
Products
 
Our products are principally offered for sale by three dedicated business groups—Cardiovascular (which includes our interventional cardiology, cardiac rhythm management and cardiovascular divisions), Endosurgery (which includes our oncology, endoscopy and urology/gynecology divisions) and Neuromodulation (which includes our cochlear and pain management divisions). Our Cardiovascular organization focuses on products and technologies for use in interventional cardiology, cardiac rhythm management, peripheral interventions, cardiac surgery, vascular surgery, electrophysiology and neurovascular procedures. Our Endosurgery organization focuses
 
on products and technologies for use in oncology, endoscopy, urology and gynecology procedures. Our Neuromodulation organization currently focuses on the treatment of auditory disorders and chronic pain. During 2006, approximately 80 percent of our net sales were derived from our Cardiovascular business groups, approximately 17 percent from our Endosurgery business groups and approximately 3 percent from our Neuromodulation business group.
 
The following section describes some of our Cardiovascular, Endosurgery and Neuromodulation offerings:
 
Cardiovascular
 
Coronary Stent Business
 
Drug-Eluting Stents
 
We market our TAXUS Express2 paclitaxel-eluting coronary stent system principally in the U.S., and we expect to launch the TAXUS Express2 stent system in Japan during the second half of 2007, subject to regulatory approval. In January 2007, the FDA approved extending the shelf life of our TAXUS coronary stent system in the U.S. from 12 to 18 months. We also market our second-generation coronary stent, the TAXUS® Liberté™ coronary stent system, in our European and Inter-Continental markets. We also expect to launch the TAXUS Liberté coronary stent system in the U.S., subject to regulatory approval.
 
During the fourth quarter of 2006, we launched our PROMUS everolimus-eluting coronary stent system in certain European countries, expanding our drug-eluting stent portfolio to include two distinct drug platforms. We expect to launch the PROMUS stent system in certain Inter-Continental countries during the second quarter of 2007 and in the U.S. in 2008, subject to regulatory approval. We also expect to launch an internally manufactured next-generation everolimus-based stent system in Europe in 2010 and in the U.S. in 2011. In addition, we have commenced regulatory filings to begin clinical trials for our next-generation paclitaxel-eluting stent beyond TAXUS Liberté stent system, the TAXUS® Element™ coronary stent system, which we expect to launch in Europe in 2009 and in the U.S. in 2010, subject to regulatory approval.
 
Bare-Metal Stents
 
We offer our Liberté coronary stent system globally. The Liberté coronary stent system serves as the platform for our second-generation paclitaxel-eluting stent system, the TAXUS Liberté coronary stent system. The Liberté bare-metal coronary stent is designed to enhance deliverability and conformability, particularly in challenging lesions.
 
Cardiac Surgery
 
Our acquisition of Guidant also enabled us to enter the cardiac surgery business. Cardiac surgery devices are used to perform endoscopic vessel harvesting, cardiac surgical ablation and less-invasive coronary artery by-pass surgery.
 
Coronary Revascularization
 
We market a broad line of products used to treat patients with atherosclerosis. Atherosclerosis, a principal cause of coronary artery obstructive disease, is characterized by a thickening of the walls of the coronary arteries and a narrowing of arterial lumens (openings) caused by the progressive development of deposits of plaque. The majority of our products in this market are used in percutaneous transluminal coronary angioplasty (PTCA) and include bare-metal and drug-
 
eluting stents, such as the TAXUS® paclitaxel-eluting coronary stent systems, PTCA balloon catheters, such as the Maverick® balloon catheter, the Cutting Balloon® microsurgical dilatation device, rotational atherectomy systems, guide wires, guide catheters and diagnostic catheters. We also market a broad line of fluid delivery sets, pressure monitoring systems, custom kits and accessories that enable the injection of contrast and saline or otherwise facilitate cardiovascular procedures.
 
Intraluminal Ultrasound Imaging
 
We market a family of intraluminal catheter-directed ultrasound imaging catheters and systems for use in coronary arteries and heart chambers as well as certain peripheral systems. In July 2006, we launched the new iLab Ultrasound Imaging System in the U.S. This new system enhances the diagnosis and treatment of blocked vessels and heart disorders.
 
Embolic Protection
 
 
Peripheral Interventions
 
We also sell various products designed to treat patients with peripheral disease (disease which appears in blood vessels other than in the heart and in biliary strictures), including a broad line of medical devices used in percutaneous transluminal angioplasty and peripheral vascular stenting. Our peripheral product line includes vascular access products, balloon catheters, stents and peripheral vascular catheters, wires and accessories. We also market the PolarCath peripheral dilatation system used in CryoPlasty® Therapy®, an innovative approach to the treatment of peripheral artery disease in the lower extremities. We launched in June 2006 the Sterling™ Balloon dilatation catheter, a dilatation catheter with several differentiating features, including the only pre- and post-stent dilatation indication for carotid artery stenting.
 
In January 2007, we completed the acquisition of EndoTex Interventional Systems, Inc., a development stage medical device company, and now market the NexStent® Carotid Stent System, a laser-cut, nitinol stent with a rolled sheet design that enables one stent size to adapt to multiple diameters in tapered or non-tapered vessel configurations.
 
Neurovascular Intervention
 
We market a line of coils (coated and uncoated), micro-delivery stents, micro-guidewires, micro-catheters, guiding catheters and embolics to neuroradiologists and neurosurgeons to treat diseases of the neurovascular system. We market the GDC® Coils (Guglielmi Detachable Coil) and Matrix® systems to treat brain aneurysms. We also offer the Wingspan™ Stent System with Gateway™ PTA Balloon Catheter under a Humanitarian Device Exemption (HDE) approval granted by the FDA. The Wingspan Stent System is designed to treat atherosclerotic lesions or accumulated plaque in brain arteries. Designed for the brain’s fragile vessels, the Wingspan Stent System is a self-expanding, nitinol stent sheathed in a delivery system that enables it to
 
reach and open narrowed arteries in the brain. The Wingspan Stent System is currently the only device available in the U.S. for the treatment of intracranial atherosclerotic disease (ICAD) and is indicated for improving cerebral artery lumen diameter in patients with ICAD who are unresponsive to medical therapy.
 
Vascular Surgery
 
We design abdominal, thoracic and peripheral vascular grafts for the treatment of aortic aneurysms and dissections, peripheral vascular occlusive diseases and dialysis access. Our grafts and fabrics are used for peripheral vascular and cardiovascular indications.
 
Electrophysiology
 
We offer medical devices for the diagnosis and treatment of cardiac conditions called arrhythmias (abnormal heartbeats). Included in our product offerings are RF generators, mapping systems, intracardiac ultrasound and steerable ablation catheters, as well as a line of diagnostic catheters and associated accessories. We also market the Chilli II™ cooled ablation catheter, the first bidirectional cooled-tip catheter available in the U.S. In 2006, we launched our next-generation line of RF generators, the MAESTRO 3000® Cardiac Ablation System.
 
Cardiac Rhythm Management
 
Through our acquisition of Guidant, we now offer a variety of implantable devices that can monitor the heart and deliver electricity to treat cardiac rhythm abnormalities, including tachycardia (abnormally fast or chaotic heart rhythms), heart failure and bradycardia (slow or irregular heart rhythms).
 
Our product offerings include:
 
·  
the VITALITY® family of defibrillators which provide a broad range of atrial (upper chambers of the heart) and ventricular (lower chambers) therapies to serve patients’ various needs;
 
·  
cardiac resynchronization therapy devices, like those in our CONTAK RENEWAL® family of devices, which can help reduce mortality and hospitalization;
 
·  
the INSIGNIA® family of pacemakers which offer proprietary blended sensor technology designed to measure patient workload through respiration and motion, providing rate response based on the patient’s activity; and
 
·  
the LATITUDE® Patient Management System, comprised of the LATITUDE Communicator, LATITUDE Website, CONTAK RENEWAL 3RF CRT-D and ZOOM® LATITUDE Programmer, which enables a physician or technician to monitor a patient’s device status and health data from home.
 
In October 2006, the FDA approved our LATITUDE® Patient Management System to be used for remote monitoring in certain existing ICD systems and cardiac resynchronization defibrillators. We are in the process of making this technology available to many of our current CRM patients.
 
The Frontier CRM technology is our next-generation CRM pulse generator platform that will incorporate new components and software and will be leveraged across all CRM product lines to
 
treat electrical dysfunction in the heart. We expect to launch various products based on the Frontier CRM technology in the U.S. over the next 36 months, subject to regulatory approval.
 
Endosurgery
 
Esophageal, Gastric and Duodenal (Small Intestine) Intervention
 
We market a broad range of products to diagnose, treat and palliate a variety of gastrointestinal diseases and conditions, including those affecting the esophagus, stomach and colon. Common disease states include esophagitis, portal hypertension, peptic ulcers and esophageal cancer. Our products in this area include disposable single and multiple biopsy forceps, balloon dilatation catheters, hemostasis catheters and enteral feeding devices. We also market a family of esophageal stents designed to offer improved dilatation force and greater resistance to tumor in-growth. We launched the Radial Jaw® 4 Single-Use Biopsy Forceps, the newest version of our Radial Jaw Single-Use Biopsy Forceps, in July 2006. The Radial Jaw 4 biopsy forceps are designed to enable collection of large high-quality tissue specimens without the need to use large channel therapeutic endoscopes.
 
Colorectal Intervention
 
We market a line of hemostatic catheters, polypectomy snares, biopsy forceps, enteral stents and dilatation catheters for the diagnosis and treatment of polyps, inflammatory bowel disease, diverticulitis and colon cancer.
 
Pancreatico-Biliary Intervention
 
We sell a variety of products to diagnose, treat and palliate benign and malignant strictures of the pancreatico-biliary system (the gall bladder, common bile duct, hepatic duct, pancreatic duct and the pancreas) and to remove stones found in the common bile duct. Our products include diagnostic catheters used with contrast media, balloon dilatation catheters and sphincterotomes. We also market self-expanding metal and temporary biliary stents for palliation and drainage of the common bile duct.  In 2006, we introduced the Spyglass™ Direct Visualization System for direct imaging of the bile duct system.  This is the first single operator cholangioscopy device that offers clinicians a direct visualization of the bile duct system and includes supporting devices for tissue acquisition, stone retrieval and lithotripsy.
 
Pulmonary Intervention
 
We market devices to diagnose, treat and palliate diseases of the pulmonary system. The major devices include pulmonary biopsy forceps, transbronchial aspiration needles, cytology brushes and tracheobronchial stents used to dilate strictures or for tumor management.
 
Urinary Tract Intervention and Bladder Disease
 
We sell a variety of products designed primarily to treat patients with urinary stone disease, including ureteral dilatation balloons used to dilate strictures or openings for scope access; stone baskets used to manipulate or remove the stone; intracorporeal shock wave lithotripsy devices and holmium laser systems used to disintegrate stones; ureteral stents implanted temporarily in the urinary tract to provide short-term or long-term drainage; and a wide variety of guidewires used to gain access to a specific site. We have also developed other devices to diagnose and treat bladder cancer and bladder obstruction.
 
Prostate Intervention
 
For the treatment of Benign Prostatic Hyperplasia (BPH), we currently market electro-surgical resection devices designed to resect large diseased tissue sites. We also market disposable needle biopsy devices, designed to take core prostate biopsy samples. In addition, we distribute and market the Prolieve thermodilatation system, a transurethral microwave thermotherapy system, and the DuoTome™ SideLite™ holmium laser treatment system for treatment of symptoms associated with BPH.
 
Pelvic Floor Reconstruction and Urinary Incontinence
 
We market a line of less-invasive devices to treat female pelvic floor conditions in the area of stress urinary incontinence and pelvic organ prolapse. These devices include a full line of mid-urethral sling products, sling materials, graft materials, suturing devices and injectables. In May 2006, we were granted exclusive U.S. distribution rights to the Coaptite® Injectable Implant, a next-generation bulking agent, for the treatment of stress urinary incontinence.    
 
Gynecology
 
We also market other products in the area of women’s health. Our Hydro ThermAblator® System (HTA® system) offers a less-invasive technology for the treatment of excessive uterine bleeding by ablating the lining of the uterus, the tissue responsible for menstrual bleeding.
 
Oncology
 
We market a broad line of products designed to treat, diagnose and palliate various forms of benign and malignant tumors. Our current suite of products includes microcatheters, embolic agents and coils designed to restrict blood supply to targeted sites. In addition, we market radiofrequency-based therapeutic devices for the ablation of various forms of soft tissue lesions (tumors). Also included in the oncology portfolio is a complete line of venous access products which are marketed for infusion therapy.
 
Neuromodulation
 
Cochlear Implants
 
We develop and market in the U.S., Europe and Japan the HiResolution® 90K Cochlear Implant System to restore hearing to the profoundly deaf. The technology consists of an external sound processor, which captures and processes sound information from the environment and transmits the digital information through the skin to the implant. The implant delivers digital pulses of electrical current to precise locations on the auditory nerve, which the brain perceives as sound. In September 2006, our next-generation cochlear implant technology, the Harmony HiResolution Bionic Ear System was approved by the FDA. We commercially launched this product on a limited basis in late 2006 and anticipate a full launch in early 2007.
 
Pain Management
 
We market the Precision® Spinal Cord Stimulation System for the treatment of chronic pain of the lower back and legs. This system delivers advanced pain management by applying a small electrical signal to mask pain signals traveling from the spinal cord to the brain. The Precision System utilizes a rechargeable battery and features a patient-directed fitting system for fast and effective programming. The Precision System is also being assessed for use in treating migraine pain.
 
 
Dedicated sales forces of approximately 2,400 individuals in approximately 45 countries internationally and over 3,400 individuals in the U.S. marketed our products worldwide as of December 31, 2006. Sales in countries where we have direct sales organizations accounted for approximately 94 percent of our net sales during 2006. A network of distributors and dealers who offer our products in more than 50 countries worldwide accounts for our remaining sales. We also have a dedicated corporate sales organization in the U.S. focused principally on selling to major buying groups and integrated healthcare networks.
 
In 2006, we sold our products to over 10,000 hospitals, clinics, out-patient facilities and medical offices. We are not dependent on any single institution and no single institution accounted for more than 10 percent of our net sales in 2006. Large group purchasing organizations, hospital networks and other buying groups have, however, become increasingly important to our business and represent a substantial portion of our U.S. net sales.
 
We also distribute certain products for third parties, including an introducer sheath and certain guidewires, as well as BPH devices, various graft materials, and pneumatic and laser lithotripters for use in connection with urology and gynecology procedures. Our agreement to distribute certain guidewire and sheath products expired during the first quarter of 2006. While we have identified replacements for these products, the sales level associated with the replacement products has been, as expected, less than that of our previously distributed products. Together, these distributed products represented less than two percent of our 2006 net sales. Leveraging our sales and marketing strength, we expect to continue to seek new opportunities for distributing complementary products as well as new technologies.
 
International Operations
 
Internationally, through 2006, we operated through three business units divided among the geographic regions of Europe, Japan and Inter-Continental. Maintaining and expanding our international presence is an important component of our long-term growth plan. Through our international presence, we seek to increase net sales and market share, leverage relationships with leading physicians and their clinical research programs, accelerate the time to bring new products to market and gain access to worldwide technological developments that may be implemented across our product lines. After our acquisition of Guidant, we integrated Guidant’s international sales operations into our geographic regions. Consistent with our geographic focus, the Guidant CRM business became a business unit within each country organization across Europe, Japan and Inter-Continental. In the first quarter of 2007, we began operating through four international business units: Europe, Asia Pacific/Japan, Inter-Continental and Distributor Management.
 
International sales accounted for approximately 38 percent of our net sales in 2006. Net sales and operating income attributable to significant geographic areas are presented in Note N—Segment Reporting to our 2006 consolidated financial statements included in Item 8 of this Form 10-K.
 
In recent years, we have expanded our direct sales presence worldwide so as to be in a position to take advantage of expanding market opportunities. As of December 31, 2006, we had direct marketing and sales operations in approximately 45 countries internationally. We believe that we will continue to leverage our infrastructure in markets where commercially appropriate and to use third parties in those markets where it is not economical or strategic to establish a direct presence.
 
We have five international manufacturing facilities in Ireland, one in Costa Rica and one in Puerto Rico. Presently, approximately 33 percent of our products sold worldwide are manufactured at these facilities. We also maintain an international research and development
 
facility in Ireland, a training facility in Tokyo, Japan, and a training and research and development center in Miyazaki, Japan. We currently share a training facility in Brussels, Belgium with Abbott.
 
Manufacturing and Raw Materials
 
We design and manufacture the majority of our products in technology centers around the world. Many components used in the manufacture of our products are readily fabricated from commonly available raw materials or off-the-shelf items available from multiple supply sources. Certain items are custom made for us to meet our specifications. We believe that in most cases, redundant capacity exists at our suppliers and that alternative sources of supply are available or could be developed within a reasonable period of time. We also have an ongoing program to identify single-source components and to develop alternative back-up supplies. However, in certain cases, we may not be able to quickly establish additional or replacement suppliers for specific components or materials, largely due to the regulatory approval system and the complex nature of the manufacturing processes employed by us and many suppliers. A reduction or interruption in supply, an inability to develop and validate alternative sources if required, or a significant increase in the price of raw materials or components could adversely affect our operations and financial condition, particularly materials or components related to our TAXUS® and PROMUS™ drug-eluting coronary stent systems and our CRM products.
 
Quality Assurance
 
On January 26, 2006, legacy Boston Scientific received a corporate warning letter from the FDA notifying us of serious regulatory problems at three of our facilities and advising us that our corporate-wide corrective action plan relating to three site-specific warning letters issued to us in 2005 was inadequate. As stated in this FDA warning letter, the FDA may not grant our requests for exportation certificates to foreign governments or approve pre-market approval (PMA) applications for class III devices to which the quality control or current good manufacturing practices deficiencies described in the letter are reasonably related until the deficiencies have been corrected. During 2005, in order to strengthen our corporate-wide quality controls, we established Project Horizon a corporate-wide cross-functional initiative to improve and harmonize our overall quality processes and systems. As part of Project Horizon, we have made modifications to our process validation and complaint management systems. Project Horizon resulted in the reallocation of significant internal engineering and management resources to quality initiatives, as well as incremental spending, which has resulted in adjustments to product launch schedules of certain products and the decision to discontinue certain other product lines over time.

In 2006, our Board of Directors created a Compliance and Quality Committee to monitor our compliance and quality initiatives. We believe we have identified solutions to the quality issues cited by the FDA, and we continue to make progress in transitioning our organization to implement those solutions. We communicate frequently and meet regularly with the FDA to apprise them of our progress. The FDA has communicated the need for us to complete substantially our remediation efforts before they will re-inspect our facilities. We have engaged a third party to audit our enhanced quality systems in order to assess our Company-wide compliance prior to re-inspection by the FDA. We believe we will be ready for third-party audit in the second quarter of 2007.

On December 23, 2005, Guidant received an FDA warning letter citing certain deficiencies with respect to its manufacturing quality systems and record keeping procedures in its CRM facility in St. Paul, Minnesota. This FDA warning letter followed an inspection by the FDA that was completed on September 1, 2005 and cited a number of observations. Guidant received a follow-up letter from the FDA dated January 5, 2006. As stated in this follow-up letter, until we have corrected the
 
identified deficiencies, the FDA may not grant requests for exportation certificates to foreign governments or approve PMA applications for class III devices to which the deficiencies described are reasonably related. The FDA conducted a further inspection of the CRM facility between December 15, 2005 and February 9, 2006 and made one additional inspectional observation. The FDA has concluded its reinspection of our CRM facilities. While we believe this reinspection went well, we may be required to take additional actions in order to comply with any FDA observations that we may receive.
 
We are committed to providing high quality products to our customers. To meet this commitment, we are implementing updated quality systems and concepts throughout our organization. Our quality system starts with the initial product specification and continues through the design of the product, component specification process and the manufacturing, sales and servicing of the product. Our quality system is designed to build in quality and process control and to utilize continuous improvement concepts throughout the product life. These systems are designed to enable us to satisfy the quality system regulations of the FDA with respect to products sold in the U.S. Many of our operations are certified under ISO 9001, ISO 9002, ISO 13485, ISO 13488, EN 46001 and EN 46002 international quality system standards. ISO 9002 requires, among other items, an implemented quality system that applies to component quality, supplier control and manufacturing operations. In addition, ISO 9001 and EN 46001 require an implemented quality system that applies to product design. These certifications can be obtained only after a complete audit of a company’s quality system by an independent outside auditor. Maintenance of these certifications requires that these facilities undergo periodic re-examination.
 
We maintain an ongoing initiative to seek ISO 14001 certification at our plants around the world. ISO 14001, the environmental management system standard in the ISO 14000 series, provides a voluntary framework to identify key environmental aspects associated with our businesses. We engage in continuous environmental performance improvement around these aspects. At present, nine of our manufacturing and distribution facilities have attained ISO 14001 certification. This initiative is expected to continue until each of our manufacturing facilities, including those we acquire, becomes certified.
 
Competition
 
We encounter significant competition across our product lines and in each market in which our products are sold from various companies, some of which may have greater financial and marketing resources than we do. Our primary competitors have historically included Johnson & Johnson (including its subsidiary, Cordis Corporation) and Medtronic, Inc. (including its subsidiary, Medtronic AVE, Inc.), as well as a wide range of companies which sell a single or limited number of competitive products or participate only in a specific market segment. Since we acquired Guidant, Abbott Laboratories has become a competitor of ours in the interventional cardiology market and St. Jude Medical, Inc. has become a competitor of ours in the CRM market, in addition to the Neuromodulation market. We also face competition from non-medical device companies, such as pharmaceutical companies, which may offer alternative therapies for disease states intended to be treated using our products.
 
We believe that our products compete primarily on the basis of their ability to safely and effectively perform diagnostic and therapeutic procedures in a less-invasive manner, including ease of use, reliability and physician familiarity. In the current environment of managed care, economically motivated buyers, consolidation among healthcare providers, increased competition and declining reimbursement rates, we have also increasingly been required to compete on the basis of price, value, reliability and efficiency. We believe that our continued competitive success will depend upon our ability to create or acquire scientifically advanced technology, apply our
 
technology cost-effectively and with superior quality across product lines and markets, develop or acquire proprietary products, attract and retain skilled development personnel, obtain patent or other protection for our products, obtain required regulatory and reimbursement approvals, continually enhance our quality systems, manufacture and successfully market our products either directly or through outside parties and supply sufficient inventory to meet customer demand.
 
 
The medical devices that we manufacture and market are subject to regulation by numerous regulatory bodies, including the FDA and comparable international regulatory agencies. These agencies require manufacturers of medical devices to comply with applicable laws and regulations governing the development, testing, manufacturing, labeling, marketing and distribution of medical devices. Devices are generally subject to varying levels of regulatory control, the most comprehensive of which requires that a clinical evaluation program be conducted before a device receives approval for commercial distribution.
 
In the U.S., permission to distribute a new device generally can be met in one of two ways. The first process requires that a pre-market notification (a 510(k) Submission) be made to the FDA to demonstrate that the device is as safe and effective as, or substantially equivalent to, a legally marketed device that is not subject to pre-market approval (PMA) (i.e., the “predicate” device). An appropriate predicate device for a pre-market notification is one that (i) was legally marketed prior to May 28, 1976, (ii) was approved under a PMA but then subsequently reclassified from class III to class II or I, or (iii) has been found to be substantially equivalent and cleared for commercial distribution under a 510(k) Submission. Applicants must submit descriptive data and, when necessary, performance data to establish that the device is substantially equivalent to a predicate device. In some instances, data from human clinical trials must also be submitted in support of a 510(k) Submission. If so, these data must be collected in a manner that conforms to the applicable Investigational Device Exemption (IDE) regulations. The FDA must issue an order finding substantial equivalence before commercial distribution can occur. Changes to existing devices covered by a 510(k) Submission which do not raise new questions of safety or effectiveness can generally be made by us without additional 510(k) Submissions. More significant changes, such as new designs or materials, may require a separate 510(k) with data to support that the modified device remains substantially equivalent.
 
The second process requires that an application for PMA be made to the FDA to demonstrate that the device is safe and effective for its intended use as manufactured. This approval process applies to certain class III devices. In this case, two steps of FDA approval are generally required before marketing in the U.S. can begin. First, we must comply with the applicable IDE regulations in connection with any human clinical investigation of the device in the U.S. Second, the FDA must review our PMA application which contains, among other things, clinical information acquired under the IDE. The FDA will approve the PMA application if it finds that there is a reasonable assurance that the device is safe and effective for its intended purpose.
 
The FDA can ban certain medical devices; detain or seize adulterated or misbranded medical devices; order repair, replacement or refund of these devices; and require notification of health professionals and others with regard to medical devices that present unreasonable risks of substantial harm to the public health. The FDA may also enjoin and restrain certain violations of the Food, Drug and Cosmetic Act and the Safe Medical Devices Act pertaining to medical devices, or initiate action for criminal prosecution of such violations. International sales of medical devices manufactured in the U.S. that are not approved by the FDA for use in the U.S., or are banned or deviate from lawful performance standards, are subject to FDA export
 
requirements. Exported devices are subject to the regulatory requirements of each country to which the device is exported. Some countries do not have medical device regulations, but in most foreign countries medical devices are regulated. Frequently, regulatory approval may first be obtained in a foreign country prior to application in the U.S. to take advantage of differing regulatory requirements. Most countries outside of the United States require that product approvals be recertified on a regular basis, generally every five years. The recertification process requires that we evaluate any device changes and any new regulations or standards relevant to the device and conduct appropriate testing to document continued compliance. Where recertification applications are required, they must be approved in order to continue to sell our products in those countries.
 
In the European Union, we are required to comply with the Medical Devices Directive and obtain CE Mark certification in order to market medical devices. The CE Mark certification, granted following approval from an independent Notified Body, is an international symbol of adherence to quality assurance standards and compliance with applicable European Medical Devices Directives. We also comply with all other foreign regulations such as the requirement that we obtain Ministry of Health, Labor and Welfare approval before we can launch new products in Japan, including our TAXUS® Express2 coronary stent system. The time required to obtain these foreign approvals to market our products may be longer or shorter than that required in the U.S., and requirements for such approval may differ from those required by the FDA.
 
We are also subject to various environmental laws, directives and regulations both in the U.S. and abroad. Our operations, like those of other medical device companies, involve the use of substances regulated under environmental laws, primarily in manufacturing and sterilization processes. We believe that compliance with environmental laws will not have a material impact on our capital expenditures, earnings or competitive position. Given the scope and nature of these laws, however, there can be no assurance that environmental laws will not have a material impact on our results of operations. We assess potential environmental contingent liabilities on a quarterly basis. At present, we are not aware of any such liabilities which would have a material impact on our business. We are also certified with respect to the enhanced environmental FTSE4Good criteria and are a constituent member of the London Stock Exchanges FTSE4Good Index, which recognizes companies that meet certain corporate responsibility standards.
 
Third-Party Coverage and Reimbursement
 
Our products are purchased by hospitals, doctors and other healthcare providers who are reimbursed by third-party payors, such as governmental programs (e.g., Medicare and Medicaid), private insurance plans and managed care programs, for the healthcare services provided to their patients. Third-party payors may provide or deny coverage for certain technologies and associated procedures based on assessment criteria as determined by the third-party payor. Reimbursement by third-party payors for these services is based on a wide range of methodologies that may reflect the services’ assessed resource costs, clinical outcomes and economic value. These reimbursement methodologies confer different, and often conflicting, levels of financial risk and incentives to healthcare providers and patients, and these methodologies are subject to frequent refinements. Third-party payors are also increasingly adjusting reimbursement rates and challenging the prices charged for medical products and services. There can be no assurance that our products will be automatically covered by third-party payors, that reimbursement will be available or, if available, that the third-party payors’ coverage policies will not adversely affect our ability to sell our products profitably.
 
Initiatives to limit the growth of healthcare costs, including price regulation, are also underway in many countries in which we do business. Implementation of cost containment initiatives and healthcare reforms in significant markets such as Japan, Europe and other international markets may limit the
 
price of, or the level at which reimbursement is provided for, our products and may influence a physician’s selection of products used to treat patients.
 
Proprietary Rights and Patent Litigation
 
We rely on a combination of patents, trademarks, trade secrets and non-disclosure agreements to protect our intellectual property. We generally file patent applications in the U.S. and foreign countries where patent protection for our technology is appropriate and available. We hold approximately 6,000 U.S. patents (many of which have foreign counterparts) and have more than 8,600 patent applications pending worldwide that cover various aspects of our technology. In addition, we hold exclusive and non-exclusive licenses to a variety of third-party technologies covered by patents and patent applications. There can be no assurance that pending patent applications will result in issued patents, that patents issued to or licensed by us will not be challenged or circumvented by competitors, or that such patents will be found to be valid or sufficiently broad to protect our technology or to provide us with a competitive advantage.
 
We rely on non-disclosure and non-competition agreements with employees, consultants and other parties to protect, in part, trade secrets and other proprietary technology. There can be no assurance that these agreements will not be breached, that we will have adequate remedies for any breach, that others will not independently develop equivalent proprietary information or that third parties will not otherwise gain access to our trade secrets and proprietary knowledge.
 
There has been substantial litigation regarding patent and other intellectual property rights in the medical device industry, particularly in the areas in which we compete. We have defended, and will continue to defend, ourself against claims and legal actions alleging infringement of the patent rights of others. Adverse determinations in any patent litigation could subject us to significant liabilities to third parties, require us to seek licenses from third parties, and, if licenses are not available, prevent us from manufacturing, selling or using certain of our products, which could have a material adverse effect on us.
 
Additionally, we may find it necessary to initiate litigation to enforce our patent rights, to protect our trade secrets or know-how and to determine the scope and validity of the proprietary rights of others. Patent litigation can be costly and time-consuming, and there can be no assurance that our litigation expenses will not be significant in the future or that the outcome of litigation will be favorable to us. Accordingly, we may seek to settle some or all of our pending litigation. Settlement may include cross-licensing of the patents which are the subject of the litigation as well as our other intellectual property and may involve monetary payments to or from third parties.
 
 
Risk Management
 
The testing, marketing and sale of human healthcare products entails an inherent risk of product liability claims. We are involved in various lawsuits arising in the normal course of business from product liability and securities claims. We are substantially self-insured with respect to general, product liability and securities claims. As a result of the economic factors currently impacting the insurance industry, meaningful liability insurance coverage became unavailable due to its economically prohibitive cost.

In connection with our acquisition of Guidant, the number of product liability claims and other legal proceedings filed against us, including private securities litigation and shareholder derivative suits, significantly increased. Product liability and securities claims against us may be asserted in the future related to unknown events at the present time. The absence of significant third-party insurance coverage increases our potential exposure to unanticipated claims or adverse decisions. Product liability claims, product recalls, securities litigation and other litigation in the future, regardless of their outcome, could have a material adverse effect on our business. We believe that our risk management practices, including limited insurance coverage, are reasonably adequate to protect against anticipated general, product liability and securities litigation losses. However, unanticipated catastrophic losses could have a material adverse impact on our financial position, results of operations and liquidity.
 
Employees
 
As of December 31, 2006, we had approximately 28,600 employees, including approximately 14,300 in operations, 2,000 in administration, 4,600 in clinical, regulatory and research and development and 7,700 in selling, marketing, distribution and related administrative support. Of these employees, approximately 14,500 were employed outside the U.S., approximately 6,200 of which are included in the Operations function. We believe that the continued success of our business will depend, in part, on our ability to attract and retain qualified personnel.
 
Seasonality
 
Our worldwide sales do not reflect any significant degree of seasonality; however, customer purchases have been lighter in the third quarter of prior years than in other quarters. This reflects, among other factors, lower demand during summer months, particularly in European countries.
 
Available Information
 
Copies of our annual report on Form 10-K, quarterly reports on Form 10-Q, current reports on Form 8-K and amendments to those reports filed or furnished pursuant to Section 13(a) or 15(d) of the Securities Exchange Act of 1934 are available free of charge on our website (www.bostonscientific.com) as soon as reasonably practicable after we electronically file the material with or furnish it to the SEC. Our Corporate Governance Guidelines and Code of Conduct, which applies to all of our directors, officers and employees, including our Board of Directors, Chief Executive Officer, Chief Financial Officer and Corporate Controller, are also available on our website (along with any amendments to those documents). Any amendments to or waivers for executive officers or directors of our Code of Conduct will be disclosed on our website promptly after the date of any such amendment or waiver. Printed copies of these posted materials are also available free of charge to shareholders who request them in writing from Investor Relations, One Boston Scientific Place, Natick, MA 01760-1537. Information on our website or connected to our website is not incorporated by reference into this Form 10-K.
 
Cautionary Statement for Purposes of the Safe Harbor Provisions of the Private Securities Litigation Reform Act of 1995
 
Certain statements that we may make from time to time, including statements contained in this report and information incorporated by reference into this report, constitute “forward-looking statements.” Forward-looking statements may be identified by words like “anticipate,” “expect,” “project,” “believe,” “plan,” “estimate,” “intend” and similar words used in connection with, among other things, discussions of our financial performance, growth strategy, regulatory
 
approvals, product development or new product launches, market position, sales efforts, intellectual property matters or acquisitions and divestitures. These forward-looking statements are based on our beliefs, assumptions and estimates using information available to us at the time and are not intended to be guarantees of future events or performance. If our underlying assumptions turn out to be incorrect, or if certain risks or uncertainties materialize, actual results could vary materially from the expectations and projections expressed or implied by our forward-looking statements. As a result, investors are cautioned not to place undue reliance on any of our forward-looking statements.
 
We do not intend to update the forward-looking statements below or the risk factors described in Item 1A under the heading “Risk Factors” even if new information becomes available or other events occur in the future. We have identified these forward-looking statements below and the risk factors described in Item 1A under the heading “Risk Factors” in order to take advantage of the safe harbor provisions of the Private Securities Litigation Reform Act of 1995. Certain factors that could cause actual results to differ materially from those expressed in forward-looking statements are contained below and in the risk factors described in Item 1A under the heading “Risk Factors.”
 
CRM Business
 
·  
The recovery of the CRM market to historical growth rates and our ability to regain CRM market share and increase CRM net sales;
 
·  
The overall performance of and referring physician, implanting physician and patient confidence in our and other CRM products and technologies, including our LATITUDE® Patient Management System and Frontier CRM technology;
 
·  
The results of CRM clinical trials undertaken by us, our competitors or other third parties;
 
·  
Our ability to launch various products utilizing the Frontier CRM technology, our next generation CRM pulse generator platform, in the U.S. over the next 36 months and to expand our CRM market position through reinvestment in our CRM products and technologies;
 
·  
Our ability to retain our CRM sales force and other key personnel;
 
·  
Competitive offerings in the CRM market and the timing of receipt of regulatory approvals to market existing and anticipated CRM products and technologies; and
 
   · 
Our ability to avoid disruption in the supply of certain components or materials or to quickly secure additional or replacement components or materials on a timely basis.
 
Coronary Stent Business
 
 
   ·
Volatility in the coronary stent market, competitive offerings and the timing of receipt of regulatory approvals to market existing and anticipated drug-eluting stent technology and other coronary and peripheral stent platforms;

 
   ·
Our ability to launch our TAXUS® Express2 coronary stent system in Japan during the second half of 2007, and to launch our next-generation drug-eluting stent system, the TAXUS® Liberté™ coronary stent system, in the U.S., subject to regulatory approval, and to maintain or expand our worldwide market leadership positions through reinvestment in our drug-eluting stent program;

 
   · 
The continued availability of our TAXUS stent system in sufficient quantities and mix, our ability to prevent disruptions to our TAXUS stent system manufacturing processes and to maintain or replenish inventory levels consistent with forecasted demand around the world as we transition to next-generation stent products;

     ·
The impact of concerns relating to late stent thrombosis on the size of the coronary stent market, distribution of share within the coronary stent market in the U.S. and around the world, the average number of stents used per procedure and average selling prices;

 
   · 
The overall performance of and continued physician confidence in our and other drug-eluting stents, our ability to adequately address concerns regarding the risk of late stent thrombosis, and the results of drug-eluting stent clinical trials undertaken by us, our competitors or other third parties;

 
   · 
Our ability to sustain or increase the penetration rate of drug-eluting stent technology in the U.S. and our European and Inter-Continental markets;

·   
Our ability to take advantage of our position as one of two early entrants in the U.S. drug-eluting stent market, to anticipate competitor products as they enter the market and to respond to the challenges presented as additional competitors enter the U.S. drug-eluting stent market;

 
   ·
Our ability to manage inventory levels, accounts receivable, gross margins and operating expenses relating to our drug-eluting stent systems and other product franchises and to react effectively to worldwide economic and political conditions;

·   
Our ability to manage the launch of our PROMUS™ everolimus-eluting stent system and the supply of this stent system in sufficient quantities and mix; and

·   
Our ability to manage the mix of our PROMUS stent system revenue relative to our total drug-eluting stent revenue and maintain our overall profitability as a percentage of revenue.
 
Litigation and Regulatory Compliance
 
 
   · 
Any conditions imposed in resolving, or any inability to resolve, our outstanding warning letters or other FDA matters, as well as risks generally associated with our regulatory compliance quality systems and complaint handling;

·   
The effect of our litigation, risk management practices, including self-insurance, and compliance activities on our loss contingency, legal provision and cash flow;

 
   · 
The impact of our stockholder derivative and class action, patent, product liability, contract and other litigation and other legal proceedings;

 
   · 
The ongoing, inherent risk of potential physician communications or field actions related to medical devices;

·   
Costs associated with our incremental compliance and quality initiatives, including Project Horizon; and

·   
The availability and rate of third-party reimbursement for our products and procedures.
 
Innovation
 
 
   · 
Our ability to complete planned clinical trials successfully, to obtain regulatory approvals and to develop and launch products on a timely basis within cost estimates, including the successful completion of in-process projects from purchased research and development;

 
   ·
Our ability to manage research and development and other operating expenses consistent with our expected revenue growth;

 
   · 
Our ability to fund and achieve benefits from our focus on internal research and development and external alliances as well as our ability to capitalize on opportunities across our businesses;

 
   · 
Our ability to develop products and technologies successfully in addition to our drug-eluting stent and cardiac rhythm management technologies;

 
   · 
Our ability to develop next-generation products and technologies within our drug-eluting stent and cardiac rhythm management business;
 
 
   · 
Our failure to succeed at, or our decision to discontinue, any of our growth initiatives;

 
   · 
Our ability to integrate the acquisitions and other strategic alliances we have consummated, including Guidant;

 
   · 
Our decision to exercise, or not to exercise, options to purchase certain companies party to our strategic alliances and our ability to fund with cash or common stock these and other acquisitions, or to fund contingent payments associated with these alliances;

 
   · 
The timing, size and nature of strategic initiatives, market opportunities and research and development platforms available to us and the ultimate cost and success of these initiatives; and

 
   · 
Our ability to successfully identify, develop and market new products or the ability of others to develop products or technologies that render our products or technologies noncompetitive or obsolete.
 
International Markets
 
 
   · 
Dependency on international net sales to achieve growth;

 
   · 
Risks associated with international operations, including compliance with local legal and regulatory requirements as well as reimbursement practices and policies; and
 
 
   ·   
The potential effect of foreign currency fluctuations and interest rate fluctuations on our net sales, expenses and resulting margins.
 
Liquidity
 
 
   ·  
Our ability to generate sufficient cash flow to fund operations and capital expenditures, as well as our strategic investments over the next twelve months and to maintain borrowing flexibility beyond the next twelve months;

 
   ·
Our ability to access the public capital markets and to issue debt or equity securities on terms reasonably acceptable to us;

 
   · 
Our ability to achieve a 21 percent effective tax rate, excluding certain charges, during 2007 and to recover substantially all of our deferred tax assets;

·   
Our ability to maintain investment-grade credit ratings and satisfy our financial covenants;

·   
Our ability to generate sufficient cash flow to effectively manage our debt levels and minimize the impact of interest rate fluctuations on our floating-rate debt; and

 
   · 
Our ability to better align expenses with future expected revenue levels and reallocate resources to support our future growth.
 
Other
 
 
   ·  
Risks associated with significant changes made or to be made to our organizational structure or to the membership of our executive committee; and

 
   ·  
Risks associated with our acquisition of Guidant Corporation, including, among other things, the indebtedness we have incurred and the integration costs and challenges we will continue to face.
 
Several important factors, in addition to the specific factors discussed in connection with each forward-looking statement individually and the risk factors described in Item 1A under the heading “Risk Factors,” could affect our future results and growth rates and could cause those results and rates to differ materially from those expressed in the forward-looking statements and the risk factors contained in this report. These additional factors include, among other things, future economic, competitive, reimbursement and regulatory conditions, new product introductions, demographic trends, intellectual property, financial market conditions and future business decisions made by us and our competitors, all of which are difficult or impossible to predict accurately and many of which are beyond our control. Therefore, we wish to caution each reader of this report to consider carefully these factors as well as the specific factors discussed with each forward-looking statement and risk factor in this report and as disclosed in our filings with the SEC. These factors, in some cases, have affected and in the future (together with other factors) could affect our ability to implement our business strategy and may cause actual results to differ materially from those contemplated by the statements expressed in this report.
 
 
In addition to the other information contained in this Form 10-K and the exhibits hereto, the following risk factors should be considered carefully in evaluating our business. Our business, financial condition or results of operations could be materially adversely affected by any of these risks. This section contains forward-looking statements. You should refer to the explanation of the qualifications and limitations on forward-looking statements set forth at the end of Item 1 of this Form 10-K. Additional risks not presently known to us or that we currently deem immaterial may also adversely affect our business, financial condition or results of operations.
 
We derive a significant portion of our revenue from the sale of drug-eluting coronary stent systems and a decline in market size or our market share of drug-eluting stents may adversely affect our results of operations or financial condition.
 
Drug-eluting coronary stent revenues represented approximately 30 percent of our consolidated net sales during the fiscal year ended December 31, 2006. Our U.S. TAXUS sales declined in 2006 relative to 2005, due in part to a decline in the U.S. market size attributable to recent uncertainty regarding the risk of late stent thrombosis following the use of drug-eluting stents. Late stent thrombosis is the formation of a clot, or thrombus, within the stented area one year or more after implantation of the stent. In the fourth quarter of 2006, the FDA held a special advisory panel meeting to discuss drug-eluting stents. If concerns about the risk of late stent thrombosis persist, there can be no assurance that the market will return to previous levels.  

In addition, lower device utilization per procedure and a decline in the overall percutaneous coronary intervention market contributed to the decline in our TAXUS stent system sales in 2006. There can be no assurance that these concerns will be alleviated in the near term or that drug-eluting stent penetration rates will return to previous levels. Our TAXUS® coronary stent system and Johnson & Johnson’s CYPHER® drug-eluting stent system are currently the only two drug-eluting stents available in the U.S. market. We expect our share of the drug-eluting stent market, as well as unit prices, to continue to be adversely affected as additional significant competitors enter the drug-eluting stent market, which began during the third quarter of 2005 internationally and is expected to continue to occur as early as the second half of 2007 in the U.S. In July 2005, Medtronic, Inc. received approval from European regulators to begin commercial sales of its Endeavor® drug-eluting stent system in the European market. As a result of Abbott’s acquisition of Guidant’s drug-eluting stent portfolio, Abbott sells its XIENCE™ V everolimus-eluting stent system in competition with us in certain international markets. In addition, Conor Medsystems, Inc., which was recently acquired by Johnson & Johnson, sells its CoStar® paclitaxel-eluting stent system in competition with us in certain international markets.
 
The manufacture of our TAXUS® coronary stent system involves the integration of multiple technologies, critical components, raw materials and complex processes. Significant favorable or unfavorable changes in forecasted demand, as well as disruptions associated with our TAXUS® stent manufacturing process, may impact our inventory levels. Variability in expected demand or the timing of the launch of next-generation products may result in excess or expired inventory positions and future inventory charges, which may adversely impact our results from operations. We share with Abbott rights to Guidant’s XIENCE™ V everolimus-eluting stent program. As a result, delays in receipt of regulatory approvals for the XIENCE™ V everolimus-eluting stent system, receipt of insufficient quantities of the PROMUS everolimus-eluting stent from Abbott or material nonacceptance of these stents in the marketplace could adversely affect our results from operations, as well as our ability to effectively differentiate ourselves from our competitors in the drug-eluting stent market as the leading company with two drug-eluting stent programs.
 
The worldwide CRM market growth rates declined during 2006 and if the CRM market does not recover, our results of operation and financial condition may be adversely impacted.
 
During 2005 and 2006, the operating and financial performance of our CRM business has been adversely impacted by various implantable defibrillator and pacemaker system field actions in the industry and a corresponding reduction in CRM market growth rates. We believe that field actions in the industry contributed to our CRM division having a lower market share for implantable defibrillator and pacemaker systems for 2006 as compared to 2005. The worldwide CRM market growth rate, including the U.S. defibrillator market growth rate, declined during the first three quarters of 2006; these growth levels are below those experienced in recent years. The U.S. defibrillator market represents approximately half of the worldwide CRM market. There can be no assurance that the CRM market will return to its historical growth rate
 
or that we will be able to regain CRM market share or increase net sales in a timely manner, if at all.
 
Because we derive a significant amount of our revenues from our cardiovascular business, changes in market or regulatory conditions that impact that business or our inability to develop non-cardiovascular products, could have a material adverse effect on our business, financial condition or results of operation.
 
During 2006, approximately 80 percent of our net sales were derived from our cardiovascular business, which includes our interventional cardiology, cardiac rhythm management and cardiovascular divisions. As a result, our sales growth and profitability from our cardiovascular business may be limited by risks and uncertainties related to market or regulatory conditions that impact that business.  For example, if the worldwide CRM market and the U.S. ICD market do not return to their historical growth rates or we are unable to regain CRM market share or increase CRM net sales, it may adversely affect our business, financial condition or results of operation.  Coronary stent revenue represented approximately 32 percent of our consolidated net sales for 2006.  If the decline in U.S. drug-eluting stent market penetration attributable to concerns regarding the risk of late stent thrombosis following the use of drug-eluting stents or the declines in device utilization per procedure and overall percutaneous coronary intervention volumes continue, there can be no assurance that the drug-eluting stent market will recover to previous levels which may have a material adverse effect on our business.  Similarly, our inability to develop products and technologies successfully in addition to our drug-eluting stent and cardiac rhythm management technologies could further expose us to fluctuations and uncertainties in these markets.
 
We may be unable to resolve issues related to our warning letters in a timely manner, which could delay the production and sale of our products and have an adverse impact on our business, financial condition and results of operation.
 
We are currently taking remedial action in response to certain deficiencies of our quality systems as cited by the FDA in its warning letters to us. For example, on January 26, 2006, we received a corporate warning letter from the FDA notifying us of serious regulatory problems at three of our facilities and advising us that our corrective action plan relating to three site-specific warning letters issued to us in 2005 was inadequate. As stated in this FDA warning letter, the FDA may not grant our requests for exportation certificates to foreign governments or approve pre-market approval (PMA) applications for our class III devices to which the quality control or current good manufacturing practices deficiencies described in the letter are reasonably related until the deficiencies have been corrected. If we are unable to resolve the issues raised by the FDA in its warning letters to the satisfaction of the FDA on a timely basis, we may not be able to launch our new class III devices as planned, including our Taxus® Liberté™ drug-eluting stent system in the United States, which may weaken our competitive position in the markets in which we participate.
 
In addition, in December 2005, Guidant received an FDA warning letter citing certain deficiencies with respect to its manufacturing quality systems and record keeping procedures in its CRM facility in St. Paul, Minnesota. This FDA warning letter followed an inspection by the FDA that was completed on September 1, 2005 and cited a number of observations. Guidant received a follow-up letter from the FDA dated January 5, 2006. As stated in this follow-up letter, until the identified deficiencies have been corrected, the FDA may not grant requests for exportation certificates to foreign governments or approve PMA applications for class III devices to which the deficiencies described are reasonably related. The FDA conducted a further inspection of the CRM facility between December 15, 2005 and February 9, 2006 and made one additional inspectional observation. The FDA has concluded its reinspection of our CRM facilities. We may be required to take additional actions in order to comply with any FDA observations that we may receive.
 
We may face enforcement actions in connection with these FDA warning letters, including injunctive relief, consent decrees or civil fines. While we are working with the FDA to resolve these issues, this work has required and will continue to require the dedication of significant incremental internal and external resources and has resulted in adjustments to the product launch schedules of certain products and the decision to discontinue certain other product lines over time. There can be no assurances regarding the length of time or cost it will take us to resolve these issues to the satisfaction of the FDA. In addition, if our remedial actions are not satisfactory to the FDA, we may have to devote additional financial and human resources to our efforts and the FDA may take further regulatory actions against us including, but not limited to, seizing our product inventory, obtaining a court injunction against further marketing of our products, assessing civil monetary penalties or imposing a consent decree on us, which could result in further regulatory constraints, including the governance of our quality system by a third party. If we or our manufacturers fail to adhere to QSR or ISO requirements, this could delay production of our products and lead to fines, difficulties in obtaining regulatory clearances, recalls or other consequences, which could in turn have a material adverse effect on our financial condition or results of operations.
 
We are subject to extensive medical device regulation which may impede or hinder the approval process for our products and, in some cases, may not ultimately result in approval or may result in the recall or seizure of previously approved products.
 
Our products, development activities and manufacturing processes are subject to extensive and rigorous regulation by the FDA pursuant to the federal Food, Drug, and Cosmetic Act (the FDC Act), by comparable agencies in foreign countries, and by other regulatory agencies and governing bodies. Under the FDC Act, medical devices must receive FDA clearance or approval before they can be commercially marketed in the U.S. In addition, most major markets for medical devices outside the U.S. require clearance, approval or compliance with certain standards before a product can be commercially marketed. The process of obtaining marketing approval or clearance from the FDA for new products, or with respect to enhancements or modifications to existing products, could:
 
• take a significant period of time;
• require the expenditure of substantial resources;
• involve rigorous pre-clinical and clinical testing;
• require changes to the products; and
• result in limitations on the indicated uses of the products.

Countries around the world have recently adopted more stringent regulatory requirements that are expected to add to the delays and uncertainties associated with new product releases, as well as the clinical and regulatory costs of supporting those releases. Even after products have received marketing approval or clearance, product approvals and clearances by the FDA can be withdrawn due to failure to comply with regulatory standards or the occurrence of unforeseen problems following initial approval. There can be no assurance that we will receive the required clearances from the FDA for new products or modifications to existing products on a timely basis or that any FDA approval will not be subsequently withdrawn.

In addition, regulations regarding the development, manufacture and sale of medical devices are subject to future change. We cannot predict what impact, if any, those changes might have on our business. Failure to comply with regulatory requirements could have a material adverse effect on our business, financial condition and results of operations. Later discovery of previously unknown problems with a product or manufacturer could result in fines, delays or suspensions of regulatory clearances, seizures or recalls of products, operating restrictions and/or criminal prosecution. The failure to receive product approval clearance on a timely basis, suspensions of regulatory clearances, seizures or recalls of products or the withdrawal of product approval by the FDA could have a material adverse effect on our business, financial condition or results of operations.
 
 
As a device manufacturer, we are required to register with the FDA and are subject to periodic inspection by the FDA for compliance with the FDA’s Quality System Regulation (QSR) requirements, which require manufacturers of medical devices to adhere to certain regulations, including testing, quality control and documentation procedures. In addition, the federal Medical Device Reporting regulations require us to provide information to the FDA whenever there is evidence that reasonably suggests that a device may have caused or contributed to a death or serious injury or, if a malfunction were to occur, could cause or contribute to a death or serious injury. Compliance with applicable regulatory requirements is subject to continual review and is
 
rigorously monitored through periodic inspections by the FDA. In the European Community, we are required to maintain certain ISO certifications in order to sell our products and must undergo periodic inspections by notified bodies to obtain and maintain these certifications.
 
Pending and future intellectual property litigation could be costly and disruptive to us.
 
We operate in an industry that is susceptible to significant intellectual property litigation and, in recent years, it has been common for companies in the medical device field to aggressively challenge the patent rights of other companies in order to prevent the marketing of new devices. We are currently the subject of various patent litigation proceedings and other proceedings described in more detail under Item 3. Legal Proceedings. Intellectual property litigation is expensive, complex and lengthy and its outcome is difficult to predict. Pending or future patent litigation may result in significant royalty or other payments or injunctions that can prevent the sale of products and may significantly divert the attention of our technical and management personnel. In the event that our right to market any of our products is successfully challenged, and if we fail to obtain a required license or are unable to design around a patent, our business, financial condition or results of operations could be materially adversely affected.
 
We may not effectively be able to protect our intellectual property rights which could have an adverse effect on our business, financial condition or results of operations.
 
The medical device market in which we primarily participate is in large part technology driven. Physician customers, particularly in interventional cardiology, move quickly to new products and new technologies. As a result, intellectual property rights, particularly patents and trade secrets, play a significant role in product development and differentiation. However, intellectual property litigation to defend or create market advantage is inherently complex and unpredictable. Furthermore, appellate courts frequently overturn lower court patent decisions.
 
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 of individual cases, but also of a series of pending and potentially related and unrelated cases. In addition, although monetary and injunctive relief is typically sought, remedies and restitution are generally not determined until the conclusion of the proceedings and are frequently 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.
 
Several third parties have asserted that our current and former stent systems or other products infringe patents owned or licensed by them. Adverse outcomes in one or more of these proceedings against us could limit our ability to sell certain stent products in certain jurisdictions, or reduce our operating margin on the sale of these products. In addition, damage awards related to historical sales could be material. We have similarly asserted that stent systems or other products sold by these companies infringe patents owned or licensed by us.
 
Patents and other proprietary rights are and will be essential to our business, and our ability to compete effectively with other companies will be dependent upon the proprietary nature of our technologies. We rely upon trade secrets, know-how, continuing technological innovations, strategic alliances and licensing opportunities to develop, maintain and strengthen our competitive position. We pursue a policy of generally obtaining patent protection in both the U.S. and abroad for patentable subject matter in our proprietary devices and also attempt to review
 
third-party patents and patent applications to the extent publicly available to develop an effective patent strategy, avoid infringement of third-party patents, identify licensing opportunities and monitor the patent claims of others. We currently own numerous U.S. and foreign patents and have numerous patent applications pending. We also are party to various license agreements pursuant to which patent rights have been obtained or granted in consideration for cash, cross-licensing rights or royalty payments. No assurance can be made that any pending or future patent applications will result in issued patents, that any current or future patents issued to, or licensed by, us will not be challenged or circumvented by our competitors, or that our patents will not be found invalid.
 
In addition, we may have to take legal action in the future to protect our patents, trade secrets or know-how or to assert them against claimed infringement by others. Any legal action of that type could be costly and time consuming to us and no assurances can be made that any lawsuit will be successful. We are generally involved as both a plaintiff and a defendant in a number of patent infringement and other intellectual property-related actions. We are involved in numerous patent-related claims with our competitors, including Johnson & Johnson.
 
The invalidation of key patents or proprietary rights that we own, or an unsuccessful outcome in lawsuits to protect our intellectual property, could have a material adverse effect on our business, financial position or results of operations.
 
Pending and future product liability claims and other litigation, including private securities litigation, shareholder derivative suits and contract litigation, may adversely affect our business, reputation and ability to attract and retain customers.
 
The design, manufacture and marketing of medical devices of the types that we produce entail an inherent risk of product liability claims. Many of the medical devices that we manufacture and sell are designed to be implanted in the human body for long periods of time or indefinitely. A number of factors could result in an unsafe condition or injury to, or death of, a patient with respect to these or other products that we manufacture or sell, including component failures, manufacturing flaws, design defects or inadequate disclosure of product-related risks or product-related information. These factors could result in product liability claims, a recall of one or more of our products or a safety alert relating to one or more of our products. Product liability claims may be brought by individuals or by groups seeking to represent a class.
 
We are currently the subject of numerous product liability claims and other litigation, including private securities litigation and shareholder derivative suits including, but not limited to, the claims and litigation described under Item 3. Legal Proceedings. In connection with our acquisition of Guidant, the number of product liability claims and other legal proceedings filed against us, including private securities litigation and shareholder derivative suits, significantly increased. We are currently involved in litigation involving a contract dispute with certain former shareholders of Advanced Bionics Corporation, one of our subsidiaries. The outcome of this litigation could prevent us from operating the Advanced Bionics business in the manner that we expected at the time of acquisition.
 
The outcome of litigation, particularly class action lawsuits, is difficult to assess or quantify. Plaintiffs in these types of lawsuits often seek recovery of very large or indeterminate amounts, including not only actual damages, but also punitive damages. The magnitude of the potential loss relating to these lawsuits may remain unknown for substantial periods of time. In addition, the cost to defend against any future litigation may be significant. Further, we are substantially self-insured with respect to general, product liability claims and securities litigation. As a result of economic factors currently impacting the insurance industry, meaningful product liability and
 
securities litigation insurance coverage has become unavailable due to its economically prohibitive cost. The absence of significant third-party insurance coverage increases our potential exposure to unanticipated claims and adverse decisions. Product liability claims, product recalls, securities litigation and other litigation in the future, regardless of their outcome, could have a material adverse effect on our financial position, results of operations or liquidity.
 
We may not be successful in our strategic acquisitions of, investments in or alliances with, other companies and businesses, which have been a significant source of historical growth for us.
 
Our strategic acquisitions, investments and alliances are intended to further expand our ability to offer customers effective, high quality medical devices that satisfy their interventional needs. Many of these alliances involve equity investments and often give us the option to acquire the other company or assets of the other company in the future. If we are unsuccessful in our acquisitions, investments and alliances, we may be unable to continue to grow our business significantly or may record asset impairment charges in the future. These acquisitions, investments and alliances have been significant sources of growth for us. The success of any acquisition, investment or alliance that we may undertake will depend on a number of factors, including:
 
 our ability to identify suitable opportunities for acquisition, investment or alliance, if at all;

 our ability to finance any future acquisition, investment or alliance on terms acceptable to us, if at all;

 whether we are able to establish an acquisition, investment or alliance on terms that are satisfactory to us, if at all;

 the strength of the other companies’ underlying technology and ability to execute;

•  intellectual property and litigation related to these technologies; and

 our ability to successfully integrate the acquired company or business with our existing business, including the ability to adequately fund acquired in-process research and development projects.
 
If we are unsuccessful in our acquisitions, investments and alliances, we may be unable to continue to grow our business significantly or may record asset impairment charges in the future.
 
We incurred substantial indebtedness in connection with our acquisition of Guidant and if we are unable to manage our debt levels and maintain our investment-grade credit ratings, it could have an adverse effect on our financial condition or results of operations.
 
We had outstanding borrowings of $8.9 billion at December 31, 2006, attributable in large part to our acquisition of Guidant. We will be required to use a significant portion of our operating cash flow to reduce our outstanding debt obligations over the next several years. We are examining all of our operations in order to identify cost improvement measures that will better align operating expenses with expected revenue levels and cash flow, and may decide to sell certain non-strategic assets or implement other strategic initiatives to generate proceeds that would be available for debt repayment. Certain of our debt agreements contain financial covenants that require us to maintain specified financial ratios. If we are unable to maintain these ratios, we may be required to obtain waivers from our lenders and no assurance can be made that our lenders
 
would grant such waivers on favorable terms or at all. While our credit ratings are currently investment grade, our Moody’s and S&P ratings outlooks are currently negative. Our inability to maintain our investment grade credit ratings could make it more expensive for us to borrow funds or issue debt securities in the public capital markets on terms reasonably acceptable to us.
 
Our future growth is dependent upon the development of new products, which requires significant research and development, clinical trials and regulatory approvals, all of which are very expensive and time-consuming and may not result in a commercially viable product.
 
In order to develop new products and improve current product offerings, we focus our research and development programs largely on the development of next-generation and novel technology offerings across multiple programs and divisions, particularly in our drug-eluting stent and CRM programs. We expect to launch our TAXUS® Liberté™ coronary stent system in the U.S., subject to regulatory approval. In addition, we expect to continue to invest in our CRM technologies, including our LATITUDE® Patient Management System and the Frontier CRM technology. If we are unable to develop and launch these and other products as anticipated, our ability to maintain or expand our market position in the drug-eluting stent and CRM markets may be adversely impacted.
 
Further, we expect to invest selectively in areas outside of drug-eluting stent and CRM technologies. There can be no assurance that these or other technologies will achieve technological feasibility, obtain regulatory approval or gain market acceptance. A delay in the development or approval of these technologies or our decision to reduce funding of these projects may adversely impact the contribution of these technologies to our future growth.
 
As a part of the regulatory process of obtaining marketing clearance from the FDA for new products, we conduct and participate in numerous clinical trials with a variety of study designs, patient populations and trial endpoints. Unfavorable or inconsistent clinical data from existing or future clinical trials conducted by us, by our competitors or by third parties, or the market’s perception of this clinical data, may adversely impact our ability to obtain product approvals from the FDA, our position in, and share of, the markets in which we participate and our business, financial condition, results of operations or future prospects.
 
We face intense competition and may not be able to keep pace with the rapid technological changes in the medical devices industry, which could have an adverse effect on our business, financial condition or results of operations.
 
The medical device market is highly competitive. We encounter significant competition across our product lines and in each market in which our products are sold from various medical device companies, some of which may have greater financial and marketing resources than we do. Our primary competitors have historically included Johnson & Johnson (including its subsidiary, Cordis Corporation) and Medtronic, Inc. (including its subsidiary, Medtronic AVE, Inc.). Through our acquisition of Guidant, Abbott has become a primary competitor of ours in the interventional cardiology market and St. Jude Medical, Inc. has become a competitor of ours in the CRM market and in the Neuromodulation market. In addition, we face competition from a wide range of companies that sell a single or a limited number of competitive products or which participate only in a specific market segment, as well as from non-medical device companies, including pharmaceutical companies, which may offer alternative therapies for disease states intended to be treated using our products.
 
Additionally, the medical device market is characterized by extensive research and development, and rapid technological change. Developments by other companies of new or improved products,
 
processes or technologies, in particular in the drug-eluting stent and CRM markets, may make our products or proposed products obsolete or less competitive and may negatively impact our revenues. We are required to devote continued efforts and financial resources to develop or acquire scientifically advanced technologies and products, apply our technologies cost-effectively across product lines and markets, attract and retain skilled development personnel, obtain patent and other protection for our technologies and products, obtain required regulatory and reimbursement approvals and successfully manufacture and market our products consistent with our quality standards. If we fail to develop new products or enhance existing products, it could have a material adverse effect on our business, financial condition or results of operations.
 
Because we derive a significant amount of our revenues from international operations and a significant percentage of our future growth is expected to come from international operations, changes in international economic or regulatory conditions could have a material impact on our business, financial condition or results of operations.
 
Sales outside the U.S. accounted for approximately 38 percent of our net sales in 2006. Additionally, a significant percentage of our future growth is expected to come from international operations. As a result, our sales growth and profitability from our international operations may be limited by risks and uncertainties related to economic conditions in these regions, foreign currency fluctuations, exchange rate fluctuations, regulatory and reimbursement approvals, competitive offerings, infrastructure development, rights to intellectual property and our ability to implement our overall business strategy. Further, international markets are also being affected by economic pressure to contain reimbursement levels and healthcare costs. The trend in countries around the world, including Japan, toward more stringent regulatory requirements for product clearance, changing reimbursement models and more rigorous inspection and enforcement activities has generally caused or may cause medical device manufacturers to experience more uncertainty, delay, risk and expense. In addition, we are required to renew regulatory approvals and obtain exportation certificates to foreign governments in order to market our products in certain international jurisdictions, which may require additional testing and documentation. These approvals and certificates have been impacted by the FDA warning letters we have received. If sufficient resources are not available to renew these approvals or these approvals are not timely renewed, our ability to market our full line of existing products within these jurisdictions may be limited. Any significant changes in the competitive, political, legal, regulatory, reimbursement or economic environment where we conduct international operations may have a material impact on our business, financial condition or results of operations.
 
 
Our products are purchased principally by hospitals or physicians, which typically bill various third-party payors, including governmental programs (e.g., Medicare and Medicaid), private insurance plans and managed care plans, for the healthcare services provided to their patients. The ability of customers to obtain appropriate reimbursement for their products and services from private and governmental third-party payors is critical to the success of medical technology companies. The availability of reimbursement affects which products customers purchase and the prices they are willing to pay. Reimbursement varies from country to country and can significantly impact the acceptance of new products and services. After we develop a promising new product, we may find limited demand for the product unless reimbursement approval is obtained from private and governmental third-party payors. Further legislative or administrative
 
reforms to the U.S. or international reimbursement systems in a manner that significantly reduces reimbursement for procedures using our medical devices or denies coverage for those procedures could have a material adverse effect on our business, financial condition or results of operations.
 
Major third-party payors for hospital services in the U.S. and abroad continue to work to contain healthcare costs. The introduction of cost containment incentives, combined with closer scrutiny of healthcare expenditures by both private health insurers and employers, has resulted in increased discounts and contractual adjustments to hospital charges for services performed and has shifted services between inpatient and outpatient settings. Initiatives to limit the increase of healthcare costs, including price regulation, are also underway in several countries in which we do business. Hospitals or physicians may respond to these cost-containment pressures by substituting lower cost products or other therapies for our products. In light of the Guidant product recalls, third-party payors may seek claims and further recourse against us for the recalled defibrillator and pacemaker systems for which Guidant had previously received reimbursement.
 
Consolidation in the healthcare industry could lead to demands for price concessions or the exclusion of some suppliers from certain of our significant market segments, which could have an adverse effect on our business, financial condition or results of operations.
 
The cost of healthcare has risen significantly over the past decade and numerous initiatives and reforms initiated by legislators, regulators and third-party payors to curb these costs have resulted in a consolidation trend in the healthcare industry, including hospitals. This in turn has resulted in greater pricing pressures and the exclusion of certain suppliers from important market segments as group purchasing organizations, independent delivery networks and large single accounts continue to consolidate purchasing decisions for some of our hospital customers. We expect that market demand, government regulation, third-party reimbursement policies and societal pressures will continue to change the worldwide healthcare industry, resulting in further business consolidations and alliances among our customers and competitors, which may reduce competition, exert further downward pressure on the prices of our products and may adversely impact our business, financial condition or results of operations.
 
 
We vertically integrate operations where integration provides significant cost, supply or quality benefits. However, we purchase many of the materials and components used in manufacturing our products, some of which are custom made. Certain supplies are purchased from single-sources due to quality considerations, costs or constraints resulting from regulatory requirements. We may not be able to establish additional or replacement suppliers for certain components or materials in a timely manner largely due to the complex nature of our and many of our suppliers’ manufacturing processes. Production issues, including capacity constraint; quality issues affecting us or our suppliers; an inability to develop and validate alternative sources if required; or a significant increase in the price of materials or components could adversely affect our operations and financial condition.
 
 
There are no material unresolved written comments that were received from the SEC staff 180 days or more before the end of our fiscal year relating to our periodic or current reports under the Securities Exchange Act of 1934.
 
 
Our world headquarters are located in Natick, Massachusetts. We have regional headquarters located in Tokyo, Japan and Paris, France. As of December 31, 2006, our manufacturing, research, distribution and other key facilities totaled more than 8,242,344 million square feet, of which more than 5,838,787 million square feet was owned by us and the balance is leased. As of December 31, 2006, our principal manufacturing and technology centers were located in Massachusetts, Indiana, Minnesota, New Jersey, Florida, California, New York, Utah, Washington, Puerto Rico, Ireland, Costa Rica and Japan, and our principal distribution centers were located in Massachusetts, The Netherlands and Japan. As of December 31, 2006, we maintained 37 manufacturing, distribution and technology centers, 25 in the U.S., one in Puerto Rico, five in Ireland, one in Costa Rica, two in The Netherlands and two in Japan. We also share a training facility in Brussels, Belgium with Abbott. Many of these facilities produce and manufacture products for more than one of our divisions and include research facilities.

             
(in square feet)
 
Total Space
 
Owned
 
Leased
Domestic
 
6,255,900
 
4,353,965
 
1,901,935
Foreign
 
1,986,444
 
1,484,822
 
   501,622
Total
 
8,242,344
 
5,838,787
 
2,403,557
             
 
 
See Note J—Commitments and Contingencies to our 2006 consolidated financial statements included in Item 8 of this Form 10-K.
 
 
None.
 
 
 
Our common stock is traded on the New York Stock Exchange under the symbol BSX. Our annual CEO certification for the previous year has been submitted to the NYSE.
 
The following table shows the market range for our common stock for each of the last eight quarters based on reported sales prices on the New York Stock Exchange.

2006
 
High
 
Low
 
First Quarter
 
$
26.48
 
$
20.90
 
Second Quarter
   
23.30
   
16.65
 
Third Quarter
   
17.75
   
14.77
 
Fourth Quarter
   
17.18
   
14.65
 
2005
             
First Quarter
 
$
35.19
 
$
28.67
 
Second Quarter
   
30.80
   
27.00
 
Third Quarter
   
28.95
   
23.05
 
Fourth Quarter
   
27.33
   
22.95
 
 
We have not paid a cash dividend during the past two years. We currently do not intend to pay dividends, and intend to retain all of our earnings to repay indebtedness and invest in the continued growth of our business. We may consider declaring and paying a dividend in the future; however, there can be no assurance that we will do so.
 
At February 23, 2007, there were 13,832 record holders of our common stock.
 
The closing price of our common stock on February 23, 2007 was $17.12.
 
There were no shares repurchased under our share repurchase program in 2006. There are approximately 37 million shares available for repurchase under our share repurchase program.
 
Stock Performance Graph

The graph below compares the five-year total return to stockholders on our common stock with the return of the Standard & Poor’s 500 Stock Index and the Standard & Poor’s Healthcare Equipment Index. The graph assumes $100 was invested in our common stock and in each of the named indices on January 1, 2002, and that all dividends were reinvested.
 
(in millions, except per share data)
 
Year Ended December 31,
 
2006
 
2005
 
2004
 
2003
 
2002
 
                       
Operating Data
                         
Net sales
 
$
7,821
 
$
6,283
 
$
5,624
 
$
3,476
 
$
2,919
 
Gross profit
   
5,614
   
4,897
   
4,332
   
2,515
   
2,049
 
Selling, general and administrative expenses
   
2,675
   
1,814
   
1,742
   
1,171
   
1,002
 
Research and development expenses
   
1,008
   
680
   
569
   
452
   
343
 
Royalty expense
   
231
   
227
   
195
   
54
   
36
 
Amortization expense
   
530
   
152
   
112
   
89
   
72
 
Litigation-related charges (credits), net
         
780
   
75
   
15
   
(99
)
Purchased research and development
   
4,119
   
276
   
65
   
37
   
85
 
Total operating expenses
   
8,563
   
3,929
   
2,758
   
1,818
   
1,439
 
Operating (loss) income
   
(2,949
)
 
968
   
1,574
   
697
   
610
 
Loss (income) before income taxes
   
(3,535
)
 
891
   
1,494
   
643
   
549
 
Net (loss) income
   
(3,577
)
 
628
   
1,062
   
472
   
373
 
 
                               
Net (loss) income per common share — basic
 
$
(2.81
)
$
0.76
 
$
1.27
 
$
0.57
 
$
0.46
 
Net (loss) income per common share — assuming dilution
 
$
(2.81
)
$
0.75
 
$
1.24
 
$
0.56
 
$
0.45
 
 
                               
Weighted average shares outstanding — assuming dilution
   
1,273.7
   
837.6
   
857.7
   
845.4
   
830.0
 


As of December 31,
 
2006
 
2005
 
2004
 
2003
 
2002
 
                       
Balance Sheet Data
                         
Cash, cash equivalents and marketable securities
 
$
1,668
 
$
848
 
$
1,640
 
$
752
 
$
260
 
Working capital
   
2,271
   
1,152
   
684
   
487
   
285
 
Total assets
   
31,096
   
8,196
   
8,170
   
5,699
   
4,450
 
Borrowings (long-term and short-term)
   
8,902
   
2,020
   
2,367
   
1,725
   
935
 
Stockholders’ equity
   
15,298
   
4,282
   
4,025
   
2,862
   
2,467
 
Book value per common share
 
$
10.37
 
$
5.22
 
$
4.82
 
$
3.46
 
$
3.00
 
 
On April 21, 2006, we consummated our acquisition of Guidant.  We consolidated Guidant’s operating results with those of Boston Scientific beginning on the date of acquisition.  See Note D - Business Combinations for further details regarding the transaction.
 
We paid a two-for-one stock split that was effected in the form of a 100 percent stock dividend on November 5, 2003. We have restated all historical amounts above to reflect the stock split.
 
See also the notes to our consolidated financial statements included in Item 8 below.
 
Overview
 
Boston Scientific Corporation is a worldwide developer, manufacturer and marketer of medical devices that are used in a broad range of interventional medical specialties. Our mission is to improve the quality of patient care and the productivity of healthcare delivery through the development and advocacy of less-invasive medical devices and procedures. This mission is accomplished through the continuing refinement of existing products and procedures and the investigation and development of new technologies that can reduce risk, trauma, cost, procedure time and the need for aftercare. Our approach to innovation combines internally developed products and technologies with those we obtain externally through our strategic acquisitions and alliances. Our quality policy, applicable to all employees, is “I improve the quality of patient care and all things Boston Scientific.”
 
Our management’s discussion and analysis (MD&A) begins with an overview of the Guidant acquisition, which represents a transforming event for Boston Scientific. It then provides an executive summary that outlines our financial highlights during 2006 and identifies some key trends that impacted operating results during the year. We supplement this summary with an in-depth look at the major issues we believe are most relevant to our current and future prospects. Next is an examination of the material changes in our operating results for 2006 as compared to 2005 and our operating results for 2005 as compared to 2004. The discussion then provides an examination of liquidity, focusing primarily on material changes in our operating, investing and financing cash flows, as depicted in our consolidated statements of cash flows, and the trends underlying these changes. Finally, the MD&A provides information on our critical accounting policies.
 
Guidant Acquisition and Abbott Transaction

On April 21, 2006, we consummated our acquisition of Guidant Corporation for an aggregate purchase price of $28.4 billion, which represented a combination of cash, common stock and fully vested stock options. The purchase price net of cash acquired was approximately $21.7 billion. In conjunction with the acquisition, we acquired approximately $6.7 billion of cash, including $4.1 billion in connection with Guidant’s prior sale of its vascular intervention and endovascular solutions businesses to Abbott Laboratories. With this acquisition, we have become a major provider in the more than $9 billion global Cardiac Rhythm Management (CRM) business, enhancing our overall competitive position and long-term growth potential and further diversifying our product portfolio. The acquisition has established us as one of the world’s largest cardiovascular device companies and a global leader in microelectronic therapeutics.

Guidant makes a variety of implantable devices that can monitor the heart and deliver electricity to treat cardiac abnormalities, including tachycardia, heart failure and bradycardia. These devices include implantable cardioverter defibrillator systems (ICDs) and pacemaker systems. In addition, Guidant also makes cardiac surgery systems to perform cardiac surgical ablation, endoscopic vessel harvesting and clampless beating-heart bypass surgery.

Prior to our acquisition of Guidant, Abbott acquired Guidant’s vascular intervention and endovascular solutions businesses and agreed to share the drug-eluting technology it acquired from Guidant with Boston Scientific. This agreement gives us access to a second drug-eluting stent program, which will complement our existing TAXUS® stent system program. See Note D - Business Combinations to our
 
2006 consolidated financial statements included in Item 8 of this Form 10-K for further details on the transaction.

We consolidated Guidant’s operating results with those of Boston Scientific beginning on the date of the acquisition, April 21, 2006. Since we have not restated our results retroactively to reflect the historical financial position or results of operations of Guidant, fluctuations in our operating results for 2006 are due primarily to the acquisition of Guidant. However, we have included supplemental pro forma financial information in Note D - Business Combinations to our 2006 consolidated financial statements included in Item 8 of this Form 10-K to give effect to the acquisition as though it had occurred at the beginning of 2006 and 2005.
 
Executive Summary
 
Our net sales in 2006 increased to $7.821 billion from $6.283 billion in 2005. Our reported net loss for 2006 was $3.577 billion, or $2.81 per diluted share, on approximately 1.274 billion weighted average shares outstanding as compared to net income of $628 million, or $0.75 per diluted share, on approximately 838 million weighted average shares outstanding in 2005. Our reported results included net after-tax charges primarily related to the acquisition of Guidant of $4.537 billion, or $3.55 per diluted share, in 2006 as compared to net after-tax charges of $894 million, or $1.07 per diluted share, in 2005.1  In addition, our cash provided by operating activities was $1.845 billion in 2006 as compared to $903 million in 2005.
 
The growth in net sales resulted largely from our acquisition of Guidant, which accounted for sales of $1.503 billion. The geographic mix of Guidant sales included $1.025 billion of U.S. and $478 million of international sales. The business mix of Guidant sales consisted of $1.371 billion of CRM net sales and $132 million of Cardiac Surgery net sales. Our CRM net sales were comprised of $988 million of ICDs and $383 million of pacemaker systems. On a pro forma basis, assuming a full year of results, CRM sales were $2.026 billion in 2006 as compared to $2.28 billion in 2005. The decline, on a pro forma basis, was a result of lower average market shares for the Guidant devices in 2006 relative to 2005. We believe the lower market share, as well as reduced market growth rates, was due primarily to previous field actions in the industry. However, during the fourth quarter of 2006, we experienced a 10 percent sequential increase in net sales from our CRM business and a 13 percent increase for U.S. ICD sales, which we believe is a sign that our market share has increased and the CRM market is stabilizing and will return to growth. We remain focused on our share recovery.
 
The increase in our sales as a result of the acquisition of Guidant was partially offset by a decrease in TAXUS stent system sales to $2.358 billion in 2006 from $2.556 billion in 2005. The geographic mix of TAXUS stent system sales in 2006 included $1.561 billion of U.S. and $797 million of international sales. In 2005, we had $1.763 billion of U.S. and $793 million of international sales. The decline in TAXUS sales during 2006 was attributable to a decrease in the U.S. market size due to recent uncertainty regarding the risk of late stent thrombosis following the use of drug-eluting stents and a decline in
_________________________
1    The 2006 net after-tax charges consisted of: $4.477 billion in expenses resulting from purchase accounting associated primarily with purchased research and development obtained as part of the Guidant acquisition and the step-up value of acquired Guidant inventory sold; $143 million in acquisition-related costs, including the fair value adjustment related to the sharing of proceeds feature of the Abbott stock purchase, a CRM technology offering charge and other business integration costs; a $31 million credit resulting primarily from the reversal of accrued contingent payments due to the cancellation of the abdominal aortic aneurysm (AAA) program that we obtained as part of the TriVascular, Inc. acquisition; $81 million in write-downs attributable to our investment portfolio; and a $133 million one-time tax benefit for the reversal of tax accruals previously established for offshore unremitted earnings. The 2005 net after-tax charges consisted of a $598 million litigation settlement with Medinol Ltd. and $267 million in purchased research and development attributable primarily to our 2005 acquisitions.
 
average market shares in 2006 relative to 2005. Late stent thrombosis is the formation of a clot, or thrombus, within the stented area one year or more after implantation of the stent. Exiting 2005, the percentage of drug-eluting stents used in U.S. interventional procedures were in the high 80 percent range, as compared to U.S. drug-eluting stent market penetration rates in the low 70 percent range exiting 2006. Our U.S. drug-eluting stent market share declined throughout the first three quarters of 2005, but has been stable during 2006 and we have maintained our market leadership position. We expect to launch our TAXUS Express2stent system in the Japan market, which we believe exceeds $500 million, in the second half of 2007 and our TAXUS Liberté stent system in the U.S., subject to regulatory approvals.
 
During 2006, our worldwide Endosurgery group sales increased to $1.346 billion from $1.228 billion in 2005, an increase of 10 percent. Further, our Neuromodulation division, formed following the June 2004 acquisition of Advanced Bionics Corporation, generated $234 million in net sales during 2006 as compared to $148 million in 2005, an increase of 58 percent.
 
Our gross profit, as a percentage of net sales, declined from 77.9 percent in 2005 to 71.8 percent in 2006 largely as a result of certain one-time purchase accounting adjustments associated with the Guidant acquisition. In addition, our gross profit declined by approximately 2.0 percentage points due to period expenses, including costs associated with Project Horizon, a corporate-wide cross-functional initiative to improve and harmonize our overall quality processes and systems. Our gross profit also declined by 0.8 percentage points due to shifts in our product sales mix toward lower margin products, including CRM products and lower sales of TAXUS stents in the U.S.
 
Our operating expenses, excluding purchased research and development and litigation-related charges, increased $1.571 billion to $4.444 billion in 2006 from $2.873 billion in 2005. Of this increase, $1.299 billion related to operating expenses associated with the Guidant business. In the second half of 2006, we maintained existing spending levels given our expectation that the CRM market and the drug-eluting stent market will recover over time and this infrastructure will be necessary to support future growth. In addition, we announced our plan to reallocate certain CRM resources, including those in the research and development and sales and marketing functions; to increase innovation, productivity and competitiveness; and to enhance our ability to deliver new products to physicians and their patients. This plan resulted in a reduction of our CRM workforce by approximately 500 to 600 employees during the first quarter of 2007. We intend to reinvest the bulk of the savings from the plan back into the CRM business to create a strong, competitive pipeline that will help grow revenue that, combined with expense controls, should lead to increased profitability. The reinvestment will include additional hiring within the research and development function where there were shortages of desired skills.
 
We continue to be focused on examining our operations in order to identify cost improvement measures and reallocate resources to support growth initiatives.
 
At December 31, 2006, we had total outstanding debt of $8.902 billion, related primarily to the Guidant acquisition, cash of $1.668 billion and working capital of $2.271 billion. We continued to generate strong operating cash flow during 2006. We expect to use a portion of our operating cash flow to reduce our outstanding debt obligations over the next several years; our first upcoming debt maturity is in April 2008 for $650 million.  
 
FDA Warning Letters

On January 26, 2006, legacy Boston Scientific received a corporate warning letter from the FDA, notifying us of serious regulatory problems at three facilities and advising us that our corrective action plan relating to three site-specific warning letters issued to us in 2005 was inadequate. As stated in this FDA warning letter, the FDA may not grant our requests for exportation certificates to foreign governments or approve pre-market approval (PMA) applications for class III devices to which the quality control or current good manufacturing practices deficiencies described in the letter are reasonably related until the deficiencies have been corrected. During 2005, in order to strengthen our corporate-wide quality controls, we launched Project Horizon, a corporate-wide cross-functional initiative to improve and harmonize our overall quality processes and systems. As part of Project Horizon, we have made modifications to our process validation and complaint management systems. Project Horizon has resulted in the reallocation of significant internal engineering and management resources to quality initiatives, as well as incremental spending. It also has resulted in adjustments to product launch schedules of certain products and the decision to discontinue certain other product lines over time.
 
In 2006, our Board of Directors created a Compliance and Quality Committee to monitor our compliance and quality initiatives. We believe we have identified solutions to the quality issues cited by the FDA, and we continue to make progress in transitioning our organization to implement those solutions. We communicate frequently and meet regularly with the FDA to apprise them of our progress. The FDA has communicated the need for us to complete substantially all remediation efforts before they will reinspect our facilities. We have engaged a third party to audit our enhanced quality systems in order to assess our corporate-wide compliance prior to reinspection by the FDA. We believe we will be ready for the third-party audit in the second quarter of 2007.

On December 23, 2005, Guidant received an FDA warning letter citing certain deficiencies with respect to its manufacturing quality systems and record-keeping procedures in its CRM facility in St. Paul, Minnesota. This FDA warning letter followed an inspection by the FDA that was completed on September 1, 2005 and cited a number of observations. Guidant received a follow-up letter from the FDA dated January 5, 2006. As stated in this follow-up letter, until we have corrected the identified deficiencies, the FDA may not grant requests for exportation certificates to foreign governments or approve PMA applications for class III devices to which the deficiencies described are reasonably related. The FDA conducted a further inspection of the CRM facility between December 15, 2005 and February 9, 2006 and made one additional inspectional observation. The FDA has concluded its reinspection of our CRM facilities. While we believe this reinspection went well, we may be required to take additional actions in order to comply with any FDA observations that we may receive.

Outlook

Guidant Acquisition

On April 21, 2006, we consummated our acquisition of Guidant. With this acquisition, we have become a major provider in the more than $9 billion global CRM business, enhancing our overall competitive position and long-term growth potential and further diversifying our product portfolio. The acquisition has established us as one of the world’s largest cardiovascular device companies and a global leader in microelectronic therapeutics.

The integration of Guidant’s operations and product lines with Boston Scientific’s is complex and time-consuming, and the separation of the Guidant businesses required by the Abbott transaction adds complexity to the transition process. We have entered transition services agreements with Abbott, under which Abbott and Boston Scientific provide or make available to each other certain services, rights, properties and assets for a temporary period. Many of these transition services agreements expire during 2007. The failure to integrate Boston Scientific and Guidant successfully and to manage the challenges presented by the transition process effectively, including the retention of key Guidant personnel and the
 
timely execution of activities under the transition services agreement, may reduce the anticipated potential benefits of the acquisition.

During 2007, we will continue to incur integration and restructuring costs as we integrate certain operations of Guidant. In January 2007, we announced our plan to reallocate certain CRM resources, including those in research and development as well as sales and marketing functions, to increase innovation, productivity and competitiveness, and to enhance our ability to deliver new products to physicians and their patients. This plan resulted in a reduction of our CRM workforce by approximately 500 to 600 employees during the first quarter of 2007. There can be no assurances that we will realize efficiencies related to the integration of the businesses sufficient to offset incremental transaction, acquisition-related, integration and restructuring costs over time.

Net sales from our CRM and Cardiac Surgery businesses were $1.503 billion for 2006, including $1.371 billion of CRM sales and $132 million of Cardiac Surgery sales. On a pro forma basis, assuming a full year of results, CRM sales were $2.026 billion in 2006 as compared to $2.28 billion in 2005. The decline, on a pro forma basis, was a result of lower average market shares for the Guidant devices in 2006 relative to 2005. We believe the lower market share, as well as reduced market growth rates, was due primarily to previous field actions in the industry. These field actions included Guidant’s decision announced on June 24, 2005 to stop selling Guidant’s leading defibrillator systems temporarily, which were returned to the market beginning on August 2, 2005. In addition, on June 26, 2006, we announced that we were retrieving a specific subset of pacemakers, cardiac resynchronization therapy pacemakers and ICDs due to a supplier’s low-voltage capacitor not performing consistently. We believe that these field actions contributed to our CRM division having a lower market share for ICDs and pacemaker systems for 2006 as compared to 2005.
 
The worldwide CRM market growth rates, including the U.S. defibrillator market, declined during the first three quarters of 2006; these growth levels are below those experienced in recent years. The U.S. defibrillator market represents approximately half of the worldwide CRM market. During the fourth quarter of 2006, we experienced a 10 percent sequential increase in net sales from our CRM business and a 13 percent increase for U.S. ICD sales, which we believe is a sign that our market share has increased and the CRM market is stabilizing and will return to growth. We expect that growth rates in the worldwide CRM market, and the U.S. ICD market, will recover over several years. However, there can be no assurance that these markets will return to their historical growth rates or that we will be able to regain CRM market share or increase net sales in a timely manner, if at all. The most significant variables that may impact the size of the CRM market and our position within this market include:
  • future product recalls or new physician advisories by us or our competitors;
  • our ability to resolve the issues identified in the CRM warning letter to the satisfaction of the FDA;
  • variations in clinical results, reliability or product performance of our and our competitors’ products;
  • our ability to retain our sales force and other key personnel;
  • our ability to reestablish the trust and confidence of the implanting community, the referring community and prospective patients in our technology;
  • delayed or limited regulatory approvals;
 
40

  • our ability to launch next-generation products and technology features in a timely manner, if at all;
  • international economic and regulatory conditions;
  • new competitive launches;
  • unfavorable reimbursement policies;
  • declines in average selling prices;
  • the overall number of procedures performed; and
  • the outcome of legal proceedings related to our CRM business.
We remain focused on our market share recovery and intend to accelerate recovery by regaining the trust and confidence of the implanting community, the referring community and prospective patients; continuing to improve our quality systems; investing in new technologies and clinical trials; retaining our sales force and other key personnel; continuing research and development productivity; and improving physician and patient communication. However, if these efforts are not successful, and the CRM market does not recover according to our expectations, or we are unable to regain market share and net sales on a timely basis, our business, financial condition and results of operations could be materially adversely affected.

Coronary Stent Business

Coronary stent revenue represented approximately 32 percent of our consolidated net sales for 2006, as compared to 43 percent in 2005, primarily as a result of the Guidant acquisition. We estimate that the worldwide coronary stent market approximated $6 billion in 2006, and estimate that drug-eluting stents represented approximately 90 percent of the dollar value of the worldwide coronary stent market in 2006. The U.S. drug-eluting stent market for 2006 approximated $3 billion. Our U.S. TAXUS sales declined to $1.561 billion for 2006 as compared to $1.763 billion for 2005. Recent uncertainty regarding the risk of late stent thrombosis following the use of drug-eluting stents contributed to a decline in the U.S. stent market size. In addition to the decline in U.S. drug-eluting stent market penetration, device utilization per procedure and overall percutaneous coronary intervention volume has decreased likely due to market conservatism. We believe this conservatism is a temporary circumstance that, if alleviated, may lead to an increase in future procedural volume and usage of drug-eluting stents. In the fourth quarter of 2006, the FDA held a special advisory panel meeting to discuss drug-eluting stents. Members of the panel concluded that drug-eluting stents remain safe and effective when used as indicated, and that the benefits outweigh the risks. We believe that percutaneous coronary interventions, device utilization per procedure and drug-eluting stent penetration rates will increase in the future, and result in a market recovery; however, there can be no assurance that this will happen or that the market will recover to previous levels. We expect that our U.S. drug-eluting stent sales in 2007 may be below those experienced in 2006.

During 2006, our international TAXUS stent system net sales remained consistent with 2005. Drug-eluting stent penetration rates increased during the first half of 2006, and remained relatively flat throughout the second half of 2006 and exiting 2006, the effect of which offset declines in our market share associated with several competitive launches of new drug-eluting stent products in our Europe and Inter-Continental markets. We expect competitive launches in these geographies to continue to put pressure on our market share and average selling prices in 2007. In addition, we expect that drug-eluting stent penetration rates will remain relatively consistent in our Europe and Inter-Continental markets during 2007 due primarily to concerns regarding the risk of late stent thrombosis. Subject to regulatory
 
approval, we expect to launch our TAXUS Express 2 stent system in Japan during the second half of 2007, where we estimate a drug-eluting stent market size exceeding $500 million.

Historically, the worldwide coronary stent market has been dynamic and highly competitive with significant market share volatility. In addition, in the ordinary course of our business, we conduct and participate in numerous clinical trials with a variety of study designs, patient populations and trial end points. Unfavorable or inconsistent clinical data from existing or future clinical trials conducted by us, by our competitors or by third parties, or the market’s perception of this clinical data, may adversely impact our position in and share of the drug-eluting stent market and may contribute to increased volatility in the market.
 
However, we believe that we can maintain a leadership position within the drug-eluting stent markets in which we compete for a variety of reasons, including:
  • the results of our TAXUS clinical trials;
  • the performance benefits of our current technology;
  • the strength of our pipeline of drug-eluting stent products and the planned launch sequence of these products;
  • our overall market leadership in interventional medicine and our sizeable interventional cardiology sales force;
  • our significant investments in our sales, clinical, marketing and manufacturing capabilities; and
  • our second drug-eluting stent platform obtained as a result of our Guidant acquisition.
However, a material decline in our drug-eluting stent revenue would have a significant adverse impact on our future operating results. The most significant variables that may impact the size of the drug-eluting coronary stent market and our position within this market include:
  • continued concerns regarding the risk of late stent thrombosis;
  • the entry of additional competitors in international markets and the U.S.;
  • continued physician and patient confidence in our technology and attitudes toward drug-eluting stents;
  • our ability to resolve the issues identified in the current legacy Boston Scientific corporate warning letter to the satisfaction of the FDA;
  • declines in the average selling prices of drug-eluting stent systems;
  • variations in clinical results or product performance of our and our competitors’ products;
  • delayed or limited regulatory approvals;
  • the overall number of procedures performed;
  • unfavorable reimbursement policies;
42

  • intellectual property litigation;
  • the average number of stents used per procedure;
  • our ability to maintain and expand indications for use;
  • our ability to launch next-generation products and technology features;
  • the international adoption rate of drug-eluting stent technology;
  • international economic and regulatory conditions; and
  • the level of supply of our drug-eluting stent systems and competitive stent systems.
The TAXUS drug-eluting stent system is currently one of only two drug-eluting products in the U.S. market. Our share of the drug-eluting stent market, as well as unit prices, may be adversely impacted as additional significant competitors enter the drug-eluting stent market, which could occur as early as the second half of 2007 in the U.S.

Prior to our acquisition of Guidant, Abbott acquired Guidant’s vascular intervention and endovascular solutions businesses and agreed to share the drug-eluting technology it acquired from Guidant with Boston Scientific, including the XIENCE™ V everolimus-eluting coronary stent system. In October of 2006, we received CE mark approval to begin marketing the PROMUS™ stent system, which is a private-labeled XIENCE V drug-eluting coronary stent system supplied to us by Abbott. During the fourth quarter of 2006, we initiated a limited launch of the PROMUS stent system in certain European countries. We expect to launch the PROMUS stent system in certain Inter-Continental countries in the second quarter of 2007 and in the U.S. in 2008, subject to regulatory approval. Under the terms of our supply arrangement with Abbott, the profit margin of a PROMUS stent system will be significantly lower than our TAXUS drug-eluting stent. Therefore, the mix of PROMUS stent system revenue relative to our total drug-eluting stent revenue could have a negative impact on our overall profitability as a percentage of revenue. In addition, we will incur incremental costs and expend incremental resources in order to develop and commercialize products utilizing the Guidant drug-eluting stent system technology and to support the launch of our internally manufactured everolimus-eluting stent system in the future, which we expect will have profit margins more comparable to our TAXUS stent system.

Regulatory Compliance

In January 2006, legacy Boston Scientific received a corporate warning letter from the FDA, notifying us of serious regulatory problems at three facilities. During 2005, in order to strengthen our corporate-wide quality controls, we launched Project Horizon, which has resulted in the reallocation of significant internal engineering and management resources to quality initiatives, as well as incremental spending. It also has resulted in adjustments to product launch schedules of certain products and the decision to discontinue certain other product lines over time. See the FDA Warning Letters section above for further information regarding the FDA warning letters.

There can be no assurances regarding the length of time or cost it will take us to resolve these issues to the satisfaction of the FDA. Our inability to resolve these issues in a timely manner may further delay product launch schedules, including the U.S. launch of our TAXUS Liberté stent, which may weaken our competitive position in the markets in which we participate. If our remedial actions are not satisfactory to the FDA, we may have to devote additional financial and human resources to our efforts, and the FDA may take further regulatory actions against us, including, but not limited to, seizing our product inventory,
 
obtaining a court injunction against further marketing of our products, issuing a consent decree or assessing civil monetary penalties.

Intellectual Property Litigation 

There continues to be significant intellectual property litigation in the coronary stent market. We are currently involved in a number of legal proceedings with our existing competitors, including Johnson & Johnson and Medtronic, Inc. There can be no assurance that an adverse outcome in one or more of these proceedings would not impact our ability to meet our objectives in the market. See Note J - Commitments and Contingencies to our 2006 consolidated financial statements included in Item 8 of this Form 10-K for a description of these legal proceedings.

Innovation

Our approach to innovation combines internally developed products and technologies with those we obtain externally through our strategic acquisitions and alliances. Our research and development program is largely focused on the development of next-generation and novel technology offerings across multiple programs and divisions. As a result of our agreement with Abbott, we now have access to a second drug-eluting stent program, which will complement our existing TAXUS stent system program. We expect to continue to invest in our paclitaxel drug-eluting stent program, along with our internally manufactured everolimus-eluting stent program, to continue to sustain our worldwide drug-eluting stent market leadership position. During 2007, we expect to incur incremental capital expenditures and research and development expenses as a result of our dual drug-eluting stent program. We successfully launched our next-generation drug-eluting stent product, the TAXUS Liberté stent system, during 2005 in our Europe and Inter-Continental markets. We expect to launch our TAXUS Liberté stent system in the U.S., subject to regulatory approval. In addition, we expect to continue to invest in our CRM technologies, including our LATITUDE® Patient Management System, which is technology that enables physicians to monitor device performance remotely while patients remain in their homes, and the Frontier CRM technology, our next-generation pulse generator platform. In October 2006, the FDA approved expansion of our LATITUDE System to be used for remote monitoring in certain existing ICDs and cardiac resynchronization defibrillators. We also expect to invest selectively in areas outside of drug-eluting stent and CRM technologies. There can be no assurance that these technologies will achieve technological feasibility, obtain regulatory approval or gain market acceptance. A delay in the development or approval of these technologies may adversely impact our future growth.

Our acquisitions and alliances are intended to expand further our ability to offer our customers effective, high-quality medical devices that satisfy their interventional needs. Management believes it has developed a sound plan to integrate acquired businesses. However, our failure to integrate these businesses successfully could impair our ability to realize the strategic and financial objectives of these transactions. Potential future acquisitions, including companies with whom we currently have strategic alliances or options to purchase, or the fulfillment of our contingent consideration obligations may be dilutive to our earnings and may require additional debt or equity financing, depending on their size and nature. Further, in connection with these acquisitions and other strategic alliances, we have acquired numerous in-process research and development projects. As we continue to undertake strategic growth initiatives, it is reasonable to assume that we will acquire additional in-process research and development projects.

In addition, we have entered a significant number of strategic alliances with privately held and publicly traded companies. Many of these alliances involve equity investments and often give us the option to acquire the other company or assets of the other company in the future. We enter these strategic alliances to broaden our product technology portfolio and to strengthen and expand our reach into existing and new markets. The success of these alliances is an element of our growth strategy and we will continue to seek
 
market opportunities and growth through selective strategic alliances and acquisitions. However, the full benefit of these alliances is often dependent on the strength of the other companies’ underlying technology and ability to execute. An inability to achieve regulatory approvals and launch competitive product offerings, or litigation related to these technologies, among other factors, may prevent us from realizing the benefit of these alliances.

Even though we believe that the drug-eluting stent market and CRM market will recover above existing levels, there can be no assurance to the timing or extent of this recovery. In 2007, we will continue to reprioritize our internal research and development project portfolio and our external investment portfolio primarily based on expectations of future market growth. This reprioritization may result in our decision to sell, discontinue, write-down, or otherwise reduce the funding of certain projects, operations, investments or assets. Any proceeds from sales, or any increases in operating cash flows, resulting from such management actions may be used to reduce debt or may be reinvested in other research and development projects or other operational initiatives. 

Reimbursement and Funding

Our products are purchased by hospitals, doctors and other healthcare providers who are reimbursed by third-party payors, such as governmental programs (e.g., Medicare and Medicaid), private insurance plans and managed-care programs, for the healthcare services provided to their patients. Third-party payors may provide or deny coverage for certain technologies and associated procedures based on assessment criteria as determined by the third-party payor. Reimbursement by third-party payors for these services is based on a wide range of methodologies that may reflect the services’ assessed resource costs, clinical outcomes and economic value. These reimbursement methodologies confer different, and often conflicting, levels of financial risk and incentives to healthcare providers and patients, and these methodologies are subject to frequent refinements. There is no way of predicting the outcome of reimbursement decisions, or their impact on our operating results. Third-party payors are also increasingly adjusting reimbursement rates and challenging the prices charged for medical products and services. There can be no assurance that our products will be automatically covered by third-party payors, that reimbursement will be available or, if available, that the third-party payors’ coverage policies will not adversely affect our ability to sell our products profitably.  

International Markets

International markets are also being affected by economic pressure to contain reimbursement levels and healthcare costs. Our sales growth and profitability from our international operations may be limited by risks and uncertainties related to economic conditions in these regions, currency fluctuations, regulatory and reimbursement approvals, competitive offerings, infrastructure development, rights to intellectual property and our ability to implement our overall business strategy. Any significant changes in the competitive, political, regulatory, reimbursement or economic environment where we conduct international operations may have a material impact on our business, financial condition or results of operations.
 
In addition, we are required to receive or renew regulatory approvals and obtain exportation certificates to foreign governments in order to market our products in certain international jurisdictions. These approvals and certificates could be impacted by the FDA warning letters we have received. If these approvals and certificates are not renewed or obtained on a timely basis, our ability to market our full line of existing products within these jurisdictions may be limited, which could have a material adverse impact on our business.
 
Results of Operations
 
Net Sales
 
The following table provides our net sales by region and the relative change on an as reported and constant currency basis:
               
2006 versus 2005
 
2005 versus 2004
 
(in millions)
 
2006
 
2005
 
2004
 
As Reported
Currency
Basis
 
Constant
Currency
Basis
 
As Reported
Currency
Basis
 
Constant
Currency
Basis
 
                               
United States
 
$
4,840
 
$
3,852
 
$
3,502
   
26
%
 
26
%
 
10
%
 
10
%
                                             
Europe
   
1,574
   
1,161
   
994
   
36
%
 
34
%
 
17
%
 
17
%
Japan
   
594
   
579
   
613
   
3
%
 
8
%
 
(6
%)
 
(4
%)
Inter-Continental
   
813
   
691
   
515
   
18
%
 
16
%
 
34
%
 
28
%
International
   
2,981
   
2,431
   
2,122
   
23
%
 
22
%
 
15
%
 
13
%
                                             
Worldwide
 
$
7,821
 
$
6,283
 
$
5,624
   
24
%
 
24
%
 
12
%
 
11
%
 
 
The following table provides our worldwide net sales by division and the relative change on an as reported basis:
(in millions)
 
2006
 
2005
 
2004
 
2006 versus 2005
 
2005 versus 2004
 
                       
Interventional Cardiology
 
$
3,612
 
$
3,783
 
$
3,451
   
(5
%)
 
10
%
Peripheral Interventions/ Vascular Surgery
   
666
   
715
   
656
   
(7
%)
 
9
%
Electrophysiology
   
134
   
132
   
130
   
2
%
 
2
%
Neurovascular
   
326
   
277
   
253
   
18
%
 
9
%
Cardiac Surgery
   
132
   
N/A
   
N/A
   
N/A
   
N/A
 
Cardiac Rhythm Management
   
1,371
   
N/A
   
N/A
   
N/A
   
N/A
 
Cardiovascular
   
6,241
   
4,907
   
4,490
   
27
%
 
9
%
                                 
Oncology
   
221
   
207
   
186
   
7
%
 
11
%
Endoscopy
   
754
   
697
   
641
   
8
%
 
9
%
Urology
   
371
   
324
   
261
   
15
%
 
24
%
Endosurgery
   
1,346
   
1,228
   
1,088
   
10
%
 
13
%
                                 
Neuromodulation
   
234
   
148
   
46
   
58
%
 
222
%
                                 
Worldwide
 
$
7,821
 
$
6,283
 
$
5,624
   
24
%
 
12
%
 
We manage our international operating regions and divisions on a constant currency basis, while market risk from currency exchange rate changes is managed at the corporate level. The relative change on a constant currency basis by division approximated the change on an as reported basis. To calculate regional and divisional revenue growth rates that exclude the impact of currency exchange, we convert actual current-period net sales from local currency to U.S. dollars using constant currency exchange rates.
 
 
U.S. Net Sales
 
In 2006, our U.S. net sales increased by $988 million, or 26 percent, as compared to 2005. The increase is related primarily to the inclusion of $1.025 billion of U.S. net sales from our new CRM and Cardiac Surgery divisions. In addition, we experienced increases in our U.S. net sales related to sales growth of $83 million from our Endosurgery group and $75 million from our Neuromodulation division. Offsetting this increase were declines in our U.S. net sales of TAXUS coronary stent systems to $1.561 billion for 2006 as compared to $1.763 billion for 2005 and sales decreases of approximately $70 million in 2006 as compared to 2005 due to the expiration during the first quarter of 2006 of our agreement to distribute certain third-party guidewire and sheath products. The decline in TAXUS sales was due principally to a decrease in the U.S. drug-eluting stent market size and a decline in average TAXUS market share in 2006 relative to 2005. The drug-eluting stent market decline was due to recent uncertainty regarding the risk of late stent thrombosis following the use of drug-eluting stents, which resulted in conservative usage by physicians. The overall size of the U.S. drug-eluting stent market is driven primarily by the number of percutaneous coronary interventional procedures performed; the number of devices used per procedure; the drug-eluting stent penetration rate or mix between bare metal and drug-eluting stents across procedures; and average drug-eluting stent selling prices. The primary reason for the decline in the U.S. drug-eluting stent market size was lower penetration rates in 2006 relative to 2005. Exiting 2005, the percentage of drug-eluting stents used in U.S. interventional procedures were in the high 80 percent range, as compared to U.S. drug-eluting stent market penetration rates in the low 70 percent range exiting 2006. The drug-eluting stent market also declined due to decreases in the number of devices used per procedure and slight reductions in average selling prices. Our drug-eluting stent market share declined throughout the first three quarters of 2005, but has been stable during 2006. See the Outlook section for a more detailed discussion of the drug-eluting stent market and our position within that market.
 
In 2005, our U.S. net sales increased by $350 million, or 10 percent, as compared to 2004. The increase resulted largely from a full year of TAXUS stent system sales, which we launched in March 2004. U.S. TAXUS stent system sales for 2005 were $1.763 billion as compared to $1.57 billion for 2004, offset by a reduction in market share compared to the prior year. The remainder of the increase in our U.S. net sales related to sales growth of $83 million from our Endosurgery group and $75 million from our Neuromodulation division.
 
International Net Sales
 
In 2006, our international net sales increased by $550 million, or 23 percent, as compared to 2005. The increase related primarily to the inclusion of $478 million of international net sales from our new CRM and Cardiac Surgery divisions. The remainder of the increase in our revenue in these markets was due to growth in various product franchises, including $35 million in net sales from our Endosurgery group and $27 million in sales growth from our Neurovascular division. TAXUS stent system sales in our Europe and Inter-Continental markets were $797 million in 2006 as compared to $793 million in 2005. TAXUS stent system sales were favorably impacted by drug-eluting stent penetration rates in these markets. The drug-eluting stent penetration rates increased during the first half of 2006, and remained relatively flat throughout the second half of 2006 and exiting 2006. Market share declines associated with several competitors having launched new drug-eluting stent products in these markets offset the favorable impact of increased penetration rates.
 
In 2006, our legacy Boston Scientific net sales in Japan, excluding the impact of currency fluctuations, were relatively consistent with the prior year. Due to the timing of regulatory approval for our TAXUS stent system and government-mandated pricing reductions for other products, we do not expect significant revenue growth in our legacy Japan business until we launch our TAXUS Express2 stent system in Japan,
 
which we expect to occur during the second half of 2007. Japan net sales for 2006 included $62 million from CRM and Cardiac Surgery products.
 
In 2005, our international net sales increased by $309 million, or 15 percent, as compared to 2004. The increase related primarily to sales growth of our TAXUS stent system by $220 million, or 38 percent, in our Europe and Inter-Continental markets. This increase in TAXUS stent system sales in these markets was primarily the result of increased market penetration rates, as well as the successful launch of our TAXUS Liberté stent system during 2005. The remainder of the increase in our revenue in these markets was due to growth in various product franchises, including $57 million in incremental sales from our Endosurgery group and $27 million in sales growth from our Neuromodulation division.
 
Gross Profit
 
The following table provides a summary of our gross profit:
 
   
2006
 
2005
 
2004
 
(in millions)
 
$
 
% of Net Sales
 
$
 
% of Net Sales
 
$
 
% of Net Sales
 
Gross profit
   
5,614
   
71.8
   
4,897
   
77.9
   
4,332
   
77.0
 
 
In 2006, our gross profit, as a percentage of net sales, decreased by 6.1 percentage points as compared to 2005. Our gross profit for 2006 decreased as a percentage of net sales by 3.8 percentage points as compared to 2005 due to costs associated with Guidant, including $267 million in step-up value of acquired Guidant inventory sold during the period and a $31 million charge associated with making our LATITUDE Patient Management System available to many of our existing CRM patients without additional charge. In connection with the accounting for the Guidant acquisition, we wrote up inventory acquired from manufacturing cost to fair value. As of December 31, 2006, we had no inventory step-up value remaining in inventory. In addition, our gross profit for 2006 decreased as a percentage of net sales by approximately 2.0 percentage points as compared to 2005 due to period expenses, including costs associated with Project Horizon and certain inventory charges. Shifts in our product sales mix toward lower margin products, including CRM products and lower sales of TAXUS stents in the U.S., decreased our gross profit as a percentage of net sales by 0.8 percentage points. These decreases were offset by a 0.8 percentage point increase due to the favorable change in currency exchange rates on our gross profit.
 
In 2005, our gross profit, as a percentage of net sales, increased by 0.9 percentage points as compared to 2004. Our 2004 gross profit decreased by approximately 1.0 percentage points due to $57 million in inventory write-downs, including a $43 million write-down attributable to recalls of certain of our coronary stent systems and a $14 million write-down of TAXUS stent inventory due to shelf-life dating. In addition, shifts in our product sales mix toward higher margin products, primarily TAXUS stents, increased our gross profit as a percentage of net sales by 0.6 percentage points. Our gross profit for 2005 was reduced as a percentage of net sales by 0.9 percentage points related to period expenses, including manufacturing start-up costs primarily associated with our TAXUS Liberté stent system and increased investment in quality initiatives. The remaining fluctuation in gross profit as a percentage of net sales primarily related to the favorable change in currency exchange rates.
 
Operating Expenses
 
Our operating expenses, excluding purchased research and development and litigation-related charges, increased $1.571 billion to $4.444 billion in 2006 from $2.873 billion in 2005. Of this increase, $1.299 billion related to operating expenses associated with the Guidant business. The significant increase in
 
each of our operating expense categories is primarily a result of Guidant operating expenses. The following table provides a summary of our operating expenses, excluding purchased research and development and litigation-related charges:
   
2006
 
2005
 
2004
 
(in millions)
 
$
 
% of Net Sales
 
$
 
% of Net Sales
 
$
 
% of Net Sales
 
Selling, general and administrative expenses
   
2,675
   
34.2
   
1,814
   
28.9
   
1,742
   
31.0
 
Research and development expenses
   
1,008
   
12.9
   
680
   
10.8
   
569
   
10.1
 
Royalty expense
   
231
   
3.0
   
227
   
3.6
   
195
   
3.5
 
Amortization expense
   
530
   
6.8
   
152
   
2.4
   
112
   
2.0
 
 
Selling, General and Administrative (SG&A) Expenses
 
In 2006, our SG&A expenses increased by $861 million, or 47 percent, as compared to 2005. As a percentage of our net sales, SG&A expenses increased to 34.2 percent in 2006 from 28.9 percent for the same period in the prior year. The increase in our SG&A expenses related primarily to: $670 million in expenditures associated with Guidant; $65 million of acquisition-related costs associated primarily with certain Guidant integration and retention programs; increases of $63 million due primarily to increased headcount attributable to the expansion of our sales force within our international regions and Neuromodulation division; and $55 million in incremental stock-based compensation expense associated with the adoption of Statement No. 123(R), Share-Based Payment. See the Critical Accounting Policies section and Note L - Stock Ownership Plans for a more detailed discussion of Statement No. 123(R). SG&A expenses for 2005 included $21 million in costs related to certain business optimization initiatives and $17 million in costs related to certain retirement benefits.

In 2005, our SG&A expenses increased by $72 million, or four percent, as compared to 2004. The increase primarily related to: approximately $100 million in increased headcount and higher compensation expense mainly attributable to the expansion of the sales force within our Interventional Cardiology business unit and Endosurgery group and costs related to market development initiatives; $75 million in incremental operating expenses associated with our 2004 and 2005 acquisitions, primarily Advanced Bionics; $21 million in costs related to certain business optimization initiatives; $19 million in stock-based compensation expense associated primarily with the issuance of deferred stock units in 2005; and $17 million in costs related to certain retirement benefits. Certain charges incurred in 2004 partially offset these increases, including a $110 million enhancement to our 401(k) Plan, and a $90 million non-cash charge resulting from certain modifications to our stock option plans. As a percentage of our net sales, SG&A expenses decreased to 28.9 percent in 2005 from 31.0 percent in 2004 primarily due to the increase in our net sales in 2005.
 
Research and Development (R&D) Expenses
 
Our investment in R&D reflects spending on regulatory compliance and clinical research as well as new product development programs. In 2006, our R&D expenses increased by $328 million, or 48 percent, as compared to 2005. As a percentage of our net sales, R&D expenses increased to 12.9 percent in 2006 from 10.8 percent in 2005. The increase primarily related to: the inclusion of $270 million in expenditures associated with Guidant; approximately $30 million in costs related to the cancellation of the TriVascular AAA program; $24 million of stock-based compensation expense associated with the adoption of Statement No. 123(R); and $13 million of acquisition-related costs associated with certain Guidant
 
integration and retention programs. See the Purchased Research and Development section for further discussion regarding the cancellation of our TriVascular AAA stent-graft program.
 
In 2005, our R&D expenses increased by $111 million, or 20 percent, as compared to 2004. As a percentage of net sales, R&D expenses increased to 10.8 percent in 2005 from 10.1 percent in 2004. The increase related primarily to an increased investment of approximately $60 million in incremental R&D expense attributable to our 2004 and 2005 acquisitions, primarily Advanced Bionics and TriVascular. In addition, we increased spending on internal R&D projects within our Endosurgery group by $25 million.
 
Royalty Expense
 
In 2006, our royalty expense increased by $4 million, or 2 percent, as compared to 2005. The increase was due to $25 million of royalty expense associated with the CRM and Cardiac Surgery products that we acquired as part of the Guidant acquisition. This increase was offset by a decrease in royalty expense attributable to sales of our TAXUS stent system by $20 million to $153 million for 2006 as compared to the prior year due primarily to lower sales volume. As a percentage of net sales, royalty expense decreased to 3.0 percent in 2006 from 3.6 percent in 2005. This decrease was primarily a result of the inclusion of net sales from our new CRM and Cardiac Surgery products, which on average have a lower royalty cost relative to legacy Boston Scientific net sales.
 
In 2005, our royalty expense increased by $32 million, or 16 percent, as compared to 2004. As a percentage of net sales, royalty expense increased to 3.6 percent in 2005 from 3.5 percent in 2004. The increase in our royalty expense related to sales growth of royalty-bearing products, primarily sales of our TAXUS stent system. Royalty expense attributable to sales of our TAXUS stent system increased by $27 million to $174 million for 2005 as compared to 2004.
 
Amortization Expense
 
In 2006, our amortization expense increased by $378 million, or 249 percent, as compared to 2005. As a percentage of our net sales, amortization expense increased to 6.8 percent in 2006 from 2.4 percent in 2005. The increase in our amortization expense related primarily to: $334 million of amortization of intangible assets obtained as part of the Guidant acquisition; $23 million for the write-off of intangible assets due to the cancellation of the TriVascular AAA program; $21 million for the write-off of the intangible assets associated with developed technology obtained as part of our 2005 acquisition of Rubicon Medical Corporation; and $12 million for the write-off of the intangible assets associated with our Real-time Position Management System (RPM) technology, a discontinued technology platform obtained as part of our acquisition of Cardiac Pathways Corporation. The write-off of the RPM intangible assets resulted from our decision to cease investment in the technology. The write-off of the Rubicon developed technology resulted from our decision to redesign the first generation of the technology and concentrate resources on the development and commercialization of the next-generation product. We do not expect these program cancellations and related write-offs to impact our future operations or cash flows materially. Amortization expense for 2005 included a $10 million write-off of intangible assets related to our Enteryx® Liquid Polymer Technology, a discontinued technology platform obtained as a part of our acquisition of Enteric Medical Technologies, Inc.. The write-off resulted from our decision during 2005 to cease selling the Enteryx product.
 
In 2005, our amortization expense increased by $40 million, or 36 percent, as compared to 2004. As a percentage of our net sales, amortization expense increased to 2.4 percent in 2005 from 2.0 percent in 2004. The increase in our amortization expense was due primarily to $25 million in incremental amortization expense from the intangible assets obtained in conjunction with our 2004 and 2005
 
acquisitions, primarily Advanced Bionics. In addition, amortization expense included a $10 million write-off of intangible assets related to Enteryx.
 
Interest Expense
 
Our interest expense increased to $435 million in 2006 as compared to $90 million in 2005. The increase in our interest expense related primarily to an increase in our average debt levels used to finance the Guidant acquisition, as well as an increase in our weighted-average borrowing cost. Our average debt levels for 2006 increased to approximately $7.2 billion as compared to approximately $2.4 billion for 2005. Our weighted-average borrowing cost for 2006 increased to 6.1 percent from 3.8 percent for 2005. At December 31, 2006, $5.886 billion, or 81 percent, of our approximately $7.234 billion in outstanding net debt is at fixed interest rates.
 
Our interest expense increased to $90 million in 2005 from $64 million in 2004. The increase in 2005 as compared to 2004 related primarily to an increase in average market interest rates on our borrowings.
 
Fair Value Adjustment

During 2006, we recorded net expense of $95 million to reflect the change in fair value related to the sharing of proceeds feature of the Abbott stock purchase, which is discussed in further detail at Note D- Business Combinations to our 2006 consolidated financial statements included in Item 8 of this Form 10-K. This sharing of proceeds feature is being marked-to-market through earnings based upon changes in our stock price, among other factors.
 
Other, net
 
Our other, net reflected expense of $56 million in 2006, income of $13 million in 2005 and expense of $16 million in 2004. Our other, net included investment write-downs of $121 million in 2006, $17 million in 2005 and $58 million in 2004, in each case attributable to an other-than-temporary decline in fair value of certain strategic alliances. These write-downs were partially offset by realized gains on investments of $9 million in 2006, $4 million in 2005 and $36 million in 2004. Our write-downs during 2006 included charges of $34 million associated with investment write-downs due primarily to the termination of a gene therapy trial being conducted by one of our portfolio companies. In addition, we recorded $27 million of investment write-downs related to one of our vascular sealing portfolio companies due to continued delays in its technology development and the resulting deterioration in its financial condition. The remaining investment write-downs were not individually significant. We do not expect these write-downs to impact our future operations or cash flows materially. In addition, our other, net included interest income of $67 million in 2006, $36 million in 2005 and $20 million in 2004. Our interest income increased in 2006 as compared to 2005 due primarily to increases in our cash and cash equivalents balances and increases in average market interest rates. Our interest income in 2005 increased as compared to 2004 due to increases in average market interest rates.
 
Tax Rate
 
The following table provides a summary of our reported tax rate:
 
 
 
 
 
 
     
Percentage Point
Increase (Decrease)
 
 
 
2006
 
2005
 
2004
 
2006 versus 2005
 
2005 versus 2004
 
Reported tax rate
   
1.2%
 
 
29.5%
 
 
28.9%
 
 
(28.3)
 
 
0.6
 
Impact of certain charges
   
(20.2%)
 
5.5%
 
 
4.9%
 
 
(25.7)
 
 
0.6
 
 
In 2006, the decrease in our reported tax rate as compared to 2005 related primarily to the impact of certain charges during 2006 that are taxed at different rates than our effective tax rate. These charges include: purchased research and development; asset write-downs; reversal of taxes associated with unremitted earnings; and tax gain on the sale of intangible assets.
 
As of December 31, 2005, we had recorded a $133 million deferred tax liability for unremitted earnings of certain foreign subsidiaries that we had anticipated repatriating in the foreseeable future. During 2006, we made a significant acquisition that, when combined with certain changes in business conditions subsequent to the acquisition, resulted in a reevaluation of this liability. We have determined that we will not repatriate these earnings in the foreseeable future and, instead, we will indefinitely reinvest these earnings in foreign operations to repay debt obligations associated with the acquisition. As a result, we reversed the deferred tax liability and reduced income tax expense by $133 million in 2006.
 
We currently estimate that our 2007 effective tax rate, excluding certain charges, will be approximately 21 percent due primarily to our intention to reinvest offshore substantially all of our offshore earnings. However, acquisitions or dispositions in 2007 and geographic changes in the manufacture of our products may positively or negatively impact our effective tax rate.
 
 
Litigation-Related Charges
 
In 2005, we recorded a $780 million pre-tax charge associated with the Medinol litigation settlement. On September 21, 2005, we reached a settlement with Medinol resolving certain contract and patent infringement litigation. In conjunction with the settlement agreement, we paid $750 million in cash and cancelled our equity investment in Medinol.
 
In 2004, we recorded a $75 million provision for certain legal and regulatory matters, which included a civil settlement with the U.S. Department of Justice, which we paid in 2005.
 
See further discussion of our material legal proceedings in Item 3. Legal Proceedings above and Note J — Commitments and Contingencies to our 2006 consolidated financial statements included in Item 8 of this Form 10-K.
 
Purchased Research and Development
 
 
in conjunction with the Guidant acquisition; a credit of approximately $67 million resulting primarily from the reversal of accrued contingent payments due to the cancellation of the TriVascular AAA program; and an expense of approximately $17 million resulting primarily from the application of equity method accounting for our investment in EndoTex Interventional Systems.

The $4.169 billion of purchased research and development associated with the Guidant acquisition consists primarily of approximately $3.26 billion for acquired CRM-related products and approximately $540 million for drug-eluting stent technology shared with Abbott. The purchased research and development value associated with the Guidant acquisition also includes approximately $369 million that represents the estimated fair value of the potential milestone payments of up to $500 million that we may receive from Abbott upon receipt of certain regulatory approvals by the vascular intervention and endovascular solutions businesses it acquired from Guidant. We recorded the amounts as purchased research and development at the acquisition date because the receipt of the payments is dependent on future research and development activity and regulatory approvals, and the asset has no alternative future use as of the acquisition date.

The most significant purchased research and development projects acquired from Guidant include the Frontier CRM technology and rights to the everolimus-eluting stent technology that we share with Abbott. The Frontier CRM technology represents Guidant’s next-generation pulse generator platform that will incorporate new components and software while leveraging certain existing intellectual property, technology, manufacturing know-how and institutional knowledge of Guidant. We expect to leverage this platform across all CRM product lines to treat electrical dysfunction in the heart. We expect to launch various Frontier-based products commercially in the U.S. over the next 36 months, subject to regulatory approval. As of December 31, 2006, we estimate that the total costs to complete the Frontier CRM technology is between $150 million and $200 million. We expect material cash inflows from Frontier-based products to commence in 2008.

The $540 million attributable to the everolimus-eluting stent technology represents the estimated fair value of the rights to Guidant’s everolimus-based drug-eluting stent technology we share with Abbott. In December 2006, we launched PROMUS, our first-generation everolimus-based stent, supplied by Abbott, in limited quantities in Europe. We expect to launch a first-generation everolimus-eluting stent, supplied by Abbott, in the U.S. in 2008, subject to regulatory approval. We expect to launch an internally manufactured next-generation everolimus-based stent in Europe in 2010 and in the U.S. in 2011. We expect that material net cash inflows (net of operating costs, including research and development costs to complete) from our internally manufactured everolimus-based drug-eluting stent will commence in 2010 or 2011, following its approval in Europe and in the U.S. As of December 31, 2006, we estimate that the cost to complete the next-generation everolimus-eluting stent technology project is between $200 million and $250 million. The in-process projects acquired in conjunction with the Guidant acquisition are generally progressing in line with our estimates as of the acquisition date.

In 2005, we recorded $276 million of purchased research and development. Our 2005 purchased research and development consisted of: $130 million relating to our acquisition of TriVascular; $73 million relating to our acquisition of Advanced Stent Technologies, Inc. (AST); $45 million relating to our acquisition of Rubicon; and $3 million relating to our acquisition of CryoVascular Systems, Inc. In addition, we recorded $25 million of purchased research and development in conjunction with obtaining distribution rights for new brain monitoring technology that Aspect Medical Systems, one of our strategic partners, is currently developing. This technology is designed to aid the diagnosis and treatment of depression, Alzheimer’s disease and other neurological conditions.

The most significant 2005 purchased research and development projects included TriVascular’s AAA stent-graft and AST’s Petal™ bifurcation stent, which collectively represented 73 percent of our 2005
 
purchased research and development. During the second quarter of 2006, management cancelled the TriVascular AAA stent-graft program. The program cancellation was due principally to forecasted increases in time and costs to complete the development of the stent-graft and to receive regulatory approval. We do not expect the program cancellation and related write-downs to impact our future operations or cash flows materially. The cancellation of the TriVascular AAA program resulted in the shutdown of our facility in Santa Rosa, California and the displacement of approximately 300 employees. During 2006, we recorded a charge to research and development expenses of approximately $20 million associated primarily with write-downs of fixed assets and a charge to research and development expenses of approximately $10 million associated with severance and related costs incurred in connection with the cancellation of the TriVascular AAA program. In addition, we recorded an impairment charge related to the remaining TriVascular intangible assets and reversed our accrual for contingent payments recorded in the initial purchase accounting. The effect of the write-off of these assets and liabilities was a $23 million charge to amortization expense and a $67 million credit to purchased research and development during the second quarter of 2006. We completed substantially the shutdown activities during the third quarter of 2006.
 
AST’s Petal bifurcation stent is designed to expand into the side vessel where a single vessel branches into two vessels, permitting blood to flow into both branches of the bifurcation and providing support at the junction. We estimate the remaining cost to complete the Petal bifurcation stent to be between $100 million and $125 million. We expect material net cash inflows from the Petal bifurcation stent to begin in 2011, which is when we expect the stent to be commercially available in the U.S. in a drug-eluting configuration. The AST Petal bifurcation stent in-process project is generally progressing in line with our estimates as of the acquisition date.
 
In 2004, we recorded $65 million of purchased research and development. Our 2004 purchased research and development consisted primarily of $50 million relating to our acquisitions of Advanced Bionics and $14 million relating to our acquisition of Precision Vascular Systems, Inc. The most significant in-process projects acquired in connection with our 2004 acquisitions included Advanced Bionics’ bion® microstimulator and drug delivery pump, which collectively represented 77 percent of our 2004 acquired in-process projects’ value. The bion microstimulator is an implantable neurostimulation device designed to treat a variety of neurological conditions. We estimate the remaining cost to complete the bion microstimulator for migraine headaches to be approximately $35 million. We expect material net cash inflows from the bion microstimulator to commence in 2011, following its approval in the U.S., which we expect to occur in 2010. The Advanced Bionics drug delivery pump is an implanted programmable device designed to treat chronic pain. We estimate the remaining cost to complete the drug delivery pump to be between $50 million and $60 million. We continue to assess the pace and risk of development of the drug delivery pump, as well as general market opportunities for the pump, which may result in a delay in the timing of regulatory approval or lower potential market value. We currently expect material net cash inflows from the drug delivery pump to commence in 2012, following its approval in the U.S., which we expect to occur in 2011 or 2012. The estimated timing and costs to complete the bion microstimulator and the drug delivery pump have increased relative to what we estimated as of the acquisition date; however, we do not believe these increases will have a material impact on our results of operations or financial condition.
 
 
The following tables provide a summary of key performance indicators that we use to assess our liquidity and operating performance:
 
 
(in millions)
 
2006
 
2005
 
2004
 
Cash and cash equivalents
 
$
1,668
 
$
689
 
$
1,296
 
Short-term marketable securities
         
159
   
344
 
Cash provided by operating activities
   
1,845
   
903
   
1,804
 
Cash used for investing activities
   
9,312
   
551
   
1,622
 
Cash provided by (used for) financing activities
   
8,439
   
(954
)
 
439
 
EBITDA2
   
(2,273
)
 
1,278
   
1,904
 

(in millions)
 
2006
 
2005
   
Short-term debt
 
$
7
 
$
156
   
Long-term debt
   
8,895
   
1,864
   
Gross debt
   
8,902
   
2,020
   
Less: cash, cash equivalents and marketable securities
   
1,668
   
848
   
Net debt
 
$
7,234
 
$
1,172
   
 
Management uses EBITDA to assess operating performance and believes that it may assist users of our financial statements in analyzing the underlying trends in our business over time. Users of our financial statements should consider this non-GAAP financial information in addition to, not as a substitute for, or as superior to, financial information prepared in accordance with GAAP. Our EBITDA included pre-tax charges of $4.715 billion in 2006, $1.112 billion in 2005 and $340 million in 2004; see the Executive Summary section for a description of these charges.
 
 
Cash generated by our operating activities continues to be a major source of funds for servicing our outstanding debt obligations and investing in our growth. The increase in cash generated by our operating activities in 2006 as compared to 2005 is attributable primarily to significant one-time payments made during 2005, consisting of: an approximate $75 million settlement payment made to the Department of Justice; a one-time $110 million 401(k) contribution; a cash settlement with Medinol of $750 million; and tax payments, including those associated with the American Jobs Creation Act. Cash paid for income taxes and interest was $423 million in 2006 and $437 million in 2005. We expect to make approximately $400 million in tax payments during the first quarter of 2007 associated primarily with the gain on the sale of Guidant’s vascular intervention and endovascular solutions businesses to Abbott.
_____________________________
2  The following represents a reconciliation between EBITDA and net (loss) income:
 
(in millions)
 
2006
 
2005
 
2004
 
EBITDA
 
$
(2,273
)
$
1,278
 
$
1,904
 
Interest income
   
67
   
36
   
20
 
Interest expense
   
(435
)
 
(90
)
 
(64
)
Income taxes
   
(42
)
 
(263
)
 
(432
)
Stock-based compensation expense
   
(113
)
 
(19
)
 
(91
)
Depreciation and amortization
   
(781
)
 
(314
)
 
(275
)
Net (loss) income
 
$
(3,577
)
$
628
 
$
1,062
 
 
Investing Activities
 
We made capital expenditures of $341 million in 2006 and 2005. Capital expenditures in 2006 included $107 million associated with our CRM and Cardiac Surgery divisions. Legacy Boston Scientific capital expenditures declined in 2006 compared to 2005 due to significant capital expenditures incurred in the prior year to enhance our manufacturing and distribution capabilities. We expect to incur capital expenditures of approximately $450 million during 2007, which includes a full year of capital expenditures for our CRM and Cardiac Surgery divisions; and capital expenditures to further upgrade our quality systems, to enhance our manufacturing capabilities in order to support a second drug-eluting stent platform, to facilitate the integration of Guidant and to support continuous growth in our business units, including our Neuromodulation division.
 
Our investing activities during 2006 included: $15.4 billion of cash payments for our acquisition of Guidant, including approximately $100 million associated with the buyout of options of certain former Guidant vascular intervention and endovascular solutions employees in connection with the sale of these businesses to Abbott, and approximately $800 million of direct acquisition costs; $6.7 billion of cash acquired from Guidant, including proceeds of $4.1 billion from Guidant’s sale of its vascular intervention and endovascular solutions businesses to Abbott; $397 million in contingent payments associated primarily with Advanced Bionics, CryoVascular and Smart Therapeutics, Inc.; and $65 million of net payments for strategic alliances with both privately held and publicly traded entities.

In January 2007, we acquired EndoTex, a developer of stents used in the treatment of stenotic lesions in the carotid arteries. In conjunction with the acquisition of EndoTex, we paid approximately $100 million, which included approximately five million shares of our common stock valued at approximately $90 million and cash of $10 million, in addition to our previous investments and notes issued of approximately $40 million, plus future consideration that is contingent upon EndoTex achieving certain performance-related milestones. We do not expect significant purchased research and development charges associated with this acquisition because EndoTex obtained FDA approval of its carotid stent system prior to acquisition.
 
Financing Activities
 
Our cash flows from financing activities reflect issuances and repayments of debt, payments for share repurchases and proceeds from stock issuances related to our equity incentive programs.
 
We had outstanding borrowings of $8.902 billion at December 31, 2006 at a weighted average interest rate of 6.03 percent as compared to outstanding borrowings of $2.02 billion at December 31, 2005 at a weighted average interest rate of 4.8 percent. During 2006, we received net proceeds from borrowings of $6.888 billion, which we used primarily to finance the cash portion of the Guidant acquisition. There were no amounts outstanding against our available credit lines of $2.35 billion at December 31, 2006.  See Note F - Borrowings and Credit Arrangements to our 2006 consolidated financial statements included in Item 8 of this Form 10-K for specific details regarding our 2006 and 2005 debt transactions.

The debt maturity schedule for the significant components of our long-term debt as of December 31, 2006, is as follows:
 
   
Payments Due by Period
     
(in millions)
 
2008
 
2009
 
2010
 
2011
 
Thereafter
 
Total
 
Term loan
 
$
650
 
$
650
 
$
1,700
 
$
2,000
       
$
5,000
 
Abbott loan
                     
900
         
900
 
Senior notes
                     
850
 
$
2,200
   
3,050
 
   
$
650
 
$
650
 
$
1,700
 
$
3,750
 
$
2,200
 
$
8,950
 
 
We expect to use a portion of our operating cash flow to reduce our outstanding debt obligations over the next several years. We will continue to examine all of our operations in order to identify cost improvement measures that will better align operating expenses with expected revenue levels and reallocate resources to better support growth initiatives. In addition, we have the flexibility to sell certain non-strategic assets and implement other strategic initiatives, which may generate proceeds that would be available for debt repayment.

As of December 31, 2006, our credit ratings were BBB from Fitch Ratings; Baa3 from Moody’s Investor Service; and BBB from Standard & Poor’s Rating Services (S&P). These credit ratings are investment grade. The Moody’s and S&P ratings outlook is currently negative.
 
Our revolving credit facility and term loan agreement requires that we maintain a ratio of debt to pro forma EBITDA, as defined by the agreement, of less than or equal to 4.5 to 1.0 through December 31, 2007 and 3.5 to 1.0 thereafter. The agreement also requires that we maintain a ratio of pro forma EBITDA, as defined by the agreement, to interest expense of greater than or equal to 3.0 to 1.0. As of December 31, 2006, we were in compliance with both of these debt covenants. Exiting 2006, our ratio of debt to pro forma EBITDA was 3.6 to 1.0 and the ratio of pro forma EBITDA to interest expense was 5.6 to 1.0. Any breach of these covenants would require that we obtain waivers from our lenders and there can be no assurance that our lenders would grant such waivers. Our inability to obtain any necessary waivers, or to obtain them on reasonable terms, could have a material adverse impact on our operations.
 
Equity
 
In March 2006, we filed a new public registration statement with the SEC. During the first quarter of 2006, we increased our authorized common stock from 1.2 billion shares to 2.0 billion shares in anticipation of our acquisition of Guidant, and issued approximately 577 million shares to former Guidant shareholders in conjunction with the acquisition. In April 2006, we issued approximately 65 million shares of our common stock under this registration statement to Abbott for $1.4 billion. See Note D- Business Combinations to our 2006 consolidated financial statements included in Item 8 of this Form 10-K for further details on the Guidant acquisition and Abbott transaction.
 
During 2006, we received $145 million in proceeds from stock issuances related to our stock option and employee stock purchase plans as compared to $94 million in 2005. Proceeds from the exercise of employee stock options and employee stock purchases vary from period to period based upon, among other factors, fluctuations in the exercise and stock purchase patterns of employees.
 
We did not repurchase any of our common stock during 2006. We repurchased approximately 25 million shares of our common stock at an aggregate cost of $734 million in 2005, and 10 million shares of our common stock at an aggregate cost of $360 million in 2004. Since 1992, we have repurchased approximately 132 million shares of our common stock and we have approximately 12 million shares of our common stock held in treasury at year-end. Approximately 37 million shares remain under our previous share repurchase authorizations.
 
Contractual Obligations and Commitments

The following table provides a summary of certain information concerning our obligations and commitments to make future payments, which is in addition to our outstanding principal debt obligations as presented in the previous table. See Note D - Business Combinations, Note F - Borrowings and Credit Arrangements and Note H - Leases to our 2006 consolidated financial statements included in Item 8 of this Form 10-K for additional information
 
regarding our business combinations, debt obligations and lease arrangements. In accordance with U.S. GAAP, our consolidated balance sheets do not reflect the obligations below that relate to expenses incurred in future periods.
 

   
Payments Due by Period
     
(in millions)
 
2007
 
2008
 
2009
 
2010
 
2011
 
Thereafter
 
Total
 
Operating leases
 
$
61
 
$
47
 
$
24
 
$
11
 
$
5
 
$
36
 
$
184
 
Purchase obligations
   
182
   
1
   
1
   
1
               
185
 
Minimum royalty obligations
   
3
   
3
   
3
   
1
   
1
   
6
   
17
 
Interest payments††
   
521
   
497
   
457
   
371
   
214
   
1,013
   
3,073
 
 
 
$
767
 
$
548
 
$
485
 
$
384
 
$
220
 
$
1,055
 
$
3,459
 
 
These obligations related primarily to inventory commitments and capital expenditures entered in the normal course of business.
††
Interest payment amounts related to the $5.0 billion five-year term loan are projected using market interest rates as of December 31, 2006. Future interest payments may differ from these projections based on changes in the market interest rates.
 
Certain of our business combinations involve the payment of contingent consideration. See Note D - Business Combinations to our 2006 consolidated financial statements included in Item 8 of this Form 10-K for the estimated maximum potential amount of future contingent consideration we could be required to pay associated with our business combinations. Since it is not possible to estimate when, or even if, the acquired companies will reach their performance milestones or the amount of contingent consideration payable based on future revenues, the maximum contingent consideration has not been included in the table above. Additionally, we may consider satisfying these commitments by issuing our stock or refinancing the commitments with cash, including cash obtained through the sale of our stock.
 
Certain of our equity investments give us the option to acquire the company in the future or may require us to make payments that are contingent upon the company achieving certain product development targets or obtaining regulatory approvals. Since it is not possible to estimate when, or even if, we will exercise our option to acquire these companies or be required to make these contingent payments, we have not included future potential payments relating to these equity investments in the table above.
 
At December 31, 2006, we had outstanding letters of credit and bank guarantees of approximately $90 million, which primarily consisted of financial lines of credit provided by banks and collateral for workers’ compensation programs. We enter these letters of credit and bank guarantees in the normal course of business. As of December 31, 2006, we have not drawn upon the letters of credit or guarantees. At this time, we do not believe we will be required to fund any amounts from the guarantees or letters of credit and, accordingly, we have not recognized a related liability in our financial statements as of December 31, 2006. Our letters of credit and bank guarantees were immaterial at December 31, 2005.
 
Critical Accounting Policies
 
We have adopted accounting policies to prepare our consolidated financial statements in conformity with U.S. GAAP. We describe these accounting polices in Note A—Significant Accounting Policies to our 2006 consolidated financial statements included in Item 8 of this Form 10-K.
 
To prepare our consolidated financial statements in accordance with U.S. GAAP, management makes estimates and assumptions that may affect the reported amounts of our assets and liabilities, the disclosure
 
of contingent assets and liabilities at the date of our financial statements and the reported amounts of our revenue and expenses during the reporting period. Our actual results may differ from these estimates.
 
We consider estimates to be critical (1) if we are required to make assumptions about material matters that are uncertain at the time of estimation or (2) if materially different, estimates could have been made or it is reasonably likely that the accounting estimate will change from period to period. The following are areas that we consider critical:
 
Revenue Recognition
 
Our revenue consists primarily of the sale of single-use medical devices. We consider revenue to be realized or realizable and earned when all of the following criteria are met: persuasive evidence of a sales arrangement exists; delivery has occurred or services have been rendered; the price is fixed or determinable; and collectibility is reasonably assured. We generally meet these criteria at the time of shipment when the risk of loss and title passes to the customer or distributor, unless a consignment arrangement exists. We recognize revenue from consignment arrangements based on product usage, or implant, which indicates that the sale is complete. For all other transactions, we recognize revenue when title to the goods and risk of loss transfer to customers, provided there are no remaining substantive performance obligations required of us or any matters requiring customer acceptance. For multiple-element arrangements, whereby the sale of devices is combined with future service obligations, we defer revenue on the undelivered elements based on verifiable objective evidence of fair value.
 
We generally allow our customers to return defective, damaged and, in certain cases, expired products for credit. In addition, we may allow customers to return previously purchased products for next-generation product offerings. We establish a reserve for sales returns when the initial product is sold. We base our estimate for sales returns upon contractual commitments and historical trends and recorded such amount as a reduction to revenue.
 
We 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.
 
Inventory Reserves
 
We base our provisions for excess, obsolete or expired inventory primarily on our estimates of forecasted net sales levels. A significant change in the timing or level of demand for our products as compared to forecasted amounts may result in recording additional provisions for excess or expired inventory in the future. The industry in which we participate is characterized by rapid product development and frequent new product introductions. Uncertain timing of next-generation product approvals, variability in product launch strategies, product recalls and variation in product utilization all impact the estimates related to excess and obsolete inventory.
 
Valuation of Business Combinations
 
We allocate the amounts we pay for each acquisition to the assets we acquire and liabilities we assume based on their fair values at the dates of acquisition. We then allocate the purchase price in excess of net tangible assets acquired to identifiable intangible assets, including purchased research and development.
 
We base the fair value of identifiable intangible assets on detailed valuations that use information and assumptions provided by management. We allocate any excess purchase price over the fair value of the net tangible and intangible assets acquired to goodwill. The use of alternative valuation assumptions, including estimated cash flows and discount rates, and alternative estimated useful life assumptions could result in different purchase price allocations, purchased research and development charges, and intangible asset amortization expense in current and future periods.
 
The valuation of purchased research and development represents the estimated fair value at the dates of acquisition related to in-process projects. Our purchased research and development represents the value of in-process projects that have not yet reached technological feasibility and have no alternative future uses as of the date of acquisition. The primary basis for determining the technological feasibility of these projects is obtaining regulatory approval to market the underlying products in an applicable geographic region. We expense the value attributable to these in-process projects at the time of the acquisition. If the projects are not successful or completed in a timely manner, we may not realize the financial benefits expected for these projects or for the acquisitions as a whole. In addition, we record certain costs associated with our strategic alliances as purchased research and development.
 
We use the income approach to determine the fair values of our purchased research and development. This approach determines fair value by estimating the after-tax cash flows attributable to an in-process project over its useful life and then discounting these after-tax cash flows back to a present value. We base our revenue assumptions on estimates of relevant market sizes, expected market growth rates, expected trends in technology and expected product introductions by competitors. In arriving at the value of the in-process projects, we consider, among other factors: the in-process projects’ stage of completion; the complexity of the work completed as of the acquisition date; the costs already incurred; the projected costs to complete; the contribution of core technologies and other acquired assets; the expected introduction date; and the estimated useful life of the technology. We base the discount rate used to arrive at a present value as of the date of acquisition on the time value of money and medical technology investment risk factors. For the in-process projects we acquired in connection with our recent acquisitions, we used the following ranges of risk-adjusted discount rates to discount our projected cash flows: 13 percent to 17 percent in 2006, 18 percent to 27 percent in 2005, and 18 percent to 27 percent in 2004. We believe that the estimated purchased research and development amounts so determined represent the fair value at the date of acquisition and do not exceed the amount a third party would pay for the projects.
 
Impairment of Intangible Assets
 
We review our intangible assets quarterly to determine if any adverse conditions exist or a change in circumstances has occurred that would indicate impairment or a change in their remaining useful life. In addition, we review our indefinite-lived intangible assets at least annually for impairment and reassess their classification as indefinite-lived assets. To test for impairment, we calculate the fair value of our indefinite-lived intangible assets and compare the calculated fair values to the respective carrying values.
 
We test our March 31 goodwill balances during the second quarter of each year for impairment, or more frequently if certain indicators are present or changes in circumstances suggest that impairment may exist. In performing the test, we calculate the fair value of our reporting units as the present value of estimated future cash flows using a risk-adjusted discount rate. The selection and use of an appropriate discount rate requires significant management judgment with respect to revenue and expense growth rates. We have not recorded impairment of goodwill in any of the years included in our consolidated statements of operations.
 
Investments in Strategic Alliances
 
We account for investments in companies over which we have the ability to exercise significant influence under the equity method if we hold 50 percent or less of the voting stock. We account for investments in companies over which we do not have the ability to exercise significant influence under the cost method. Our determination of whether we have the ability to exercise significant influence over an investment requires judgment. Factors that we consider in determining whether we have the ability to exercise significant influence include, but are not limited to:
 
• our level of representation on the Board of Directors;
• our participation in the investee’s policy-making processes;
• transactions with the investee in the ordinary course of business;
• interchange of managerial personnel;
• our ownership in relation to the concentration of other shareholders.
 
We regularly review our strategic alliance investments for impairment indicators.  If we determine that impairment exists and it is other-than-temporary, we recognize an impairment loss equal to the difference between an investment’s carrying value and its fair value. Our exposure to loss related to our strategic alliances is generally limited to our equity investments and notes receivable associated with these alliances.
 
See Note A - Significant Accounting Policies and Note C - Investments in Strategic Alliances to our 2006 consolidated financial statements included in Item 8 of this Form 10-K for a detailed analysis of our investments and our accounting treatment for our investment portfolio.
 
Income Taxes
 
We utilize the asset and liability method for accounting for income taxes. Under this method, we determine deferred tax assets and liabilities based on differences between the financial reporting and tax bases of our assets and liabilities. We measure deferred tax assets and liabilities using the enacted tax rates and laws that will be in effect when we expect the differences to reverse.
 
We recognized net deferred tax liabilities of $2.201 billion at December 31, 2006 and $110 million at December 31, 2005. The liabilities relate primarily to deferred taxes associated with our acquisitions. The assets relate primarily to the establishment of inventory and product-related reserves, litigation and product liability reserves, purchased research and development, net operating loss carryforwards and tax credit carryforwards. In light of our historical financial performance, we believe we will substantially recover these assets.
 
We reduce our deferred tax assets by a valuation allowance if, based upon the weight of available evidence, it is more likely than not that we will not realize some portion or all of the deferred tax assets. We consider relevant evidence, both positive and negative, to determine the need for a valuation allowance. Information evaluated includes our financial position and results of operations for the current and preceding years, as well as an evaluation of currently available information about future years.
 
We do not provide income taxes on unremitted earnings of our foreign subsidiaries where we have indefinitely reinvested such earnings in our foreign operations. It is not practical to estimate the amount of income taxes payable on the earnings that are indefinitely reinvested in foreign operations. Unremitted earnings of our foreign subsidiaries that we have indefinitely reinvested offshore are $7.186 billion at December 31, 2006 and $2.106 billion at December 31, 2005.
 
We provide for potential amounts due in various tax jurisdictions. In the ordinary course of conducting business in multiple countries and tax jurisdictions, there are many transactions and calculations where
 
the ultimate tax outcome is uncertain. Judgment is required in determining our worldwide income tax provision. In our opinion, we have made adequate provisions for income taxes for all years subject to audit. Although we believe our estimates are reasonable, we can make no assurance that the final tax outcome of these matters will not be different from that which we have reflected in our historical income tax provisions and accruals. Such differences could have a material impact on our income tax provision and operating results in the period in which we make such determination.
 
See Note I — Income Taxes to our 2006 consolidated financial statements included in Item 8 of this Form 10-K for a detailed analysis of our income tax accounting.
 
Legal, Product Liability Costs and Securities Claims
 
We are involved in various legal and regulatory proceedings, including intellectual property, breach of contract, securities litigation and product liability suits. In some cases, the claimants seek damages, as well as other relief, which if granted, could require significant expenditures or impact our ability to sell our products. We are substantially self-insured with respect to general, product liability and securities claims and record losses for claims in excess of the limits of purchased insurance in earnings at the time and to the extent they are probable and estimable. In accordance with FASB Statement No. 5, Accounting for Contingencies, we accrue anticipated costs of settlement, damages, loss for general product liability claims and, under certain conditions, costs of defense based on historical experience or to the extent specific losses are probable and estimable. Otherwise, we expense these costs as incurred. If the estimate of a probable loss is a range and no amount within the range is more likely, we accrue the minimum amount of the range. Our accrual for legal matters that are probable and estimable was $485 million at December 31, 2006 and $35 million at December 31, 2005. In connection with our acquisition of Guidant, the number of product liability claims and other legal proceedings filed against us, including private securities litigation and shareholder derivative suits, significantly increased. The amounts accrued at December 31, 2006 represent primarily accrued legal defense costs related to assumed Guidant litigation and product liability claims recorded as part of the purchase price. In connection with the acquisition of Guidant, we are still assessing certain assumed litigation and product liability claims to determine the amounts that management believes will be paid as a result of such claims and litigation and, therefore, additional losses may be accrued in the future. See further discussion of our material legal proceedings in Item 3. Legal Proceedings above and Note J — Commitments and Contingencies to our 2006 consolidated financial statements included in Item 8 of this Form 10-K.
 
Stock-Based Compensation
 
On January 1, 2006, we adopted FASB Statement No. 123(R), Share-Based Payment, which requires all share-based payments to employees, including grants of employee stock options, to be recognized in the consolidated statements of operations based on their fair values. We adopted Statement No. 123(R) using the “modified-prospective method” and have not restated prior period results of operations and financial position to reflect the impact of stock-based compensation expense under Statement No. 123(R). We use the Black-Scholes option-pricing model to calculate the grant-date fair value of our stock options. We value restricted stock awards and deferred stock units based on the closing trading value of our shares on the date of grant. The following represents the assumptions used in calculating our stock-based compensation expense that require significant judgment by management:

Expected Volatility - We have considered a number of factors in estimating volatility. For options granted prior to 2006, we used our historical volatility as a basis to estimate expected volatility in our valuation of stock options. We changed our method of estimating volatility upon the adoption of Statement No. 123(R). We now consider historical volatility, trends in volatility within our industry/peer group and implied volatility.

Expected Term - We estimate the expected term of our options using historical exercise and forfeiture data. We believe that this historical data is currently the best estimate of the expected term of our new option grants.

Estimated Forfeiture Rate -We have applied, based on an analysis of our historical forfeitures, an annual forfeiture rate of eight percent to all unvested stock awards as of December 31, 2006, which represents the portion that we expect will be forfeited each year over the vesting period. We will reevaluate this analysis periodically and adjust the forfeiture rate as necessary. Ultimately, we will only recognize expense for those shares that vest.

See Note L - Stock Ownership Plans to our 2006 consolidated financial statements included in Item 8 of this Form 10-K for further discussion regarding our adoption of Statement No. 123(R).
 
New Accounting Standard
 
In July 2006, the FASB issued Interpretation No. 48, Accounting for Uncertainty in Income Taxes - an interpretation of FASB Statement No. 109, Accounting for Income Taxes, to create a single model to address accounting for uncertainty in tax positions. Interpretation No. 48 requires the use of a two-step approach for recognizing and measuring tax benefits taken or expected to be taken in a tax return and disclosures regarding uncertainties in income tax positions, including a roll forward of tax benefits taken that do not qualify for financial statement recognition. We will record the cumulative effect of initially adopting Interpretation No. 48 as an adjustment to opening retained earnings in the year of adjustment and present such adjustment separately. Only tax positions that we are more likely than not to realize at the effective date may be recognized upon adoption of Interpretation No. 48. We are required to adopt Interpretation No. 48 effective for our first quarter of 2007. We are currently in the process of assessing the impact of the new standard.
 
Management’s Report on Internal Control over Financial Reporting
 
As the management of Boston Scientific Corporation, we are responsible for establishing and maintaining adequate internal control over financial reporting. We designed our internal control system to provide reasonable assurance to management and the Board of Directors regarding the preparation and fair presentation of our financial statements.
 
We assessed the effectiveness of our internal control over financial reporting as of December 31, 2006. In making this assessment, we used the criteria set forth by the Committee of Sponsoring Organizations of the Treadway Commission in Internal Control—Integrated Framework. Based on our assessment, we believe that, as of December 31, 2006, our internal control over financial reporting is effective at a reasonable assurance level based on these criteria.
 
Ernst & Young LLP, an independent registered public accounting firm, has issued an audit report on management’s assessment of internal control over financial reporting and on the effectiveness of our internal control over financial reporting. This report in which they expressed an unqualified opinion is included below.
 

       
/s/ James R. Tobin
 
/s/ Lawrence C. Best
 
President and Chief Executive Officer
 
Executive Vice President and Chief Financial Officer
 

 

Report of Independent Registered Public Accounting Firm on Internal Control over Financial Reporting
 
The Board of Directors and Stockholders of Boston Scientific Corporation
 
        We have audited management’s assessment, included in the accompanying Management’s Report on Internal Control over Financial Reporting, that Boston Scientific Corporation maintained effective internal control over financial reporting as of December 31, 2006, based on criteria established in Internal Control—Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission (the COSO criteria). Boston Scientific Corporation’s management is responsible for maintaining effective internal control over financial reporting and for its assessment of the effectiveness of internal control over financial reporting. Our responsibility is to express an opinion on management’s assessment and an opinion on the effectiveness of the company’s internal control over financial reporting based on our audit.
 
        We conducted our audit in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether effective internal control over financial reporting was maintained in all material respects. Our audit included obtaining an understanding of internal control over financial reporting, evaluating management’s assessment, testing and evaluating the design and operating effectiveness of internal control and performing such other procedures as we considered necessary in the circumstances. We believe that our audit provides a reasonable basis for our opinion.
 
        A company’s internal control over financial reporting is a process designed to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles. A company’s internal control over financial reporting includes those policies and procedures that (1) pertain to the maintenance of records that, in reasonable detail, accurately and fairly reflect the transactions and dispositions of the assets of the company; (2) provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with generally accepted accounting principles, and that receipts and expenditures of the company are being made only in accordance with authorizations of management and directors of the company; and (3) provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use, or disposition of the company’s assets that could have a material effect on the financial statements.
 
        Because of its inherent limitations, internal control over financial reporting may not prevent or detect misstatements. Also, projections of any evaluation of effectiveness to future periods are subject to the risk that controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate.
 
        In our opinion, management’s assessment that Boston Scientific Corporation maintained effective internal control over financial reporting as of December 31, 2006, is fairly stated, in all material respects, based on the COSO criteria. Also, in our opinion, Boston Scientific Corporation maintained, in all material respects, effective internal control over financial reporting as of December 31, 2006, based on the COSO criteria.
 
        We also have audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States), the consolidated balance sheets of Boston Scientific Corporation as of December 31, 2006 and December 31, 2005, and the related consolidated statements of operations, stockholders’ equity and cash flows for each of the three years in the period ended December 31, 2006 of Boston Scientific Corporation and our report dated February 26, 2007, expressed an unqualified opinion thereon.
 
 
/s/ Ernst & Young LLP
 
Boston, Massachusetts
February 26, 2007 
 
We develop, manufacture and sell medical devices globally and our earnings and cash flow are exposed to market risk from changes in currency exchange rates and interest rates. We address these risks through a risk management program that includes the use of derivative financial instruments. We operate the program pursuant to documented corporate risk management policies. We do not enter derivative transactions for speculative purposes. Gains and losses on derivative financial instruments substantially offset losses and gains on underlying hedged exposures. Furthermore, we manage our exposure to counterparty nonperformance on derivative instruments by entering into contracts with a diversified group of major financial institutions and by monitoring outstanding positions.
 
Our currency risk consists primarily of foreign currency denominated firm commitments, forecasted foreign currency denominated intercompany and third-party transactions and net investments in certain subsidiaries. We use both nonderivative (primarily European manufacturing operations) and derivative instruments to manage our earnings and cash flow exposure to changes in currency exchange rates. We had currency derivative instruments outstanding in the contract amount of $3.413 billion at December 31, 2006 and $3.593 billion at December 31, 2005. We recorded $71 million of other assets and $27 million of other liabilities to recognize the fair value of these derivative instruments at December 31, 2006 as compared to $176 million of other assets and $55 million of other liabilities recorded at December 31, 2005. A 10 percent appreciation in the U.S. dollar’s value relative to the hedged currencies would increase the derivative instruments’ fair value by $112 million at December 31, 2006 and by $129 million at December 31, 2005. A 10 percent depreciation in the U.S. dollar’s value relative to the hedged currencies would decrease the derivative instruments’ fair value by $134 million at December 31, 2006 and $157 million at December 31, 2005. Any increase or decrease in the fair value of our currency exchange rate sensitive derivative instruments would be substantially offset by a corresponding decrease or increase in the fair value of the hedged underlying asset, liability or forecasted transaction.
 
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 the risk of interest rate changes either by converting floating-rate borrowings into fixed-rate borrowings or fixed-rate borrowings into floating-rate borrowings. We had interest rate derivative instruments outstanding in the notional amount of $2.0 billion at December 31, 2006 and $1.1 billion at December 31, 2005. The increase in the notional amount is due to $2.0 billion of hedge contracts related to our $5.0 billion five-year term loan, offset by our termination of $1.1 billion in hedge contracts related to certain of our existing senior notes. We recorded $11 million of other liabilities to recognize the fair value of our interest rate derivative instruments at December 31, 2006 as compared to $21 million of other assets and $7 million of other liabilities recorded at December 31, 2005. A one percentage point increase in interest rates would increase the derivative instruments’ fair value by $26 million at December 31, 2006 as compared to a decrease of $74 million at December 31, 2005. A one percentage point decrease in interest rates would decrease the derivative instruments’ fair value by $26 million at December 31, 2006 as compared to an increase of $80 million at December 31, 2005. Any increase or decrease in the fair value of our interest rate derivative instruments would be substantially offset by a corresponding decrease or increase in the fair value of the hedged interest payments related to the hedged term loan. At December 31, 2006, $5.886 billion, or 81 percent, of our approximately $7.234 billion in outstanding net debt is at fixed interest rates. 
 
See Note G - Financial Instruments to our 2006 consolidated financial statements included in Item 8 of this Form 10-K for detailed information regarding our derivative financial instruments.
 
 
 
 
 
CONSOLIDATED STATEMENTS OF OPERATIONS (in millions, except per share data)
               
Year Ended December 31,
 
2006
 
2005
 
2004
 
               
Net sales
 
$
7,821
 
$
6,283
 
$
5,624
 
Cost of products sold
   
2,207
   
1,386
   
1,292
 
Gross profit
   
5,614
   
4,897
   
4,332
 
                     
Selling, general and administrative expenses
   
2,675
   
1,814
   
1,742
 
Research and development expenses
   
1,008
   
680
   
569
 
Royalty expense
   
231
   
227
   
195
 
Amortization expense
   
530
   
152
   
112
 
Litigation-related charges
         
780
   
75
 
Purchased research and development
   
4,119
   
276
   
65
 
Total operating expenses
   
8,563
   
3,929
   
2,758
 
Operating (loss) income
   
(2,949
)
 
968
   
1,574
 
                     
Other income (expense):
                   
Interest expense
   
(435