UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-K
(Mark One)
ý | ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 |
For the Fiscal Year Ended December 31, 2016
OR
o | TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 |
For the Transition Period From to
Commission File Number 1-15525
EDWARDS LIFESCIENCES CORPORATION
(Exact name of registrant as specified in its charter)
Delaware | 36-4316614 | |
(State or other jurisdiction of incorporation or organization) | (I.R.S. Employer Identification No.) | |
One Edwards Way, Irvine, California 92614 (Address of principal executive offices) (ZIP Code) | ||
(949) 250-2500 Registrant's telephone number, including area code | ||
Securities registered pursuant to Section 12(b) of the Act: | Name of each exchange on which registered: | |
Common Stock, par value $1.00 per share | New York Stock Exchange | |
Securities registered pursuant to Section 12(g) of the Act: None | ||
Indicate by check mark if the registrant is a well-known seasoned issuer, as defined by Rule 405 of the Securities Act. Yes ý No o
Indicate by check mark if the registrant is not required to file reports pursuant to Section 13 or 15(d) of the Exchange Act. Yes o No ý
Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes ý No o
Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files). Yes ý No o
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 registrant'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. ý
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company. See the definitions of "large accelerated filer," "accelerated filer," and "smaller reporting company" in Rule 12b-2 of the Exchange Act. (Check one):
Large accelerated filer ý | Accelerated filer o | Non-accelerated filer o (Do not check if a smaller reporting company) | Smaller Reporting Company o | |||
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act). Yes o No ý
The aggregate market value of the registrant's common stock held by non-affiliates as of June 30, 2016 (the last trading day of the registrant's most recently completed second quarter): $21,062,047,999 based on the closing price of the registrant's common stock on the New York Stock Exchange. This calculation does not reflect a determination that persons are affiliates for any other purpose.
The number of shares outstanding of the registrant's common stock, $1.00 par value, as of January 31, 2017, was 212,495,798.
Documents Incorporated by Reference
Portions of the registrant's proxy statement for the 2017 Annual Meeting of Stockholders (to be filed within 120 days of December 31, 2016) are incorporated by reference into Part III, as indicated herein.
EDWARDS LIFESCIENCES CORPORATION
Form 10-K Annual Report—2016
Table of Contents
PART I
Item 1. Business
This report contains forward-looking statements within the meaning of Section 27A of the Securities Act of 1933 and Section 21E of the Securities Exchange Act of 1934. We intend the forward-looking statements contained in this report to be covered by the safe harbor provisions of such Acts. All statements other than statements of historical fact in this report or referred to or incorporated by reference into this report are "forward-looking statements" for purposes of these sections. These statements include, among other things, any predictions of earnings, revenues, expenses or other financial items, plans or expectations with respect to development activities, clinical trials or regulatory approvals, any statements of plans, strategies and objectives of management for future operations, any statements concerning our future operations, financial conditions and prospects, and any statements of assumptions underlying any of the foregoing. These statements can sometimes be identified by the use of the forward-looking words such as "may," "believe," "will," "expect," "project," "estimate," "should," "anticipate," "plan," "goal," "continue," "seek," "pro forma," "forecast," "intend," "guidance," "optimistic," "aspire," "confident," other forms of these words or similar words or expressions or the negative thereof. Investors are cautioned not to unduly rely on such forward-looking statements. These forward-looking statements are subject to substantial risks and uncertainties that could cause our results or future business, financial condition, results of operations or performance to differ materially from the our historical results or experiences or those expressed or implied in any forward-looking statements contained in this report. See "Risk Factors" in Part I, Item 1A below for a discussion of these risks, as well as our subsequent reports on Forms 10-Q and 8-K. These forward-looking statements speak only as of the date on which they are made and we do not undertake any obligation to update any forward-looking statement to reflect events or circumstances after the date of the statement. If we do update or correct one or more of these statements, investors and others should not conclude that we will make additional updates or corrections.
Overview
Edwards Lifesciences Corporation is the global leader in patient-focused innovations for structural heart disease and critical care monitoring. Driven by a passion to help patients, we partner with the world’s leading clinicians and researchers and aggressively invest in research and development to transform care for structural heart disease and critically ill patients. A pioneer in the development of heart valve therapies, we are the world's leading manufacturer of heart valve systems and repair products used to replace or repair a patient's diseased or defective heart valve. Our innovative work in heart valves encompasses both surgical and transcatheter therapies for heart valve replacement. We are also a global leader in hemodynamic monitoring systems used to measure a patient's cardiovascular function in the hospital setting.
Cardiovascular disease is the number-one cause of death in the world, and is the top disease in terms of health care spending in nearly every country. Cardiovascular disease is progressive in that it tends to worsen over time and often affects the structure of an individual's heart.
Patients undergoing treatment for cardiovascular disease can be treated with a number of our medical technologies. For example, an individual with a heart valve disorder may have a faulty valve that is affecting the function of their heart or blood flow throughout their body. A clinician may elect to remove the valve and replace it with one of our bioprosthetic surgical tissue heart valves, surgically re-shape and repair the faulty valve with an Edwards Lifesciences annuloplasty ring, or implant an Edwards Lifesciences transcatheter valve via a catheter-based system that does not require traditional open-heart surgery and can be done while the heart continues to beat. Patients in the hospital setting, including high-risk patients in the operating room or intensive care unit, are candidates for having their cardiac function or fluid levels monitored by our Critical Care products. These technologies enable proactive clinical decisions and may be important for improving diagnoses and developing individualized therapeutic management plans for patients.
Segment and Geographical Information
We conduct operations worldwide and are managed in the following geographical regions: United States, Europe, Japan, and Rest of World. All regions sell products that are used to treat advanced cardiovascular disease. Additional segment and geographical information is incorporated herein by reference to Note 18 to the "Consolidated Financial Statements." See also the risk factor "Our business is subject to economic, political, and other risks associated with international sales and operations, including risks arising from currency exchange rate fluctuations" in Part I, Item 1A, "Risk Factors," for information regarding risks involving our international operations.
1
Corporate Background
Edwards Lifesciences Corporation was incorporated in Delaware on September 10, 1999. Unless otherwise indicated or otherwise required by the context, the terms "we," "our," "it," "its," "Company," "Edwards," and "Edwards Lifesciences" refer to Edwards Lifesciences Corporation and its subsidiaries.
Our principal executive offices are located at One Edwards Way, Irvine, California 92614. The telephone number at that address is (949) 250-2500. We make available, free of charge on our website located at www.edwards.com, our annual report on Form 10-K, quarterly reports on Form 10-Q, current reports on Form 8-K, and any amendments to those reports, as soon as reasonably practicable after filing such reports with the Securities and Exchange Commission ("SEC"). The contents of our website are not incorporated by reference into this report.
Edwards Lifesciences' Product and Technology Offerings
The following discussion summarizes the main areas of products and technologies we offer to treat advanced cardiovascular disease. These are categorized into three main areas: Transcatheter Heart Valve Therapy, Surgical Heart Valve Therapy, and Critical Care. For more information on net sales from these three main areas, see "Net Sales by Product Group" in Part II, Item 7 "Management's Discussion and Analysis of Financial Condition and Results of Operations."
Transcatheter Heart Valve Therapy
We are a global leader in transcatheter heart valve replacement technologies designed for the nonsurgical replacement of heart valves. The Edwards SAPIEN family of valves, including Edwards SAPIEN XT and Edwards SAPIEN 3 transcatheter aortic heart valves and their respective delivery systems, are used to treat heart valve disease using catheter-based approaches for certain patients for whom traditional open-heart surgery is not optimal. Delivered while the heart is beating, these valves can enable patients to experience a better quality of life sooner than patients receiving traditional surgical therapies. We began offering our transcatheter heart valves to patients commercially in Europe in 2007, in the United States in 2011, and in Japan in 2013. As of December 31, 2016, our transcatheter aortic heart valves were available in more than 65 countries. Supported by extensive customer training and service, and a growing body of compelling clinical evidence, our SAPIEN family of transcatheter aortic heart valves are the most widely prescribed transcatheter heart valves in the world.
Sales of our transcatheter heart valves represented 55%, 47%, and 41% of our net sales in 2016, 2015, and 2014, respectively.
Surgical Heart Valve Therapy
The core of our surgical tissue heart valve product line is the Carpentier-Edwards PERIMOUNT pericardial valve platform, including the line of PERIMOUNT Magna Ease pericardial valves for aortic and mitral surgical valve replacement. With more long-term clinical publications on durability and performance than any other surgical valve, PERIMOUNT valves are the most widely implanted surgical tissue heart valves in the world. Our EDWARDS INTUITY Elite Valve System, which is available in Europe, the United States, and certain other geographies, is a minimally invasive aortic heart valve system designed to enable faster procedures, shorter patient times on cardiopulmonary bypass, and smaller incisions. In addition to our replacement valves, we pioneered and are the worldwide leader in surgical heart valve repair therapies, including annuloplasty rings and systems. We are also a global leader in cardiac cannula devices and offer a variety of innovative procedure-enabling platforms to advance minimally invasive surgery.
Sales of our surgical tissue heart valve products represented 23%, 28%, and 31% of our net sales in 2016, 2015, and 2014, respectively.
Critical Care
We are a world leader in hemodynamic monitoring systems used to measure a patient's heart function and fluid status in surgical and intensive care settings. Hemodynamic monitoring enables a clinician to balance the supply and demand of oxygen in critically ill patients, and plays an important role in enhancing surgical recovery by enabling appropriate tissue and organ perfusion, and ultimately enabling the improvement of patient outcomes and survival. Our hemodynamic monitoring technologies are used before, during, and after surgeries, such as open-heart, major vascular, major abdominal, neurological, and orthopedic surgical procedures; as well as for acutely ill patients with conditions such as sepsis, shock, acute respiratory distress syndrome, and multi-organ failure.
2
Edwards’ complete hemodynamic portfolio helps clinicians make proactive clinical decisions for their patients, and includes the minimally invasive FloTrac system and the noninvasive ClearSight system. Our hemodynamic monitoring portfolio also comprises the Swan-Ganz line of pulmonary artery catheters and the Edwards Oximetry Central Venous Catheters for continuous measurement of central venous oxygen saturation. Our EV1000 clinical monitoring platform displays a patient's physiological status and integrates many of our sensors and catheters into one platform, giving clinicians multiple options to meet their clinical and patient needs.
We are also the global leader in disposable pressure monitoring devices and innovative closed blood sampling systems to help protect both patients and clinicians from the risk of infection.
We manufacture and sell a variety of peripheral vascular products used to treat endolumenal occlusive disease, including the Fogarty line of embolectomy catheters, which has been an industry standard for removing blood clots from peripheral blood vessels for more than 40 years.
Sales of our core hemodynamic products represented 12%, 13%, and 15% of our net sales in 2016, 2015, and 2014, respectively.
Competition
The medical technology industry is highly competitive. We compete with many companies, including divisions of companies much larger than us and smaller companies that compete in specific product lines or certain geographies. Furthermore, new product development and technological change characterize the areas in which we compete. Our present or future products could be rendered obsolete or uneconomical as a result of technological advances by one or more of our present or future competitors or by other therapies, including drug therapies. We must continue to develop and commercialize new products and technologies to remain competitive in the cardiovascular medical technology industry. We believe that we compete primarily on the basis of clinical superiority supported by extensive data, and innovative features that enhance patient benefit, product performance, and reliability. Customer and clinical support, and data that demonstrate both improvement in a patient's quality of life and a product's cost-effectiveness are additional aspects of competition.
The cardiovascular segment of the medical technology industry is dynamic and subject to significant change due to cost-of-care considerations, regulatory reform, industry and customer consolidation, and evolving patient needs. The ability to provide products and technologies that demonstrate value and improve clinical outcomes is becoming increasingly important for medical technology manufacturers.
We believe that we are a leading global competitor in each of our product lines. In Transcatheter Heart Valve Therapy, our primary competitors include Medtronic PLC, Boston Scientific Corporation, Abbott Laboratories, and Symetis SA. In Surgical Heart Valve Therapy, our primary competitors include Medtronic PLC, Abbott Laboratories, and LivaNova PLC. In Critical Care, we compete primarily with a variety of companies in specific product lines including ICU Medical, Inc., PULSION Medical Systems SE, a subsidiary of Getinge AB, and LiDCO Group PLC.
Sales and Marketing
We have a number of broad product lines that require a sales and marketing strategy tailored to our customers in order to deliver high-quality, cost-effective products and technologies to all of our customers worldwide. Our portfolio includes some of the most recognizable product brands in cardiovascular devices today. To help broaden awareness of our products and technologies, we conduct educational symposia and provide training to our customers.
Because of the diverse global needs of the population that we serve, our distribution system consists of several direct sales forces as well as independent distributors. We are not dependent on any single customer and no single customer accounted for 10% or more of our net sales in 2016.
Where we choose to market our products is also influenced by the existence of, or potential for, adequate reimbursement to hospitals by national healthcare systems. Sales personnel work closely with the customers who purchase our products, which primarily include physicians, nurses, and other clinical personnel, but can also include decision makers such as material managers, biomedical staff, hospital administrators and executives, purchasing managers, and ministries of health. Also, for certain of our products and where appropriate, our corporate sales team actively pursues approval of Edwards Lifesciences as a qualified supplier for hospital group purchasing organizations ("GPOs") that negotiate contracts with suppliers of medical products. Additionally, we have contracts with a number of United States and European national and regional buying groups.
3
United States. In the United States, we sell substantially all of our products through our direct sales forces. In 2016, 55% of our sales were derived from sales to customers in the United States.
International. In 2016, 45% of our sales were derived internationally through our direct sales forces and independent distributors. Of the total international sales, 56% were in Europe, 23% were in Japan, and 21% were in Rest of World. We sell our products in approximately 100 countries, and our major international markets include Canada, China, France, Germany, Italy, Japan, Spain, and the United Kingdom. A majority of the sales and marketing approach outside the United States is direct sales, although it varies depending on each country's size and state of development.
Raw Materials and Manufacturing
We operate manufacturing facilities in various geographies around the world. Our Transcatheter Heart Valve Therapy and Surgical Heart Valve Therapy products are manufactured primarily in the United States (California and Utah), Singapore, and Switzerland. A heart valve manufacturing facility is also currently under construction in Costa Rica. Critical Care products are manufactured primarily in our facilities located in Puerto Rico and the Dominican Republic ("DR").
We use a diverse and broad range of raw and organic materials in the design, development, and manufacture of our products. Our non-implantable products are manufactured from man-made raw materials including resins, chemicals, electronics, and metals. Most of our Transcatheter Heart Valve Therapy and Surgical Heart Valve Therapy products are manufactured from natural tissues harvested from animal tissue, as well as man-made materials. We purchase certain materials and components used in manufacturing our products from external suppliers. In addition, we purchase certain supplies from single sources for reasons of sole source availability or constraints resulting from regulatory requirements.
We work closely with our suppliers to mitigate risk and seek continuity of supply while maintaining uncompromised quality and reliability. Alternative supplier options are generally considered, identified, and approved for materials deemed critical to our products.
We follow rigorous sourcing and manufacturing procedures intended to safeguard humans from potential risks associated with diseases such as bovine spongiform encephalopathy ("BSE"). We comply with all current global guidelines regarding risks for products intended to be implanted in humans. We obtain bovine tissue used in our pericardial tissue valve products only from sources within the United States and Australia, where strong control measures and surveillance programs exist. In addition, bovine tissue used in our pericardial tissue valve products is from tissue types considered by global health and regulatory organizations to have shown no risk of infectibility. Our manufacturing and sterilization processes are designed to render tissue biologically safe from all known infectious agents and viruses.
Quality Assurance
We are committed to providing to our patients quality products that comply with the United States Food and Drug Administration ("FDA") and other applicable regulations. We have implemented modern quality systems and concepts throughout the organization. The quality system starts with the initial design concept and product specification, and continues through the design of the product, component specification processes, and the manufacturing, sales, and servicing of the product. The quality system is intended to design quality into products and utilizes continuous improvement concepts, including Lean/Six Sigma principles, throughout the product lifecycle.
Our operations are frequently inspected by the FDA, our European Notified Bodies, and other regulatory entities. Our facilities and operations are designed to comply with all applicable international quality systems standards, including the International Organization for Standardization ("ISO") 13485. These standards require, among other items, quality system controls that are applied to product design, component material, suppliers, and manufacturing operations. These regulatory approvals and ISO certifications can be obtained only after a successful audit of a company's quality system has been conducted by regulatory or independent outside auditors. Periodic reexamination by an independent outside auditor is required to maintain these certifications.
Environmental, Health, and Safety
We are committed to providing a safe and healthy workplace, promoting environmental excellence in our communities, and complying with all relevant regulations and medical device industry standards. Through our corporate and site level Environmental, Health, and Safety functions, we establish and monitor programs to reduce pollution, prevent injuries, and maintain compliance. In order to measure performance, we monitor and report on a number of metrics, including regulated and non-regulated waste disposal, energy usage, water consumption, air toxic emissions, and injuries from our production activities.
4
Each of our manufacturing sites is evaluated regularly with respect to a broad range of Environmental, Health, and Safety criteria.
Research and Development
We are engaged in ongoing research and development to deliver clinically advanced new products, to enhance the effectiveness, ease of use, safety, and reliability of our current leading products, and to expand the applications of our products as appropriate. We focus on opportunities within specific areas of structural heart disease and critical care monitoring, and we are dedicated to developing novel technologies to better enable clinicians to treat patients.
We invested $443 million in research and development in 2016, $383 million in 2015, and $347 million in 2014 (15.0%, 15.4%, and 14.9% of net sales, respectively). The majority of our research and development investment has been applied to strengthen our leadership position in our existing product lines. We have also dedicated a sizable portion of our research and development investment to developing additional advanced technologies designed to address unmet clinical needs within our areas of strategic focus. A considerable portion of our research and development investment includes clinical trials and the collection of evidence that provide data for use in regulatory submissions, and required post-market approval studies involving applications of our products. Our investment in clinical studies also includes outcomes and cost-effectiveness data for payers, clinicians, and healthcare systems.
In Transcatheter Heart Valve Therapy, we are developing new products to further streamline transcatheter heart valve replacement procedures and strengthen our leadership position. The Edwards SAPIEN 3 Ultra System is designed to incorporate several delivery system enhancements with the Axela sheath, which allows for dynamic expansion and contraction. The self-expanding CENTERA valve is designed to offer a low profile, repositionable technology delivered via a motorized handle.
We are also making significant investments in the development of transcatheter heart valve technologies designed to treat mitral and tricuspid valve diseases and other structural heart conditions. We are developing the Edwards-CardiAQ valve for mitral replacement, the PASCAL system for mitral repair, and the Edwards FORMA tricuspid spacer. In 2016, we entered into an agreement to acquire Valtech Cardio Ltd. ("Valtech"), which is developing both mitral and tricuspid repair technologies. We completed this acquisition on January 23, 2017. In addition, we have made investments in several companies that are independently developing less-invasive technologies to treat mitral regurgitation and left ventricular dysfunction. We have rights to acquire some of these companies at pre-determined prices should we elect to do so.
Our Surgical Heart Valve Therapy development program includes innovative platforms for patients remaining in surgery. The INSPIRIS aortic valve incorporates the RESILIA tissue integrity preservation technology and VFit technology for potential future valve-in-valve procedures. The KONECT conduit, designed for complex combined procedures, is a conduit pre-assembled with the PERIMOUNT Magna Ease valve and RESILIA tissue.
In our Critical Care product line, we are pursuing the development of a variety of decision support solutions for our clinicians. This includes next-generation noninvasive and minimally invasive hemodynamic monitoring systems, including a next-generation hemodynamic monitor with advanced data integration capabilities. We are also developing a comprehensive decision support software suite with advanced algorithms for proactive decision making, including an integrated semi-closed loop system for standardized management of patient fluid levels.
Our research and development activities are conducted primarily in facilities located in the United States and Israel. Our experienced research and development staff is focused on product design and development, quality, clinical research, and regulatory compliance. To pursue primary research efforts, we have developed alliances with several leading research institutions and universities, and also work with leading clinicians around the world in conducting scientific studies on our existing and developing products.
Proprietary Technology
Patents, trademarks, and other proprietary rights are important to the success of our business. We also rely upon trade secrets, know-how, continuing innovations, and licensing opportunities to develop and maintain our competitive position.
We own more than 2,700 issued United States patents, pending United States patent applications, issued foreign patents, and pending foreign patent applications. We also have licensed various United States and foreign patents and patent applications that relate to aspects of the technology incorporated in certain of our products, including our heart valves and annuloplasty rings. We also own or have rights in United States and foreign patents and patent applications in the field of
5
transcatheter heart valve repair and replacement. In addition, we own or have rights in United States and foreign patents and patent applications that cover catheters, systems and methods for hemodynamic monitoring, and vascular access products, among others.
We are a party to several license agreements with unrelated third parties pursuant to which we have obtained, for varying terms, the exclusive or non-exclusive rights to certain patents held by such third parties in consideration for cross-licensing rights and/or royalty payments. We have also licensed certain patent rights to others.
We monitor the products of our competitors for possible infringement of our owned and licensed patents. Litigation has been necessary to enforce certain patent rights held by us, and we plan to continue to defend and prosecute our rights with respect to such patents.
We own certain United States registered trademarks used in our business. Many of our trademarks have also been registered for use in certain foreign countries where registration is available and where we have determined it is commercially advantageous to do so.
Government Regulation and Other Matters
Our products and facilities are subject to regulation by numerous government agencies, including the U.S. FDA, European Community Notified Bodies, and the Japanese Pharmaceuticals and Medical Devices Agency, to confirm compliance with the various laws and regulations governing the development, testing, manufacturing, labeling, marketing, and distribution of our products. We are also governed by federal, state, local, and international laws of general applicability, such as those regulating employee health and safety, and the protection of the environment. Overall, the amount and scope of domestic and foreign laws and regulations applicable to our business has increased over time.
United States Regulation. In the United States, the FDA has responsibility for regulating medical devices. The FDA regulates design, development, testing, clinical studies, manufacturing, labeling, promotion, and record keeping for medical devices, and reporting of adverse events, recalls, or other field actions by manufacturers and users to identify potential problems with marketed medical devices. Many of the devices that we develop and market are in a category for which the FDA has implemented stringent clinical investigation and pre-market clearance or approval requirements. The process of obtaining FDA clearance or approval to market a product is resource intensive, lengthy, and costly. FDA review may involve substantial delays that adversely affect the marketing and sale of our products. A number of our products are pending regulatory clearance or approval to begin commercial sales in various markets. Ultimately, the FDA may not authorize the commercial release of a medical device if it determines the device is not safe and effective or does not meet other standards for clearance. Additionally, even if a product is cleared or approved, the FDA may require testing and surveillance programs to monitor the effects of these products once commercialized.
The FDA has the authority to halt the distribution of certain medical devices, detain or seize adulterated or misbranded medical devices, order the repair, replacement, or refund of the costs of such devices, or preclude the importation of devices that are or appear violative. The FDA also conducts inspections to determine compliance with the quality system regulations concerning the manufacturing and design of devices and current medical device reporting regulations, recall regulations, clinical testing regulations, and other requirements. The FDA may withdraw product clearances or approvals due to failure to comply with regulatory standards, or the occurrence of unforeseen problems following initial approval, and require notification of health professionals and others with regard to medical devices that present unreasonable risks of substantial harm to the public health. Additionally, the failure to comply with FDA or comparable regulatory standards or the discovery of previously unknown product problems could result in fines, delays, or suspensions of regulatory clearances or approvals, seizures, injunctions, recalls, refunds, civil money penalties, or criminal prosecution. Our compliance with applicable regulatory requirements is subject to continual review. Moreover, the FDA and several other United States agencies administer controls over the export of medical devices from the United States and the import of devices into the United States, which could also subject us to sanctions for noncompliance.
6
We are also subject to additional laws and regulations that govern our business operations, products, and technologies, including:
• | federal, state, and foreign anti-kickback laws and regulations, which generally prohibit payments to physicians or other purchasers of medical products as an inducement to purchase a product; |
• | the Stark law, which prohibits physicians from referring Medicare or Medicaid patients to a provider that bills these programs for the provision of certain designated health services if the physician (or a member of the physician's immediate family) has a financial relationship with that provider; |
• | federal and state laws and regulations that protect the confidentiality of certain patient health information, including patient records, and restrict the use and disclosure of such information, in particular, the Health Insurance Portability and Accountability Act of 1996; |
• | the Physician Payments Sunshine Act, which requires public disclosure of the financial relationships of United States physicians and teaching hospitals with applicable manufacturers, including medical device, pharmaceutical, and biologics companies; |
• | the False Claims Act, which prohibits the submission of false or otherwise improper claims for payment to a federally funded health care program, and health care fraud statutes that prohibit false statements and improper claims to any third-party payor; and |
• | the United States Foreign Corrupt Practices Act, which can be used to prosecute companies in the United States for arrangements with foreign government officials or other parties outside the United States. |
Failure to comply with these laws and regulations could result in criminal liability, significant fines or penalties, negative publicity, and substantial costs and expenses associated with investigation and enforcement activities. To assist in our compliance efforts, we adhere to many codes of ethics and conduct regarding our sales and marketing activities in the United States and other countries in which we operate. In addition, we have in place a dedicated team to improve our internal business compliance programs and policies.
International Regulation. Internationally, the regulation of medical devices is complex. In Europe, our products are subject to extensive regulatory requirements. The regulatory regime in the European Union for medical devices became mandatory in June 1998. It requires that medical devices may only be placed on the market if they do not compromise safety and health when properly installed, maintained, and used in accordance with their intended purpose. National laws conforming to the European Union's legislation regulate our products under the medical devices regulatory system. Although the more variable national requirements under which medical devices were formerly regulated have been substantially replaced by the European Union Medical Devices Directive, individual nations can still impose unique requirements that may require supplemental submissions. The European Union medical device laws require manufacturers to declare that their products conform to the essential regulatory requirements after which the products may be placed on the market bearing the CE Mark. Manufacturers' quality systems for products in all but the lowest risk classification are also subject to certification and audit by an independent notified body. In Europe, particular emphasis is being placed on more sophisticated and faster procedures for the reporting of adverse events to the competent authorities.
In Japan, pre-market approval and clinical studies are required as is governmental pricing approval for medical devices. Clinical studies are subject to a stringent "Good Clinical Practices" standard. Approval time frames from the Japanese Ministry of Health, Labour and Welfare vary from simple notifications to review periods of one or more years, depending on the complexity and risk level of the device. In addition, importation of medical devices into Japan is subject to the "Good Import Practices" regulations. As with any highly regulated market, significant changes in the regulatory environment could adversely affect future sales.
7
In many of the other foreign countries in which we market our products, we may be subject to regulations affecting, among other things:
• | product standards and specifications; |
• | packaging requirements; |
• | labeling requirements; |
• | product collection and disposal requirements; |
• | quality system requirements; |
• | import restrictions; |
• | tariffs; |
• | duties; and |
• | tax requirements. |
Many of the regulations applicable to our devices and products in these countries are similar to those of the FDA. In some regions, the level of government regulation of medical devices is increasing, which can lengthen time to market and increase registration and approval costs. In many countries, the national health or social security organizations require our products to be qualified before they can be marketed and considered eligible for reimbursement.
Health Care Initiatives. Government and private sector initiatives to limit the growth of health care costs, including price regulation and competitive pricing, coverage and payment policies, comparative effectiveness reviews, technology assessments, and managed-care arrangements, are continuing in many countries where we do business, including the United States, Europe, and Japan. As a result of these changes, the marketplace has placed increased emphasis on the delivery of more cost-effective medical therapies. For example, government programs, private health care insurance, and managed-care plans have attempted to control costs by restricting coverage and limiting the level of reimbursement for procedures or treatments, and some third-party payors require their pre-approval before new or innovative devices or therapies are utilized by patients. These various initiatives have created increased price sensitivity over medical products generally and may impact demand for our products and technologies.
The delivery of our products is subject to regulation by the Department of Health and Human Services ("HHS") in the United States and comparable state and foreign agencies responsible for reimbursement and regulation of health care items and services. Foreign governments also impose regulations in connection with their health care reimbursement programs and the delivery of health care items and services. Reimbursement schedules regulate the amount the United States government will reimburse hospitals and doctors for the inpatient care of persons covered by Medicare. HHS' Centers for Medicare & Medicaid Services may also review whether and/or under what circumstances a procedure or technology is reimbursable for Medicare beneficiaries. Changes in current reimbursement levels could have an adverse effect on market demand and our pricing flexibility.
Health care cost containment efforts have also prompted domestic hospitals and other customers of medical device manufacturers to consolidate into larger purchasing groups to enhance purchasing power, and this trend is expected to continue. The medical device industry has also experienced some consolidation, partly in order to offer a broader range of products to large purchasers. As a result, transactions with customers are larger, more complex, and tend to involve more long-term contracts than in the past. These larger customers, due to their enhanced purchasing power, may attempt to increase the pressure on product pricing.
Health Care Reform. In 2010, significant reforms to the health care system were adopted as law in the United States. The law includes provisions that, among other things, reduce or limit Medicare reimbursement, require all individuals to have health insurance (with limited exceptions), and impose increased taxes. Specifically, the law requires the medical device industry to subsidize health care reform in the form of a 2.3% excise tax on United States sales of most medical devices. The excise tax, which increased our operating expenses, was suspended for calendar years 2016 and 2017, but is scheduled to resume in 2018. The long term impact of the payment reform provisions in the 2010 health care law remains uncertain to us as these programs continue to evolve. This law or any future legislation, including deficit reduction legislation, could reduce
8
medical procedure volumes, lower reimbursement for our products, and impact the demand for our products or the prices at which we sell our products.
In late 2016, legislation was signed into law that, among other things, increases funding for medical research and eases the development and approval of experimental treatments. Known as the 21st Century Cures Act, the law also provides new funding for the National Institutes of Health and the FDA. Although it will take some time to be fully implemented, the 21st Century Cures Act could help accelerate the discovery, development, and delivery of medical advancements to ensure more timely access to new treatments and cures for patients in need.
Seasonality
Our quarterly net sales are influenced by many factors, including new product introductions, acquisitions, regulatory approvals, patient and physician holiday schedules, and other factors. Net sales in the third quarter are typically lower than other quarters of the year due to the seasonality of the United States and European markets, where summer vacation schedules normally result in fewer medical procedures.
Employees
As of December 31, 2016, we had approximately 11,100 employees worldwide, the majority of whom were located in the United States, the Dominican Republic, Singapore, and Puerto Rico. Other major concentrations of employees are located in Europe and Japan. We emphasize competitive compensation, benefits, equity participation, and a positive and attractive work environment in our efforts to attract and retain qualified personnel, and employ a rigorous talent management system. None of our North American employees are represented by a labor union. In various countries outside of North America, we interact with trade unions and work councils that represent a limited number of employees.
Item 1A. Risk Factors
Our business and assets are subject to varying degrees of risk and uncertainty. An investor should carefully consider the risks described below, as well as other information contained in this Annual Report on Form 10-K and in our other filings with the SEC. Additional risks not presently known to us or that we currently deem immaterial may also adversely affect our business. If any of these events or circumstances occurs, our business, financial condition, results of operations, or prospects could be materially harmed. In that case, the value of our securities could decline and an investor could lose part or all of his or her investment. In addition, forward-looking statements within the meaning of the federal securities laws that are contained in this Annual Report on Form 10-K or in our other filings or statements may be subject to the risks described below as well as other risks and uncertainties. Please read the cautionary notice regarding forward-looking statements in Item 1, "Business," above.
Business and Operating Risks
If we do not introduce new products in a timely manner, our products may become obsolete and our operating results may suffer.
The cardiovascular products industry is characterized by technological changes, frequent new product introductions, and evolving industry standards. Without the timely introduction of new and improved products, our products could become technologically obsolete or more susceptible to competition and our revenue and operating results would suffer. Even if we are able to develop new or improved products, our ability to market them could be limited by the need for regulatory clearance, restrictions imposed on approved indications, entrenched patterns of clinical practice, uncertainty over third-party reimbursement, or other factors. We devote significant financial and other resources to our research and development activities; however, the research and development process is prolonged and entails considerable uncertainty. Accordingly, products we are currently developing may not complete the development process or obtain the regulatory or other approvals required to market such products in a timely manner or at all.
Technical innovations often require substantial time and investment before we can determine their commercial viability. We may not have the financial resources necessary to fund all of these projects. In addition, even if we are able to successfully develop new or improved products, they may not produce revenue in excess of the costs of development, and they may be rendered obsolete or less competitive by changing customer preferences or the introduction by our competitors of products with newer technologies or features or other factors.
9
We may experience supply interruptions that could harm our ability to manufacture products.
We use a broad range of raw and organic materials and other items in the design and manufacture of our products. Our Surgical and Transcatheter Heart Valve Therapy products are manufactured from treated natural animal tissue and man-made materials. Our non-implantable products are manufactured from man-made raw materials including resins, chemicals, electronics, and metals. We purchase certain of the materials and components used in the manufacture of our products from external suppliers, and we purchase certain supplies from single sources for reasons of quality assurance, cost-effectiveness, availability, or constraints resulting from regulatory requirements. We also contract with third parties for important services related to infrastructure and information technology. General economic conditions could adversely affect the financial viability of our suppliers, resulting in their inability to provide materials and components used in the manufacture of our products. While we work closely with suppliers to monitor their financial viability, assure continuity of supply, and maintain high quality and reliability, these efforts may not be successful. In addition, due to the rigorous regulations and requirements of the FDA and foreign regulatory authorities regarding the manufacture of our products (including the need for approval of any change in supply arrangements), we may have difficulty establishing additional or replacement sources on a timely basis or at all if the need arises. Certain suppliers may also elect to no longer service medical device companies due to the high amount of requirements and regulation. Although alternative supplier options are considered and identified, we typically do not pursue regulatory qualification of alternative sources due to the strength of our existing supplier relationships and the time and expense associated with the regulatory validation process. A change in suppliers could require significant effort or investment in circumstances where the items supplied are integral to product performance or incorporate unique technology, and the loss of any existing supply contract could have a material adverse effect on us.
Regulatory agencies in the United States or other international geographies from time to time have limited or banned the use of certain materials used in the manufacture of our products. In these circumstances, transition periods typically provide time to arrange for alternative materials. In addition, the SEC enacted disclosure rules regarding products that may contain certain minerals that originate from conflict areas in and around the Democratic Republic of Congo. If our suppliers cannot verify that their components do not originate from these conflict areas, we may need to source components from alternative suppliers. If we are unable to identify alternative materials or suppliers and secure approval for their use in a timely manner, our business could be harmed.
Some of our suppliers are located outside the United States. As a result, trade or regulatory embargoes imposed by foreign countries or the United States could result in delays or shortages that could harm our business.
The manufacture of many of our products is highly complex and subject to strict quality controls. If we or one of our suppliers or logistics partners encounters manufacturing, logistics, or quality problems, including as a result of natural disasters, our business could suffer.
The manufacture of many of our products is highly complex and subject to strict quality controls, due in part to rigorous regulatory requirements. In addition, quality is extremely important due to the serious and costly consequences of a product failure. Problems can arise during the manufacturing process for a number of reasons, including equipment malfunction, failure to follow protocols and procedures, raw material problems, software problems, or human error. Although closely managed, disruptions can occur during implementation of new equipment and systems to replace aging equipment, as well as during production line transfers and expansions. As we expand into new markets, we may face unanticipated surges in demand which could strain our production capacity. If these problems arise or if we otherwise fail to meet our internal quality standards or those of the FDA or other applicable regulatory body, which include detailed record-keeping requirements, our reputation could be damaged, we could become subject to a safety alert or a recall, we could incur product liability and other costs, product approvals could be delayed, and our business could otherwise be adversely affected.
In addition, our manufacturing and warehousing facilities, as well as those of our suppliers and logistics partners, could be materially damaged by earthquakes, hurricanes, volcanoes, fires, and other natural disasters or catastrophic circumstances. While we believe that our exposure to significant losses from a catastrophic disaster could be partially mitigated by our ability to manufacture, store, and distribute some of our products at other facilities, the losses could have a material adverse effect on our business for an indeterminate period of time before this transition is complete and operates without significant disruption.
We may be required, from time to time, to recognize charges in connection with the write-down of our assets or dispositions of business operations or for other reasons.
From time to time, we identify operations and products that are not performing at a level commensurate with the rest of our business. We may seek to dispose of these underperforming operations or products. We may also seek to dispose of other operations or products for strategic or other business reasons. If we cannot dispose of an operation or product on acceptable
10
terms, we may voluntarily cease operations related to that product. Any of these events could result in charges, which could be substantial and which could adversely affect our results of operations.
We may not successfully identify and complete acquisitions or strategic alliances on favorable terms or achieve anticipated synergies relating to any acquisitions or alliances, and such acquisitions could result in unforeseen operating difficulties and expenditures, require significant management resources, and require significant charges or write-downs.
We regularly explore potential acquisitions of complementary businesses, technologies, services, or products, as well as potential strategic alliances. We may be unable to find suitable acquisition candidates or appropriate partners with which to form alliances. Even if we identify appropriate acquisition or alliance candidates, we may be unable to complete the acquisitions or alliances on favorable terms, if at all. In addition, the process of integrating an acquired business, technology, service, or product into our existing operations could result in unforeseen difficulties and expenditures. Integration of an acquired company often requires significant expenditures as well as significant management resources that otherwise would be available for ongoing development of our other businesses. Moreover, we may not realize the anticipated financial or other benefits of an acquisition or alliance.
We may be required to take charges or write-downs in connection with acquisitions. In particular, acquisitions of businesses engaged in the development of new products may give rise to in-process research and development ("IPR&D") assets. To the extent that the value of these assets declines, we may be required to write down the value of the assets. Also, in connection with certain asset acquisitions, we may be required to take an immediate charge related to acquired IPR&D. Either of these situations could result in substantial charges, which could adversely affect our results of operations.
Future acquisitions could also involve the issuance of equity securities, the incurrence of debt, contingent liabilities, or amortization of expenses related to other intangible assets, any of which could adversely impact our financial condition or results of operations. In addition, equity or debt financing required for such acquisitions may not be available.
We face intense competition, and if we do not compete effectively, our business will be harmed.
The cardiovascular medical device industry is highly competitive. We compete with many companies, some of which are larger and have longer operating histories, better brand or name recognition, and broader product offerings. Our customers consider many factors when selecting a product, including product reliability, breadth of product line, clinical outcomes, product availability, price, availability and rate of reimbursement, and services provided by the manufacturer. In addition, our ability to compete will depend in large part on our ability to develop and acquire new products and technologies, anticipate technology advances, and keep pace with other developers of cardiovascular therapies and technologies. Our sales, technical, and other key personnel play an integral role in the development, marketing, and selling of new and existing products. If we are unable to recruit, hire, develop, and retain a talented, competitive workforce, our ability to compete may be adversely affected. Our competitive position can also be adversely affected by product problems, physician advisories, and safety alerts, reflecting the importance of quality in the medical device industry. Our position can shift as a result of any of these factors. In addition, given the trend toward value-based healthcare, if we are not able to continue to demonstrate the full value of our products to healthcare providers and payors, our competitive position could be adversely affected. See "Competition" under "Business" included herein.
Unsuccessful clinical trials or procedures relating to products under development could have a material adverse effect on our prospects.
The regulatory approval process for new products and new indications for existing products requires extensive clinical trials and procedures, including early clinical feasibility and regulatory studies. Unfavorable or inconsistent clinical data from current or future clinical trials or procedures conducted by us, our competitors, or third parties, or perceptions regarding this clinical data, could adversely affect our ability to obtain necessary approvals and the market's view of our future prospects. Such clinical trials and procedures are inherently uncertain and there can be no assurance that these trials or procedures will be completed in a timely or cost-effective manner or result in a commercially viable product or expanded indication. Failure to successfully complete these trials or procedures in a timely and cost-effective manner could have a material adverse effect on our prospects. Clinical trials or procedures may experience significant setbacks even after earlier trials have shown promising results. Further, preliminary results from clinical trials or procedures may be contradicted by subsequent clinical analysis. In addition, results from our clinical trials or procedures may not be supported by actual long-term studies or clinical experience. If preliminary clinical results are later contradicted, or if initial results cannot be supported by actual long-term studies or clinical experience, our business could be adversely affected. Clinical trials or procedures may be delayed, suspended, or terminated by us, the FDA, or other regulatory authorities at any time if it is believed that the trial participants face unacceptable health risks or any other reasons.
11
The success of many of our products depends upon strong relationships with certain key physicians.
The development, marketing, and sale of many of our products requires us to maintain working relationships with physicians upon whom we rely to provide considerable knowledge and experience. These physicians may assist us as researchers, marketing consultants, product trainers and consultants, inventors, and as public speakers. If new laws, regulations, or other developments limit our ability to maintain strong relationships with these professionals or to continue to receive their advice and input, the development and marketing of our products could suffer, which could have a material adverse effect on our business, financial condition, and results of operations.
Market and Other External Risks
General economic and political conditions could have a material adverse effect on our business.
External factors can affect our profitability and financial condition. Such external factors include general domestic and global economic conditions, such as interest rates, tax rates, and factors affecting global economic stability, and the political environment regarding health care in general. The strength and timing of the current economic recovery remains uncertain, and we cannot predict to what extent the global economic conditions may negatively impact our business. For example, negative conditions in the credit and capital markets could impair our ability to access the financial markets for working capital or other funds, and could negatively impact our ability to borrow. An increase in interest rates could result in an increase in our borrowing costs and could otherwise restrict our ability to access the capital markets. Such conditions could result in decreased liquidity and impairments in the carrying value of our investments, and could adversely affect our results of operations and financial condition. These and other conditions could also adversely affect our customers, and may impact their ability or decision to purchase our products or make payments on a timely basis.
In 2010, significant reforms to the health care system were adopted as law in the United States. The law includes provisions that, among other things, reduce or limit Medicare reimbursement, require all individuals to have health insurance (with limited exceptions), and impose increased taxes. Specifically, the law requires the medical device industry to subsidize health care reform in the form of a 2.3% excise tax on United States sales of most medical devices. The excise tax, which increased our operating expenses, was suspended for calendar years 2016 and 2017, but is scheduled to resume in 2018. The long term impact of the payment reform provisions in the 2010 health care law remains uncertain to us as these programs continue to evolve. This law or any future legislation, including deficit reduction legislation, could adversely affect our results of operations, financial condition, and prospects if they were to impact the demand for our products or pricing, or result in cuts to, or a restructuring of, entitlement programs such as Medicare and Medicaid.
Our business is subject to economic, political, and other risks associated with international sales and operations, including risks arising from currency exchange rate fluctuations.
Because we sell our products in a number of countries, our business is subject to the risks of doing business internationally, including risks associated with anti-corruption and anti-bribery laws. Our net sales originating outside the United States, as a percentage of total net sales, were 45% in 2016. We anticipate that sales from international operations will continue to represent a substantial portion of our total sales. In addition, many of our manufacturing facilities and suppliers are located outside of the United States. Accordingly, our future results could be harmed by a variety of factors, including:
• | changes in local medical reimbursement policies and programs; |
• | changes in foreign regulatory requirements; |
• | changes in a specific country's or region's political or economic conditions, including changing circumstances in emerging regions, that may reduce the number of procedures that use our products; |
• | trade protection measures, quotas, embargoes, import or export licensing requirements, and duties, tariffs, or surcharges; |
• | potentially negative impact of tax laws, including transfer pricing liabilities and tax costs associated with the repatriation of cash; |
• | difficulty in staffing and managing global operations; |
12
• | cultural, exchange rate, or other local factors affecting financial terms with customers; |
• | local economic and financial conditions, including sovereign defaults and decline in sovereign credit ratings, affecting the collectability of receivables, including receivables from sovereign entities; |
• | an outbreak of any life-threatening communicable disease; |
• | economic and political instability and local economic and political conditions; |
• | differing labor regulations; and |
• | differing protection of intellectual property. |
Substantially all of our sales outside of the United States are denominated in local currencies, principally in Europe (and primarily denominated in the Euro) and in Japan. The United States dollar value of our international sales varies with currency exchange rate fluctuations. Decreases in the value of the United States dollar to the Euro or the Japanese yen, as well as other currencies, have the effect of increasing our reported revenues even when the volume of international sales has remained constant. Increases in the value of the United States dollar relative to the Euro or the Japanese yen, as well as other currencies, have the opposite effect. Significant increases or decreases in the value of the United States dollar could have a material effect on our revenues, cost of sales, and results of operations. We have a hedging program for certain currencies that attempts to manage currency exchange rate risks to an acceptable level based on management's judgment of the appropriate trade-off between risk, opportunity, and cost; however, this hedging program does not completely eliminate the effects of currency exchange rate fluctuations.
The United States Foreign Corrupt Practices Act, the United Kingdom Bribery Act, and similar laws in other jurisdictions contain prohibitions against bribery and other illegal payments, and make it an offense to fail to have procedures in place that prevent such payments. Recent years have seen an increasing number of investigations and other enforcement activities under these laws. Although we have compliance programs in place with respect to these laws, which may be used as a defense to prove we had adequate procedures, no assurance can be given that a violation will not be found, and if found, the resulting penalties could adversely affect us and our business.
The stock market can be volatile and fluctuations in our quarterly sales and operating results as well as other factors could cause our financial guidance to vary from actual results and our stock price to decline.
From time to time, the stock market experiences extreme price and volume fluctuations. This volatility can have a significant effect on the market prices of securities for reasons unrelated to underlying performance. These broad market fluctuations may materially adversely affect our stock price, regardless of our operating results. In addition, the market price of our common stock could fluctuate substantially in response to any of the other risk factors set out above and below, as well as a number of other factors, including the performance of comparable companies or the medical device industry, or changes in financial estimates and recommendations of securities analysts.
Our sales and operating results may vary significantly from quarter to quarter. A high proportion of our costs are fixed, due in part to significant selling, research and development, and manufacturing costs. Thus, small declines in revenue could disproportionately affect our operating results in a quarter, and the price of our common stock could fall. Other factors that could affect our quarterly sales and operating results include:
• | announcements of innovations, new products, strategic developments, or business combinations by us or our competitors; |
• | demand for and clinical acceptance of products; |
• | the timing and execution of customer contracts, particularly large contracts that would materially affect our operating results in a given quarter; |
• | the timing of sales of products and of the introduction of new products; |
• | the timing of marketing, training, and other expenses related to the introduction of new products; |
• | the timing of regulatory approvals; |
13
• | changes in foreign currency exchange rates; |
• | delays or problems in introducing new products, such as slower than anticipated adoption of transcatheter heart valves; |
• | changes in our pricing policies or the pricing policies of our competitors; |
• | the timing of approvals of governmental reimbursement rates or changes in reimbursement rates for our products; |
• | increased expenses, whether related to sales and marketing, raw materials or supplies, product development, or administration; |
• | changes in the level of economic activity in the United States or other regions in which we do business; |
• | changes to accounting standards; |
• | costs related to acquisitions of technologies or businesses; and |
• | our ability to expand our operations and the amount and timing of expansion-related expenditures. |
The quarterly and full-year financial guidance we provide to investors and analysts with insight to our view of our future performance is based on assumptions about our sales and operating results. Due to the nature of our business and the numerous factors that can impact our sales and operating performance, including those described above, our financial guidance may vary from actual results. If we fail to meet any financial guidance that we provide, or if we find it necessary to revise such guidance during the year, the price of our common stock could decline.
Consolidation in the health care industry could have an adverse effect on our sales and results of operations.
The health care industry has been consolidating, and organizations such as GPOs, independent delivery networks, and large single accounts, such as the United States Veterans Administration, continue to consolidate purchasing decisions for many of our health care provider customers. As a result, transactions with customers are larger and more complex, and tend to involve more long-term contracts. The purchasing power of these larger customers has increased, and may continue to increase, causing downward pressure on product pricing. If we are not one of the providers selected by one of these organizations, we may be precluded from making sales to its members or participants. Even if we are one of the selected providers, we may be at a disadvantage relative to other selected providers that are able to offer volume discounts based on purchases of a broader range of medical equipment and supplies. Further, we may be required to commit to pricing that has a material adverse effect on our revenues, profit margins, business, financial condition, and results of operations. We expect that market demand, governmental regulation, third-party reimbursement policies, and societal pressures will continue to change the worldwide health care industry, resulting in further business consolidations and alliances, which may exert further downward pressure on the prices of our products and could adversely impact our business, financial condition, and results of operations.
If third-party payors decline to reimburse our customers for our products or impose other cost containment measures to reduce reimbursement levels, our ability to profitably sell our products will be harmed.
We sell our products and technologies to hospitals and other health care providers, all of which receive reimbursement for the health care services provided to patients from third-party payors, such as government programs (both domestic and international), private insurance plans, and managed care programs. The ability of customers to obtain appropriate reimbursement for their products 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 acceptance of new products.
Third-party payors are increasingly attempting to contain health care costs by limiting both coverage and the level of reimbursement for medical products and services. There can be no assurance that levels of reimbursement, if any, will not be decreased in the future, or that future legislation, regulation, or reimbursement policies of third-party payors will not otherwise adversely affect the demand for and price levels of our products. The introduction of cost containment incentives, combined with closer scrutiny of health care expenditures by both private health insurers and employers, has resulted in increased discounts and contractual adjustments to hospital charges for services performed. Hospitals or physicians may respond to such cost-containment pressures by substituting lower cost products or other therapies. In addition, the 2010 United States health
14
care law could adversely affect reimbursement levels for our products, or otherwise adversely affect our product pricing and profitability.
Initiatives to limit the growth of health care costs, including price regulation, are underway in several countries around the world. In many countries, customers are reimbursed for our products under a government operated insurance system. Under such a system, the government periodically reviews reimbursement levels and may limit patient access. If a government were to decide to reduce reimbursement levels, our product pricing could be adversely affected.
Third-party payors may deny reimbursement if they determine that a device used in a procedure was not used in accordance with cost-effective treatment methods as determined by such third-party payors, or was used for an unapproved indication. Third-party payors may also deny reimbursement for experimental procedures and devices. We believe that many of our existing products are cost-effective, even though the one-time cost may be significant, because they are intended to improve quality of life and reduce overall health care costs over a long period of time. We cannot be certain that these third-party payors will recognize these cost savings instead of merely focusing on the lower initial costs associated with competing therapies. If our products are not considered cost-effective by third-party payors, our customers may not be reimbursed for them, resulting in lower sales of our products.
Legal, Compliance, and Regulatory Risks
We may incur losses from product liability or other claims that could adversely affect our operating results.
Our business exposes us to potential product liability risks that are inherent in the design, manufacture, and marketing of medical devices. Our products are often used in surgical and intensive care settings with seriously ill patients. In addition, many of the medical devices we manufacture and sell are designed to be implanted in the human body for long periods of time. Component failures, manufacturing and assembly flaws, design defects, or inadequate disclosure of product-related risks or product-related information could result in an unsafe condition or injury to, or death of, patients. Such problems could result in product liability, medical malpractice or other lawsuits and claims, safety alerts, or product recalls in the future, which, regardless of their ultimate outcome, could have a material adverse effect on our business, reputation, and ability to attract and retain customers. Product liability claims may be brought from time to time either by individuals or by groups seeking to represent a class. We may incur charges related to such matters in excess of any established reserves and such charges, including the establishment of any such reserves, could have a material adverse impact on our net income and net cash flows.
Our inability to protect our intellectual property or failure to maintain the confidentiality and integrity of data or other sensitive company information, by cyber-attack or other event, could have a material adverse effect on our business.
Our success and competitive position are dependent in part upon our proprietary intellectual property. We rely on a combination of patents and trade secrets to protect our proprietary intellectual property, and we expect to continue to do so. Although we seek to protect our proprietary rights through a variety of means, we cannot guarantee that the protective steps we have taken are adequate to protect these rights. Patents issued to or licensed by us in the past or in the future may be challenged and held invalid. In addition, as our patents expire, we may be unsuccessful in extending their protection through patent term extensions. The expiration of, or the failure to maintain or extend our patents, could have a material adverse effect on us.
We also rely on confidentiality agreements with certain employees, consultants, and other third parties to protect, in part, trade secrets and other proprietary information. These agreements could be breached, and we may not have adequate remedies for such a breach. In addition, others could independently develop substantially equivalent proprietary information or gain access to our trade secrets or proprietary information.
Our intellectual property, other proprietary technology, and other sensitive company information is dependent on sophisticated information technology systems and is potentially vulnerable to cyber-attacks, loss, damage, destruction from system malfunction, computer viruses, loss of data privacy, or misappropriation or misuse of it by those with permitted access, and other events. While we have invested to protect our intellectual property and other information, and continue to work diligently to upgrade and enhance our systems to keep pace with continuing changes in information processing technology, there can be no assurance that our precautionary measures will prevent breakdowns, breaches, cyber-attacks, or other events. Such events could have a material adverse effect on our reputation, financial condition, or results of operations.
We spend significant resources to enforce our intellectual property rights, sometimes resulting in litigation. Intellectual property litigation is complex and can be expensive and time-consuming. However, our efforts in this regard may not be successful. We may not be able to detect infringement. In addition, competitors may design around our technology or develop competing technologies. Patent litigation can result in substantial cost and diversion of effort. Intellectual property protection
15
may also be unavailable or limited in some foreign countries, enabling our competitors to capture increased market position. The invalidation of key intellectual property rights or an unsuccessful outcome in lawsuits filed to protect our intellectual property could have a material adverse effect on our financial condition, results of operations, or prospects.
Third parties may claim we are infringing their intellectual property, and we could suffer significant litigation or licensing expenses or be prevented from selling products.
During recent years, we and our competitors have been involved in substantial litigation regarding patent and other intellectual property rights in the medical device industry. From time to time, we have been and may in the future be forced to defend against claims and legal actions alleging infringement of the intellectual property rights of others, and such intellectual property litigation is typically costly and time-consuming. Adverse determinations in any such litigation could result in significant liabilities to third parties or injunctions that bar the sale of our products, or could require us to seek licenses from third parties and, if such licenses are not available on commercially reasonable terms, prevent us from manufacturing, selling, or using certain products, any one of which could have a material adverse effect on us. In addition, some licenses may be non-exclusive, which could provide our competitors access to the same technologies.
Third parties could also obtain patents that may require us to either redesign products or, if possible, negotiate licenses from such third parties. Such licenses may materially increase our expenses. If we are unable to redesign products or obtain a license, we might have to exit a particular product offering.
We and our customers are subject to rigorous governmental regulations and we may incur significant expenses to comply with these regulations and develop products that are compatible with these regulations. In addition, failure to comply with these regulations could subject us to substantial sanctions which could adversely affect our business, results of operations, and financial condition.
The medical technologies we manufacture and market are subject to rigorous regulation by the FDA and numerous other federal, state, and foreign governmental authorities, including regulations that cover the composition, labeling, testing, clinical study, design, sourcing, manufacturing, packaging, marketing, advertising, promotion, and distribution of our products.
We are required to register with the FDA as a device manufacturer. As a result, we 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, design, quality control, and documentation procedures. The FDA may also inspect our compliance with requirements related to adverse event reporting, recalls or corrections (field actions), the conduct of clinical studies, and other requirements. In the European Union, we are required to maintain certain CE Mark and ISO certifications in order to sell our products, and are subject to periodic inspections by notified bodies to obtain and maintain these certifications. If we or our suppliers fail to adhere to QSR, CE Mark, ISO, or similar requirements, this could delay or interrupt product production or sales and/or lead to fines, difficulties in obtaining regulatory clearances, recalls, or other consequences, which in turn could have a material adverse effect on our financial condition and results of operations or prospects.
Medical devices must receive FDA clearance or approval before they can be commercially marketed in the United States. In addition, the FDA may require testing and surveillance programs to monitor the effects of approved products that have been commercialized, and can prevent or limit further marketing of a product based upon the results of post-marketing programs. 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, would be likely to cause or contribute to a death or serious injury. Federal regulations also require us to report certain recalls or corrective actions to the FDA. Furthermore, most major markets for medical devices outside the United States require clearance, approval, or compliance with certain standards before a product can be commercially marketed. The process of obtaining regulatory clearances or approvals to market a medical device, particularly from the FDA and certain foreign governmental authorities, can be costly and time-consuming, and clearances or approvals may not be granted for products or product improvements on a timely basis, if at all. Delays in receipt of, or failure to obtain, clearances or approvals for products or product improvements could result in delayed realization of product revenues or in substantial additional costs, which could have a material adverse effect on our business or results of operations or prospects. At any time after approval of a product for commercial sale, the FDA may conduct periodic inspections to determine compliance with QSR requirements, and/or current Medical Device Reporting regulations, or other regulatory requirements. Noncompliance with applicable requirements may subject us or responsible individuals to sanctions including civil money penalties, product seizure, injunction, or criminal prosecution. In addition, the FDA may withhold or delay pre-market approval of our products until the noncompliance is resolved. Product approvals by the FDA can also be withdrawn due to failure to comply with regulatory standards or the occurrence of unforeseen problems following initial approval.
16
Regulatory agencies in the United States or other international geographies from time to time limit or ban the use of certain materials used in the manufacture of our products, require collection and disposal of products at the end of their lifecycle, and require disclosure of the origin of certain raw materials in our products. Noncompliance with applicable requirements could have a material adverse effect on our business.
The United States Physician Payment Sunshine Act, and similar laws in other jurisdictions, also impose reporting and disclosure requirements on device, pharmaceutical, and biologics companies for certain financial relationships with United States health care providers and teaching hospitals. Failure to submit required information or submitting incorrect information may result in significant civil monetary penalties.
We are also subject to various United States and international laws pertaining to health care pricing, anti-corruption, and fraud and abuse, including prohibitions on kickbacks and the submission of false claims laws and restrictions on relationships with physicians and other referral sources. These laws are broad in scope and are subject to evolving interpretation, which could require us to incur substantial costs to monitor compliance or to alter our practices if we are found not to be in compliance. Violations of these laws may be punishable by criminal or civil sanctions against us and our officers and employees, including substantial fines, imprisonment, and exclusion from participation in governmental health care programs.
Despite our implementation of robust compliance processes, we may be subject, from time to time, to inspections, investigations, and other enforcement actions by governmental authorities. If we are found not to be in compliance with applicable laws or regulations, the applicable governmental authority can impose fines, delay, suspend, or revoke regulatory clearances or approvals, institute proceedings to detain or seize our products, issue a recall, impose marketing or operating restrictions, enjoin future violations and assess civil penalties against us or our officers or employees, and institute criminal prosecution. Moreover, governmental authorities can ban or request the recall, repair, replacement, or refund of the cost of any device or product we manufacture or distribute. Any of the foregoing actions could result in decreased sales as a result of negative publicity and product liability claims, and could have a material adverse effect on our financial condition, results of operations, and prospects. In addition to the sanctions for noncompliance described above, commencement of an enforcement proceeding, inspection, or investigation could divert substantial management attention from the operation of our business and have an adverse effect on our business, results of operations, and financial condition.
Our industry is experiencing greater scrutiny and regulation by governmental authorities, which may lead to greater governmental regulation in the future.
In recent years, the medical device industry has been subject to increased regulatory scrutiny, including by the FDA, numerous other federal, state, and foreign governmental authorities, as well as members of Congress. This has included increased regulation, enforcement, inspections, and governmental investigations of the medical device industry and disclosure of financial relationships with health care professionals. We anticipate that the government will continue to scrutinize our industry closely, and that additional regulation by governmental authorities, both foreign and domestic, may increase compliance costs, exposure to litigation, and other adverse effects to our operations.
We are subject to risks arising from concerns and/or regulatory actions relating to “mad cow disease.”
Certain of our products, including pericardial tissue valves, are manufactured using bovine tissue. Concerns relating to the potential transmission of BSE, commonly known as "mad cow disease," from cows to humans may result in reduced acceptance of products containing bovine materials. Certain medical device regulatory agencies have considered whether to continue to permit the sale of medical devices that incorporate bovine material. We obtain bovine tissue only from closely controlled sources within the United States and Australia. The bovine tissue used in our pericardial tissue valves is from tissue types considered by global health and regulatory organizations to have shown no risk of infectibility for the suspected BSE infectious agent. We have not experienced any significant adverse impact on our sales as a result of concerns regarding BSE, but no assurance can be given that such an impact may not occur in the future.
Use of our products in unapproved circumstances could expose us to liabilities.
The marketing approval from the FDA and other regulators of certain of our products are, or are expected to be, limited to specific indications. We are prohibited from marketing or promoting any unapproved use of our products. Physicians, however, can use these products in ways or circumstances other than those strictly within the scope of the regulatory approval. Although the product training we provide to physicians and other health care professionals is limited to approved uses or for clinical trials, no assurance can be given that claims might not be asserted against us if our products are used in ways or for procedures that are not approved.
17
Our operations are subject to environmental, health, and safety regulations that could result in substantial costs.
Our operations are subject to environmental, health, and safety laws, and regulations concerning, among other things, the generation, handling, transportation, and disposal of hazardous substances or wastes, the cleanup of hazardous substance releases, and emissions or discharges into the air or water. We have incurred and may incur expenditures in the future in connection with environmental, health and safety laws, and regulations. New laws and regulations, violations of these laws or regulations, stricter enforcement of existing requirements, or the discovery of previously unknown contamination could require us to incur costs or could become the basis for new or increased liabilities that could be material.
Item 1B. Unresolved Staff Comments
None.
Item 2. Properties
The locations and uses of our major properties are as follows:
North America | ||||
Irvine, California | (1 | ) | Corporate Headquarters, Research and Development, Regulatory and Clinical Affairs, Manufacturing, Administration | |
Draper, Utah | (1 | ) | Administration, Manufacturing | |
Haina, Dominican Republic | (2 | ) | Manufacturing | |
Añasco, Puerto Rico | (2 | ) | Manufacturing | |
Central America | ||||
Costa Rica | (2 | ) | Manufacturing | |
Europe | ||||
Horw, Switzerland | (2 | ) | Manufacturing, Administration | |
Nyon, Switzerland | (1 | ) | Administration, Marketing | |
Prague, Czech Republic | (2 | ) | Administration | |
Asia | ||||
Tokyo, Japan | (2 | ) | Administration, Marketing, Distribution | |
Shanghai, China | (2 | ) | Administration | |
Singapore | (1),(2) | Manufacturing, Marketing, Distribution, Administration | ||
_______________________________________________________________________________
(1) | Owned property. |
(2) | Leased property. |
The Dominican Republic lease expires in 2022; the Puerto Rico property has one lease that expires in 2017 and one that expires in 2018; the Costa Rica lease expires in 2021; the Horw, Switzerland lease expires in 2018; the Prague, Czech Republic lease expires in 2019; the Tokyo, Japan lease expires in 2018; the Shanghai, China lease expires in 2018; and Singapore has one land lease that expires in 2036 and one that expires in 2041. We believe our properties have been well maintained, are in good operating condition, and are adequate for current needs.
Item 3. Legal Proceedings
For a description of our material pending legal proceedings, please see Note 17 to the "Consolidated Financial Statements" of this Annual Report on Form 10-K, which is incorporated by reference.
Item 4. Mine Safety Disclosures
Not applicable.
18
PART II
Item 5. Market for Registrant's Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities
Market Price
The principal market for our common stock is the New York Stock Exchange (the "NYSE"). The table below sets forth, for the calendar quarters indicated, the high and low prices of our common stock, as reported by the NYSE.
2016 | 2015 | ||||||||||||||
High | Low | High | Low | ||||||||||||
Calendar Quarter Ended: | |||||||||||||||
March 31 | $ | 89.93 | $ | 72.20 | $ | 75.21 | $ | 61.99 | |||||||
June 30 | 112.00 | 86.73 | 73.65 | 61.38 | |||||||||||
September 30 | 121.73 | 98.02 | 79.50 | 62.53 | |||||||||||
December 31 | 121.75 | 81.12 | 83.43 | 70.32 | |||||||||||
Number of Stockholders
On January 31, 2017, there were 11,371 stockholders of record of our common stock.
Dividends
We have never paid any cash dividends on our capital stock and have no current plans to pay any cash dividends. Our current policy is to retain any future earnings for use in our business.
Issuer Purchases of Equity Securities
Period | Total Number of Shares (or Units) Purchased (a) | Average Price Paid per Share (or Unit) | Total Number of Shares (or Units) Purchased as Part of Publicly Announced Plans or Programs | Maximum Number (or Approximate Dollar Value) of Shares that May Yet Be Purchased Under the Plans or Programs (in millions) (b), (c) | |||||||||||||
October 1, 2016 through October 31, 2016 | 44,109 | $ | 101.82 | 44,109 | $ | 277.5 | |||||||||||
November 1, 2016 through November 30, 2016 | 411 | 89.63 | — | 1,277.5 | |||||||||||||
December 1, 2016 through December 31, 2016 | 2,700,000 | 91.25 | 2,700,000 | 1,031.0 | |||||||||||||
Total | 2,744,520 | 91.42 | 2,744,109 | ||||||||||||||
_______________________________________________________________________________
(a) | The difference between the total number of shares (or units) purchased and the total number of shares (or units) purchased as part of publicly announced plans or programs is due to shares withheld by us to satisfy tax withholding obligations in connection with the vesting of restricted stock units issued to employees. |
(b) | On July 10, 2014, the Board of Directors approved a stock repurchase program authorizing us to purchase on the open market, including pursuant to a Rule 10b5-1 plan and in privately negotiated transactions, up to $750.0 million of our common stock. On November 10, 2016, the Board of Directors approved a new stock repurchase program providing for an additional $1.0 billion of repurchases of our common stock. |
(c) | In October 2016, our accelerated share repurchase ("ASR") agreement concluded and we received an additional 44 thousand shares of our common stock. Shares purchased pursuant to the ASR agreement are presented in the table above in the periods in which they were received. |
19
Performance Graph
The following graph compares the performance of our common stock with that of the S&P 500 Index and the S&P 500 Healthcare Equipment Index. The cumulative total return listed below assumes an initial investment of $100 at the market close on December 30, 2011 and reinvestment of dividends.
Total Cumulative Return | 2012 | 2013 | 2014 | 2015 | 2016 | ||||||||||||||
Edwards Lifesciences | $ | 127.54 | $ | 93.01 | $ | 180.17 | $ | 223.42 | $ | 265.06 | |||||||||
S&P 500 | 116.00 | 153.58 | 174.60 | 177.01 | 198.18 | ||||||||||||||
S&P 500 Healthcare Equipment Index | 117.42 | 150.28 | 181.96 | 194.37 | 207.46 | ||||||||||||||
20
Item 6. Selected Financial Data
As of or for the Years Ended December 31, | ||||||||||||||||||||
2016 | 2015 | 2014 | 2013 | 2012 | ||||||||||||||||
(in millions, except per share data) | ||||||||||||||||||||
OPERATING RESULTS | Net sales | $ | 2,963.7 | $ | 2,493.7 | $ | 2,322.9 | $ | 2,045.5 | $ | 1,899.6 | |||||||||
Gross profit | 2,166.3 | 1,876.5 | 1,697.3 | 1,528.9 | 1,408.6 | |||||||||||||||
Net income(a) | 569.5 | 494.9 | 811.1 | 389.1 | 291.5 | |||||||||||||||
COMMON STOCK INFORMATION | Net income per common share(a): | |||||||||||||||||||
Basic | $ | 2.67 | $ | 2.30 | $ | 3.81 | $ | 1.74 | $ | 1.27 | ||||||||||
Diluted | 2.61 | 2.25 | 3.74 | 1.71 | 1.23 | |||||||||||||||
Cash dividends declared per common share | — | — | — | — | — | |||||||||||||||
BALANCE SHEET DATA | Total assets | $ | 4,510.0 | $ | 4,056.3 | $ | 3,519.0 | $ | 2,704.8 | $ | 2,209.3 | |||||||||
Long-term debt(b) | 822.3 | 596.9 | 594.1 | 588.0 | 189.3 | |||||||||||||||
_______________________________________________________________________________
(a) | The above results include special charges of $34.5 million during 2016 and $70.7 million during 2014. In addition, the above results include $750.0 million ($487.9 million, net of tax) in 2014 for an upfront payment received under a litigation settlement agreement. See Part II, Item 7, "Management's Discussion and Analysis of Financial Condition and Results of Operations" and Note 3 and Note 4 to the "Consolidated Financial Statements" for additional information. |
(b) | In October 2013, we issued $600.0 million of 2.875% fixed-rate unsecured senior notes due October 15, 2018 ("the Notes"). |
Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations
The following discussion and analysis presents the factors that had a material effect on our results of operations during the three years ended December 31, 2016. Also discussed is our financial position as of December 31, 2016. You should read this discussion in conjunction with the historical consolidated financial statements and related notes included elsewhere in this Form 10-K.
Overview
We are the global leader in patient-focused medical innovations for structural heart disease and critical care monitoring. Driven by a passion to help patients, we partner with the world's leading clinicians and researchers and aggressively invest in research and development to transform care for structural heart disease and critically ill patients. We conduct operations worldwide and are managed in the following geographical regions: United States, Europe, Japan, and Rest of World. Our products are categorized into the following main areas: Transcatheter Heart Valve Therapy ("THVT"), Surgical Heart Valve Therapy ("SHVT"), and Critical Care.
21
Financial Highlights
Our sales growth was led by our THVT products, which benefited from the launches of the Edwards SAPIEN 3 transcatheter heart valve in the United States (July 2015), Europe (January 2014), and Japan (March 2016). Our gross profit margin in 2016 was negatively impacted relative to 2015 by foreign currency exchange rate fluctuations, partially offset by an improved product mix, led by THVT products. Our gross profit margin in 2015 benefited from foreign exchange rate fluctuations and an improved product mix, led by THVT products. Our net income in 2016 increased compared to 2015 primarily due to increased sales, partially offset by an in-process research and development ("IPR&D") charge for technology we acquired for use in our transcatheter heart valve programs. Net income in 2014 benefited from the receipt of $750.0 million ($487.9 million, net of tax) for an upfront payment due under a litigation settlement agreement.
Healthcare Environment, Opportunities, and Challenges
The medical technology industry is highly competitive and continues to evolve. Our success is measured both by the development of innovative products and the value we bring to our stakeholders. We are committed to developing new technologies and providing innovative patient care, and we are committed to defending our intellectual property in support of those developments. In 2016, we invested 15.0% of our net sales in research and development. The following is a summary of important developments during 2016:
• | we received FDA approval for an expanded indication study of the Edwards SAPIEN 3 valve. The investigational device exemption study will enroll elderly patients with severe, symptomatic aortic stenosis who have been determined by a heart team to be at low risk for mortality if they were to undergo surgical aortic valve replacement; |
• | we received FDA approval to expand use of the Edwards SAPIEN XT transcatheter heart valve for pulmonic valve replacement procedures. The approval enables the treatment of adult and pediatric patients who suffer from either a narrowed pulmonary valve or moderate or greater pulmonary regurgitation caused by congenital heart disease; |
• | we received approval in Japan of the Edwards SAPIEN 3 valve for the treatment of patients suffering from severe, symptomatic aortic stenosis; |
• | we received FDA approval of our advanced EDWARDS INTUITY Elite Valve System, a rapid deployment device for surgical aortic valve replacement, and CE Mark for our INSPIRIS RESILIA aortic valve, the first in a new class of resilient heart valves, designed for potential future valve-in-valve procedures; |
• | we received FDA approval and CE Mark to expand use of the Edwards SAPIEN 3 valve for the treatment of patients suffering from severe, symptomatic aortic stenosis who have been determined by a heart team to be at intermediate risk for open-heart surgery; |
22
• | we received CE Mark for our Acumen Hypotension Probability Indicator ("HPI"), a technology that alerts clinicians to potential hypotension, or abnormally low blood pressure, in their surgical and critical care patients before it occurs; and |
• | we entered into an agreement to acquire Valtech, a privately held company based in Israel and developer of the Cardioband System for transcatheter repair of the mitral and tricuspid valves. We completed the acquisition on January 23, 2017. |
We are dedicated to generating robust clinical, economic, and quality of life evidence increasingly expected by patients, clinicians, and payors in the current healthcare environment, with the goal of encouraging the adoption of innovative new medical therapies that demonstrate superior outcomes.
Results of Operations
Net Sales by Major Regions
(dollars in millions)
Years Ended December 31, | Change | Percent Change | |||||||||||||||||||||||
2016 | 2015 | 2014 | 2016 | 2015 | 2016 | 2015 | |||||||||||||||||||
United States | $ | 1,615.7 | $ | 1,262.9 | $ | 1,047.3 | $ | 352.8 | $ | 215.6 | 27.9 | % | 20.6 | % | |||||||||||
Europe | 749.0 | 717.3 | 744.5 | 31.7 | (27.2 | ) | 4.4 | % | (3.6 | )% | |||||||||||||||
Japan | 309.3 | 246.2 | 257.9 | 63.1 | (11.7 | ) | 25.6 | % | (4.6 | )% | |||||||||||||||
Rest of World | 289.7 | 267.3 | 273.2 | 22.4 | (5.9 | ) | 8.4 | % | (2.1 | )% | |||||||||||||||
International | 1,348.0 | 1,230.8 | 1,275.6 | 117.2 | (44.8 | ) | 9.5 | % | (3.5 | )% | |||||||||||||||
Total net sales | $ | 2,963.7 | $ | 2,493.7 | $ | 2,322.9 | $ | 470.0 | $ | 170.8 | 18.8 | % | 7.4 | % | |||||||||||
International net sales include the impact of foreign currency exchange rate fluctuations. The impact of foreign currency exchange rate fluctuations on net sales is not necessarily indicative of the impact on net income due to the corresponding effect of foreign currency exchange rate fluctuations on international manufacturing and operating costs and our hedging activities. For more information see "Quantitative and Qualitative Disclosures About Market Risk."
Net Sales by Product Group
(dollars in millions)
Year Ended December 31, | Change | Percent Change | |||||||||||||||||||||||
2016 | 2015 | 2014 | 2016 | 2015 | 2016 | 2015 | |||||||||||||||||||
Transcatheter Heart Valve Therapy | $ | 1,628.5 | $ | 1,180.3 | $ | 943.6 | $ | 448.2 | $ | 236.7 | 38.0 | % | 25.1 | % | |||||||||||
Surgical Heart Valve Therapy | 774.9 | 785.0 | 826.1 | (10.1 | ) | (41.1 | ) | (1.3 | )% | (5.0 | )% | ||||||||||||||
Critical Care | 560.3 | 528.4 | 553.2 | 31.9 | (24.8 | ) | 6.0 | % | (4.5 | )% | |||||||||||||||
Total net sales | $ | 2,963.7 | $ | 2,493.7 | $ | 2,322.9 | $ | 470.0 | $ | 170.8 | 18.8 | % | 7.4 | % | |||||||||||
23
Transcatheter Heart Valve Therapy
2016 Compared with 2015
The increase in net sales of THVT products in the United States was due primarily to:
• | increased sales of the Edwards SAPIEN 3 valve, driven by its launch in July 2015; |
partially offset by:
• | lower sales of the Edwards SAPIEN XT valve as customers converted to Edwards SAPIEN 3. |
The increase in international net sales of THVT products was due primarily to increased sales of the Edwards SAPIEN 3 valve, driven primarily by its launch in Europe in January 2014 and in Japan in March 2016.
2015 Compared with 2014
The increase in net sales of THVT products in the United States was due primarily to:
• | the Edwards SAPIEN 3 valve, driven by its launch in July 2015; and |
• | the Edwards SAPIEN XT valve, driven by its launch in June 2014; |
partially offset by:
• | lower sales of the Edwards SAPIEN valve as customers converted to Edwards SAPIEN XT. |
The increase in international net sales of THVT products was due primarily to:
• | the Edwards SAPIEN 3 valve, driven primarily by its launch in Europe in January 2014; and |
• | the Edwards SAPIEN XT valve in Japan, driven by its launch in October 2013; |
partially offset by:
• | lower sales of the Edwards SAPIEN XT valve in Europe, as customers converted to Edwards SAPIEN 3; and |
24
• | foreign currency exchange rate fluctuations, which decreased net sales by $71.2 million, due primarily to the weakening of the Euro against the United States dollar. |
In March 2016, we received approval from the the FDA to expand use of the Edwards SAPIEN XT transcatheter heart valve for pulmonic valve replacement procedures. The approval enables the treatment of adult and pediatric patients who suffer from either a narrowed pulmonary valve, or moderate or greater pulmonary regurgitation caused by congenital heart disease. Also in March 2016, we received approval for SAPIEN 3 in Japan for the treatment of patients suffering from severe, symptomatic aortic stenosis. In August 2016, we received approval from the FDA, and in September 2016, we received CE Mark in Europe, to expand use of the Edwards SAPIEN 3 transcatheter heart valve for the treatment of patients suffering from severe, symptomatic aortic stenosis who have been determined to be at intermediate risk for open-heart surgery. In January 2017, we received FDA approval for EARLY-TAVR, our trial that will study patients diagnosed with severe aortic stenosis who have not yet developed symptoms. Patients will be randomized to receive either transfemoral SAPIEN 3 or clinical surveillance.
Surgical Heart Valve Therapy
2016 Compared with 2015
The decrease in net sales of SHVT products was due primarily to:
• | lower sales of aortic tissue valves in the United States, as sales of Edwards SAPIEN 3 increased; and |
• | lower international sales of mitral tissue valves, primarily in Europe and Rest of World, primarily due to supply constraints; |
partially offset by:
• | higher sales of aortic tissue valves in Europe, Japan, and Rest of World; and |
• | foreign currency exchange rate fluctuations, which increased net sales by $2.2 million, due primarily to the strengthening of the Japanese yen against the United States dollar, partially offset by the weakening of various currencies against the United States dollar. |
25
2015 Compared with 2014
The decrease in net sales of SHVT products was due primarily to:
• | foreign currency exchange rate fluctuations, which decreased net sales by $59.7 million, due primarily to the weakening of the Euro and the Japanese yen against the United States dollar; |
partially offset by:
• | higher sales of (1) surgical heart valve products, driven by pericardial aortic tissue valves, primarily in Europe, Japan, and the United States, and (2) EDWARDS INTUITY Elite valves, primarily in Europe. |
In August 2016, the FDA approved our advanced EDWARDS INTUITY Elite Valve System, a rapid deployment device for surgical aortic valve replacement. In September 2016, we received CE Mark for our INSPIRIS RESILIA aortic valve, the first in a new class of resilient heart valves designed for potential future valve-in-valve procedures.
Critical Care
2016 Compared with 2015
The increase in net sales of Critical Care products was due primarily to:
• | higher sales of enhanced surgical recovery products in the United States, Europe, and Rest of World; |
• | higher sales of core hemodynamic products, primarily in Rest of World; |
• | higher sales of hardware in the United States; and |
• | foreign currency exchange rate fluctuations, which increased net sales by $5.0 million due primarily to the strengthening of the Japanese yen against the United States dollar, partially offset by the weakening of various currencies against the United States dollar. |
2015 Compared with 2014
The decrease in net sales of Critical Care products was due primarily to:
• | foreign currency exchange rate fluctuations, which decreased net sales by $41.3 million due primarily to the weakening of the Euro and the Japanese yen against the United States dollar; |
26
partially offset by:
• | higher sales of enhanced surgical recovery products in the United States, Europe, and Rest of World. |
In October 2016, we received CE Mark for our HPI, a technology that alerts clinicians to potential hypotension, or abnormally low blood pressure, in their surgical and critical care patients. HPI is enabled by the minimally invasive FloTrac IQ sensor, which also received CE Mark.
Gross Profit
The decrease in gross profit as a percentage of net sales in 2016 was driven by:
• | a 4.3 percentage point decrease due to the impact of foreign currency exchange rate fluctuations, including the settlement of foreign currency hedging contracts; and |
• | investments in manufacturing capacity; |
partially offset by:
• | a 1.6 percentage point increase in the United States, and a 0.5 percentage point increase in international markets, due to an improved product mix, driven by THVT products. |
The increase in gross profit as a percentage of net sales in 2015 was driven by:
• | a 1.9 percentage point increase due to the impact of foreign currency exchange rate fluctuations, including the settlement of foreign currency hedging contracts; and |
• | a 0.9 percentage point increase in the United States, and a 0.4 percentage point increase in international markets, due to an improved product mix, driven by THVT products; |
partially offset by:
• | multiple investments in our operations, including an increase in costs to improve our manufacturing processes. |
27
Selling, General, and Administrative ("SG&A") Expenses
The increase in SG&A expenses in 2016 resulted primarily from (1) higher sales and marketing expenses in the United States and Europe, mainly to support our THVT program, and (2) higher personnel-related costs. These increases were partially offset by the suspension of the medical device excise tax in the United States, which was suspended for calendar years 2016 and 2017. The decrease in SG&A expenses as a percentage of net sales in 2016 was due primarily to higher sales in the United States and Japan.
The decrease in SG&A expenses in 2015 resulted primarily from foreign currency, which reduced expenses by $61.1 million due primarily to the weakening of the Euro and the Japanese yen against the United States dollar. This decrease was partially offset by (1) higher sales and marketing expenses in Europe, the United States, and Japan, mainly to support our THVT program and (2) higher personnel-related costs. The decrease in SG&A expenses as a percentage of net sales in 2015 was due primarily to higher sales in the United States, Europe, and Japan.
Research and Development ("R&D") Expenses
The increase in R&D expenses in 2016 was due primarily to mitral and aortic THVT product development efforts. The suspension of the United States medical device excise tax during 2016 provided additional flexibility to accelerate investments in structural heart initiatives.
28
The increase in R&D expenses in 2015 was due primarily to new THVT and SHVT product development efforts. These costs were partially offset by lower spending for THVT clinical trials.
Intellectual Property Litigation Expenses (Income), Net
In May 2014, we entered into an agreement with Medtronic, Inc. ("Medtronic") to settle all outstanding patent litigation between the companies, and, pursuant to the agreement, we received an upfront payment from Medtronic in the amount of $750.0 million.
We incurred external legal costs related to intellectual property litigation of $32.6 million, $7.0 million, and $9.6 million for the years ended December 31, 2016, 2015, and 2014, respectively. The increase in intellectual property litigation expenses in 2016 was due primarily to the first quarter resolution of an intellectual property litigation matter, and increased costs associated with ongoing litigation in the United States and Europe.
Special Charges
For information on special charges, see Note 4 to the "Consolidated Financial Statements."
Interest Expense
Interest expense was $19.2 million, $17.2 million, and $17.2 million in 2016, 2015, and 2014, respectively. The increase in interest expense for 2016 as compared to 2015 resulted primarily from higher average interest rates. Interest expense for 2015 remained flat compared to 2014 as the impact of higher average interest rates was offset by a lower average debt balance compared to 2014.
Interest Income
Interest income was $10.8 million, $7.9 million, and $6.4 million in 2016, 2015, and 2014, respectively. The increase in interest income for 2016 resulted primarily from higher average interest rates. The increase in interest income for 2015 resulted primarily from higher average investment balances and higher average interest rates.
Other Expense, net
(in millions)
Years Ended December 31, | |||||||||||
2016 | 2015 | 2014 | |||||||||
Charitable foundation contribution | $ | 5.0 | $ | — | $ | — | |||||
Foreign exchange losses, net | 0.5 | 4.8 | 2.0 | ||||||||
(Gain) loss on investments | (0.2 | ) | (0.1 | ) | 4.5 | ||||||
Promissory note impairment | — | — | 4.0 | ||||||||
Insurance settlement gain | — | — | (3.7 | ) | |||||||
Lease contract termination costs | — | — | 1.0 | ||||||||
Other | (0.4 | ) | (0.7 | ) | (0.1 | ) | |||||
Total other expense, net | $ | 4.9 | $ | 4.0 | $ | 7.7 | |||||
In March 2016, we contributed $5.0 million to the Edwards Lifesciences Foundation, a related-party not-for-profit organization intended to provide philanthropic support to health- and community-focused charitable organizations. The
contribution was irrevocable and was recorded as an expense at the time of payment.
The foreign exchange losses relate to the foreign currency fluctuations primarily in our intercompany receivable and payable balances, partially offset by the gains and losses on derivative instruments intended to hedge those exposures.
The (gain) loss on investments represents our net share of gains and losses in investments accounted for under the equity method, and realized gains and losses on our available-for-sale and cost method investments. During 2014, we recorded an other-than-temporary impairment charge of $3.5 million related to one of our cost method investments.
29
In December 2014, we recorded a $4.0 million impairment charge related to a promissory note receivable because it was likely that we would be unable to collect the scheduled payments of principal or interest when due according to the contractual terms of the promissory note agreement.
In March 2014, we recorded a $3.7 million insurance settlement gain related to inventory that was damaged in the fourth quarter of 2013.
In September 2014, we committed to purchase our Draper, Utah facility under a purchase option provided in the lease agreement. Under the terms of the lease agreement, we accrued $1.0 million for certain lease contract termination costs.
Provision for Income Taxes
Our effective income tax rates for 2016, 2015, and 2014 were impacted as follows (in millions):
Years Ended December 31, | |||||||||||
2016 | 2015 | 2014 | |||||||||
Income tax expense at U.S. federal statutory rate | $ | 258.3 | $ | 217.8 | $ | 400.4 | |||||
Foreign income taxed at different rates | (88.6 | ) | (105.8 | ) | (67.1 | ) | |||||
State and local taxes, net of federal tax benefit | 9.7 | 3.1 | 19.3 | ||||||||
Tax credits, federal and state | (21.3 | ) | (15.7 | ) | (13.5 | ) | |||||
Build (release) of reserve for uncertain tax positions for prior years | 4.6 | 3.3 | (4.8 | ) | |||||||
U.S. tax on foreign earnings, net of credits | 5.1 | 20.5 | (3.1 | ) | |||||||
Nondeductible stock-based compensation | 3.6 | 2.3 | 2.1 | ||||||||
Other | (3.0 | ) | 2.0 | (0.4 | ) | ||||||
Income tax provision | $ | 168.4 | $ | 127.5 | $ | 332.9 | |||||
Uncertain Tax Positions
As of December 31, 2016 and 2015, the gross uncertain tax positions were $245.5 million and $216.1 million, respectively. We estimate that these liabilities would be reduced by $44.9 million and $40.6 million, respectively, from offsetting tax benefits associated with the correlative effects of potential transfer pricing adjustments, state income taxes, and timing adjustments. The net amounts of $200.6 million and $175.5 million, respectively, if not required, would favorably affect our effective tax rate.
A reconciliation of the beginning and ending amount of uncertain tax positions, excluding interest, penalties, and foreign exchange, is as follows (in millions):
Years Ended December 31, | |||||||||||
2016 | 2015 | 2014 | |||||||||
Uncertain gross tax positions, January 1 | $ | 216.1 | $ | 192.3 | $ | 127.7 | |||||
Current year tax positions | 29.0 | 29.6 | 75.9 | ||||||||
Increase prior year tax positions | 2.7 | 2.2 | 0.6 | ||||||||
Decrease prior year tax positions | (0.9 | ) | (7.4 | ) | (10.5 | ) | |||||
Settlements | (0.3 | ) | (0.4 | ) | (1.0 | ) | |||||
Lapse of statutes of limitations | (1.1 | ) | (0.2 | ) | (0.4 | ) | |||||
Uncertain gross tax positions, December 31 | $ | 245.5 | $ | 216.1 | $ | 192.3 | |||||
We recognize interest and penalties, if any, related to uncertain tax positions in the provision for income taxes. As of December 31, 2016, we had accrued $14.7 million (net of $10.8 million tax benefit) of interest related to uncertain tax positions, and as of December 31, 2015, we had accrued $10.7 million (net of $7.6 million tax benefit) of interest related to uncertain tax positions. During 2016, 2015, and 2014, we recognized interest expense, net of tax benefit, of $4.0 million, $3.9 million, and $2.3 million, respectively, in “Provision for Income Taxes” on the consolidated statements of operations.
30
We strive to resolve open matters with each tax authority at the examination level and could reach agreement with a tax authority at any time. While we have accrued for matters we believe are more likely than not to require settlement, the final outcome with a tax authority may result in a tax liability that is more or less than that reflected in the consolidated financial statements. Furthermore, we may later decide to challenge any assessments, if made, and may exercise our right to appeal. The uncertain tax positions are reviewed quarterly and adjusted as events occur that affect potential liabilities for additional taxes, such as lapsing of applicable statutes of limitations, proposed assessments by tax authorities, negotiations between tax authorities, identification of new issues, and issuance of new legislation, regulations, or case law. Management believes that adequate amounts of tax and related penalty and interest have been provided in income tax expense for any adjustments that may result from our uncertain tax positions.
At December 31, 2016, all material state, local, and foreign income tax matters have been concluded for years through 2008. The Internal Revenue Service ("IRS") has substantially completed its fieldwork for the 2009 through 2012 tax years. However, the audits are currently in suspense pending a final determination with respect to a pending application for an Advance Pricing Agreement ("APA"). The IRS began its examination of the 2014 tax year during the fourth quarter of 2016.
We have been pursuing an APA between the Switzerland and United States governments for the years 2009 through 2013 covering transfer pricing matters with the possibility of a roll-forward of the results to subsequent years. These discussions remain ongoing as of December 31, 2016. These transfer pricing matters are significant to our consolidated financial statements as the disputed amounts are material, and the final outcome is uncertain. We continue to believe our positions are supportable.
Additionally, during the fourth quarter of 2016, we received notification of preliminary agreement on methodology between the respective Competent Authorities for the requested APAs for 2015-2019 between the United States and Japan, Switzerland and Japan, and Singapore and Japan. These are expected to be formalized and executed during 2017.
During 2014, we filed with the IRS a request for a pre-filing agreement associated with a tax return filing position on a portion of the litigation settlement payment received from Medtronic in May 2014. During the first quarter of 2015, the IRS accepted the pre-filing agreement into the pre-filing agreement program. The closing agreement for this matter was finalized during the fourth quarter of 2016. There remains a disputed issue and we expect to enter the Fast-Track Appeals process during 2017. We made an advance payment of tax in December 2015 solely to prevent the further accrual of interest on any potential deficiency, not to signify any potential agreement to a contrary position that may be taken by the IRS.
Management believes that adequate amounts of tax and related penalty and interest have been provided in income tax expense for any adjustments that may result from our uncertain tax positions. Based upon the information currently available and numerous possible outcomes, we cannot reasonably estimate what, if any, changes in our existing uncertain tax positions may occur in the next 12 months and thus have recorded the gross uncertain tax positions as a long-term liability. However, if the APA and/or the appeals process related to the pre-filing agreement is finalized in the next 12 months, it is reasonably possible that these events could result in a significant change in our uncertain tax positions within the next 12 months.
The effective income tax rate for the year ended December 31, 2016 was higher than the rate for the year ended December 31, 2015 primarily because of fluctuations in the relative contribution of our foreign operations and United States operations to worldwide pre-tax income, offset by an increase in benefits from the federal and California research credits.
We have received tax incentives in certain non-U.S. tax jurisdictions, the primary benefit of which will expire in 2024. The tax reductions as compared to the local statutory rates were $77.4 million ($0.32 per diluted share), $59.1 million ($0.25 per diluted share), and $68.3 million ($0.31 per diluted share) for the years ended December 31, 2016, 2015, and 2014, respectively.
Our DR branch receives tax incentives, including an exemption from paying DR income taxes, under a Free Trade Zone law. Effective November 9, 2012, DR enacted a law which, among other tax provisions, would apply a 10% withholding tax on dividends or branch remittances from a Free Trade Zone company to its shareholder(s). The DR withholding tax provision was, however, contingent upon certain future events. On October 5, 2016, the DR Ministry of Finance published a notification confirming that the 10% withholding tax on branch remittances would be due and payable by DR Free Trade Zone companies for dividends and remittances paid on or after October 5, 2016. As a result, we expect this action will increase our effective tax rate in 2017; however, the amount is not expected to have a material impact on our results of operations.
31
Liquidity and Capital Resources
Our sources of cash liquidity include cash and cash equivalents, short-term investments, amounts available under credit facilities, and cash from operations. We believe that these sources are sufficient to fund the current requirements of working capital, capital expenditures, and other financial commitments for the next twelve months. However, we periodically consider various financing alternatives and may, from time to time, seek to take advantage of favorable interest rate environments or other market conditions.
As of December 31, 2016, cash and cash equivalents and short-term investments held in the United States and outside the United States were $214.1 million and $1,057.0 million, respectively. We believe that cash held in the United States, in addition to amounts available under credit facilities and cash from operations, are sufficient to fund our United States operating requirements for the next twelve months. Cash and cash equivalents and short-term investments held outside the United States, the majority of which relates to undistributed earnings of our foreign subsidiaries, which are considered by us to be indefinitely reinvested, have historically been used to fund international operations and acquire businesses and assets outside of the United States. We consider making short-term loans of cash held outside the United States to the United States from time to time based on facts and circumstances. The permanent repatriations of cash and cash equivalents and short-term investments held outside the United States are subject to restrictions in certain jurisdictions, and may be subject to withholding and other taxes. The potential tax liability related to any repatriation would be dependent on the facts and circumstances that exist at the time such repatriation is made and the complexities of the tax laws of the United States and the respective foreign jurisdictions.
On November 26, 2016, we entered into an agreement and plan of merger to acquire Valtech for approximately $340.0 million, subject to certain adjustments, in stock and cash to be paid at closing, with the potential for up to $350.0 million in additional pre-specified milestone-driven payments over the next 10 years. Our acquisition of Valtech closed on January 23, 2017, and we issued an aggregate of approximately 2.8 million shares of our common stock, and paid approximately $84.3 million in cash to holders of Valtech securities. Prior to the close of the transaction, Valtech spun off its early-stage transseptal mitral valve replacement technology program. We have an option to acquire that program and its associated intellectual property for approximately $200.0 million, subject to certain adjustments. For further information, see Note 7 to the "Consolidated Financial Statements."
In December 2015, we purchased an exclusive option to acquire Harpoon Medical, Inc. ("Harpoon Medical") for up to $250.0 million, depending upon the achievement of certain milestones and regulatory approvals. In December 2014, we purchased an exclusive option to acquire CardioKinetix, Inc. ("CardioKinetix") for up to $375.0 million, depending upon the achievement of certain milestones and regulatory approvals. For further information, see Note 6 to the "Consolidated Financial Statements."
On July 3, 2015, we entered into an agreement and plan of merger to acquire CardiAQ for an aggregate cash purchase price of $350.0 million, subject to certain adjustments, plus an additional $50.0 million if a certain European regulatory approval is obtained within 48 months of the acquisition closing date. We closed the purchase in August 2015 with available cash on hand in the United States. For further information, see Note 7 to the "Consolidated Financial Statements."
We have a Five-Year Credit Agreement ("Credit Agreement") which provides up to an aggregate of $750.0 million in borrowings in multiple currencies. We may increase the amount available under the Credit Agreement, subject to agreement of the lenders, by up to an additional $250.0 million in the aggregate. As of December 31, 2016, borrowings of $225.0 million were outstanding under the Credit Agreement, and have been classified as long-term obligations in accordance with the terms of the Credit Agreement. In October 2013, we issued $600.0 million of 2.875% fixed-rate unsecured senior notes due October 15, 2018. As of December 31, 2016, the total carrying value of our long-term debt was $822.3 million. For further information on our long-term debt, see Note 9 to the "Consolidated Financial Statements."
We periodically repurchase shares of our common stock under share repurchase programs authorized by the Board of Directors. We consider several factors in determining when to execute share repurchases, including, among other things, expected dilution from stock plans, cash capacity, and the market price of our common stock. During 2016, under the Board authorized repurchase programs, we repurchased a total of 7.2 million shares at an aggregate cost of $646.5 million, including amounts purchased under accelerated share repurchase agreements, and as of December 31, 2016, we had remaining authority to purchase $1,031.0 million of our common stock. For further information, see Note 13 to the "Consolidated Financial Statements."
32
Consolidated Cash Flows - For the twelve months ended December 31, 2016, 2015, and 2014
Net cash flows provided by operating activities of $704.4 million for 2016 increased $154.7 million from 2015 due primarily to (1) improved operating performance and (2) lower supplier payments in 2016 compared to 2015, partially offset by (1) the impact of excess tax benefits from stock plans, primarily due to our increased stock price, and (2) an increase in accounts receivable due to increased sales, primarily in the United States.
Net cash flows provided by operating activities of $549.7 million for 2015 decreased $472.6 million from 2014 due primarily to (1) the $750.0 million upfront payment received from Medtronic under a litigation settlement agreement, and (2) a higher bonus payout in 2015 associated with 2014 performance. These decreases were partially offset by (1) income tax payments of $224.5 million made in 2014 related to the Medtronic settlement, (2) improved operating performance in 2015, and (3) the $50.0 million charitable contribution made in 2014 to the Edwards Lifesciences Foundation.
Net cash used in investing activities of $211.7 million in 2016 consisted primarily of capital expenditures of $176.1 million and $41.3 million for the acquisition of intangible assets.
Net cash used in investing activities of $316.1 million in 2015 consisted primarily of a $320.1 million net payment associated with the acquisition of CardiAQ, and capital expenditures of $102.7 million, partially offset by net proceeds from investments of $119.6 million.
Net cash used in investing activities of $633.0 million in 2014 consisted primarily of net purchases of investments of $527.4 million and capital expenditures of $82.9 million.
Net cash used in financing activities of $268.5 million in 2016 consisted primarily of purchases of treasury stock of $662.3 million, partially offset by (1) net proceeds from the issuance of debt of $222.1 million, (2) proceeds from stock plans of $103.3 million, and (3) the excess tax benefit from stock plans of $64.3 million.
Net cash used in financing activities of $158.6 million in 2015 consisted primarily of purchases of treasury stock of $280.1 million, partially offset by (1) proceeds from stock plans of $87.2 million, and (2) the excess tax benefit from stock plans of $41.3 million.
Net cash used in financing activities of $153.0 million in 2014 consisted primarily of purchases of treasury stock of $300.9 million, partially offset by (1) proceeds from stock plans of $113.3 million, and (2) the excess tax benefit from stock plans of $49.4 million (including the realization of previously unrealized excess tax benefits).
33
A summary of all of our contractual obligations and commercial commitments as of December 31, 2016 were as follows (in millions):
Payments Due by Period | |||||||||||||||||||
Contractual Obligations | Total | Less Than 1 Year | 1-3 Years | 4-5 Years | After 5 Years | ||||||||||||||
Debt | $ | 825.0 | $ | — | $ | 825.0 | $ | — | $ | — | |||||||||
Operating leases | 72.6 | 22.3 | 24.9 | 8.8 | 16.6 | ||||||||||||||
Interest on debt | 30.8 | 16.4 | 14.4 | — | — | ||||||||||||||
Pension obligations (a) | 6.1 | 6.1 | — | — | — | ||||||||||||||
Capital commitment obligations (b) | 0.6 | 0.3 | 0.3 | — | — | ||||||||||||||
Purchase and other commitments | 16.4 | 13.7 | 2.7 | — | — | ||||||||||||||
Total contractual cash obligations (c), (d) | $ | 951.5 | $ | 58.8 | $ | 867.3 | $ | 8.8 | $ | 16.6 | |||||||||
_______________________________________________________________________________
(a) | The amount included in "Less Than 1 Year" reflects anticipated contributions to our various pension plans. Anticipated contributions beyond one year are not determinable. The total accrued benefit liability for our pension plans recognized as of December 31, 2016 was $50.1 million. This amount is impacted by, among other items, pension expense funding levels, changes in plan demographics and assumptions, and investment returns on plan assets. Therefore, we are unable to make a reasonably reliable estimate of the amount and period in which the liability might be paid, and did not include this amount in the contractual obligations table. See Note 12 to the "Consolidated Financial Statements" for further information. |
(b) | Capital commitment obligations consist primarily of cash that we are obligated to pay to our limited partnership and limited liability corporation investees. These investees make equity investments in various development stage biopharmaceutical and medical device companies, and it is not certain if and/or when these payments will be made. |
(c) | As of December 31, 2016, the gross liability for uncertain tax positions, including interest, was $271.0 million. We have been pursuing an APA between the Switzerland and United States governments for the years 2009 through 2013 covering transfer pricing matters with the possibility of a roll-forward of the results to subsequent years. These transfer pricing matters are significant to our consolidated financial statements, and the final outcome of the negotiations is uncertain. Management believes that adequate amounts of tax and related penalty and interest have been provided in income tax expense for any adjustments that may result for our uncertain tax positions. We are unable to make a reasonably reliable estimate of the amount and period in which the liability might be paid, and did not include this amount in the contractual obligations table. |
(d) | We acquire assets still in development, enter into research and development arrangements, acquire businesses, and sponsor certain clinical trials that often require milestone, royalty, or other future payments to third-parties, contingent upon the occurrence of certain future events. In situations where we have no ability to influence the achievement of the milestone or otherwise avoid the payment, we have included those payments in the table above. However, we have excluded from the table contingent milestone payments and other contingent liabilities for which we cannot reasonably predict future payments or for which we can avoid making payment by unilaterally deciding to stop development of a product or cease progress of a clinical trial. We estimate that these contingent payments could be up to approximately $510.0 million if all milestones or other contingent obligations were met. Included in this amount is $350.0 million of contingent obligations related to our acquisition of Valtech, which may be paid through a combination of cash and issuance of common stock. In addition, the Valtech acquisition closed in January 2017, and the consideration paid included the issuance of approximately 2.8 million shares of our common stock (fair value of $266.5 million) and cash of $84.3 million, which has not been included in the above table. |
Critical Accounting Policies and Estimates
Our results of operations and financial position are determined based upon the application of our accounting policies, as discussed in the notes to the "Consolidated Financial Statements." Certain of our accounting policies represent a selection among acceptable alternatives under Generally Accepted Accounting Principles in the United States ("GAAP"). In evaluating our transactions, management assesses all relevant GAAP and chooses the accounting policy that most accurately reflects the nature of the transactions.
The application of accounting policies requires the use of judgment and estimates. These matters that are subject to judgments and estimation are inherently uncertain, and different amounts could be reported using different assumptions and
34
estimates. Management uses its best estimates and judgments in determining the appropriate amount to reflect in the consolidated financial statements, using historical experience and all available information. We also use outside experts where appropriate. We apply estimation methodologies consistently from year to year.
We believe the following are the critical accounting policies which could have the most significant effect on our reported results and require subjective or complex judgments by management.
Revenue Recognition
When we recognize revenue from the sale of our products, we record an estimate of various sales returns and allowances which reduces product sales and accounts receivable. These adjustments include estimates for rebates, returns, and other sales allowances. These provisions are estimated based upon historical payment experience, historical relationship to revenues, estimated customer inventory levels, and current contract sales terms with direct and indirect customers. Product returns are not significant because returns are generally not allowed unless the product is damaged at time of receipt. If the historical data and inventory estimates used to calculate these provisions do not approximate future activity, our financial position, results of operations, and cash flows could be impacted.
In addition, we may allow customers to return previously purchased products for next-generation product offerings. For these transactions, we defer recognition of revenue on the sale of the earlier generation product based upon an estimate of the amount to be returned when the next-generation products are shipped to the customer. Uncertain timing of next-generation product approvals, variability in product launch strategies, product recalls, and variation in product utilization all affect the estimates related to sales returns and could cause actual returns to differ from these estimates.
Our sales adjustment related to distributor rebates given to our United States distributors represents the difference between our sales price to the distributor (at our distributor "list price") and the negotiated price to be paid by the end-customer. We validate the distributor rebate accrual quarterly through either a review of the inventory reports obtained from our distributors or an estimate of the distributor's inventory. This distributor inventory information is used to verify the estimated liability for future distributor rebate claims based on historical rebates and contract rates. We periodically monitor current pricing trends and distributor inventory levels to ensure the credit for future distributor rebates is fairly stated.
Excess and Obsolete Inventory
The valuation of our inventory requires us to estimate excess, obsolete, and expired inventory. We base our provisions for excess, obsolete, and expired inventory on our estimates of forecasted net sales. A significant change in the timing or level of demand for our products as compared to forecasted amounts may result in recording additional allowances for excess, obsolete, and expired inventory in the future. In addition, our industry 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, increasing levels of consigned inventory, and variation in product utilization all affect our estimates related to excess, obsolete, and expired inventory.
Intangible Assets and Long-lived Assets
We acquire intangible assets in connection with business combinations and asset purchases. The acquired intangible assets are recorded at fair value, which is determined based on a discounted cash flow analysis. The determination of fair value requires significant estimates, including, but not limited to, the amount and timing of projected future cash flows, the discount rate used to discount those cash flows, the assessment of the asset's life cycle, including the timing and expected costs to complete in-process projects, and the consideration of legal, technical, regulatory, economic, and competitive risks.
IPR&D acquired in business combinations is reviewed for impairment annually, or whenever an event occurs or circumstances change that would indicate the carrying amount may be impaired. Additionally, management reviews the carrying amounts of other intangible and long-lived assets whenever events or circumstances indicate that the carrying amounts of an asset may not be recoverable. The impairment reviews require significant estimates about fair value, including estimation of future cash flows, selection of an appropriate discount rate, and estimates of long-term growth rates.
35
Contingent Consideration
We record contingent consideration resulting from a business combination at its fair value on the acquisition date. We determine the fair value of the contingent consideration based primarily on the following factors:
• | timing and probability of success of clinical events or regulatory approvals; |
• | timing and probability of success of meeting commercial milestones; and |
• | discount rates. |
On a quarterly basis, we revalue these obligations and record changes in their fair value as an adjustment to earnings. Changes to contingent consideration obligations can result from adjustments to discount rates, accretion of the discount rates due to the passage of time, changes in our estimates of the likelihood or timing of achieving development or commercial milestones, changes in the probability of certain clinical events, or changes in the assumed probability associated with regulatory approval.
The assumptions related to determining the value of contingent consideration include a significant amount of judgment, and any changes in the underlying estimates could have a material impact on the amount of contingent consideration expense recorded in any given period.
Income Taxes
The determination of our provision for income taxes requires significant judgment, the use of estimates, and the interpretation and application of complex tax laws. Realization of certain deferred tax assets, primarily net operating loss and other carryforwards, is dependent upon generating sufficient taxable income in the appropriate jurisdiction prior to the expiration of the carryforward periods. Failure to achieve forecasted taxable income in the applicable taxing jurisdictions could affect the ultimate realization of deferred tax assets and could result in an increase in our effective tax rate on future earnings.
We are subject to income taxes in the United States and numerous foreign jurisdictions. Our income tax returns are periodically audited by domestic and foreign tax authorities. These audits include questions regarding our tax filing positions, including the timing and amount of deductions and the allocation of income amongst various tax jurisdictions. We evaluate our tax positions and establish liabilities in accordance with the applicable accounting guidance on uncertainty in income taxes. Significant judgment is required in evaluating our uncertain tax positions, including estimating the ultimate resolution to intercompany pricing controversies between countries when there are numerous possible outcomes. We review these tax uncertainties quarterly and adjust the liability as events occur that affect potential liabilities for additional taxes, such as the progress of tax audits, lapsing of applicable statutes of limitations, negotiations between tax authorities, identification of new issues, and issuance of new legislation, regulations, or case law.
For additional details on our income taxes, see Note 2 and Note 16 to the "Consolidated Financial Statements."
Stock-based Compensation
We measure and recognize compensation expense for all stock-based awards based on estimated fair values. Stock-based awards consist of stock options, service-based restricted stock units, market-based restricted stock units, performance-based restricted stock units, and employee stock purchase subscriptions. The fair value of each option award and employee stock purchase subscription is estimated on the date of grant using the Black-Scholes option valuation model. The fair value of market-based restricted stock units is determined using a Monte Carlo simulation model, which uses multiple input variables to determine the probability of satisfying the market condition requirements. The Black-Scholes and Monte Carlo models require various highly judgmental assumptions, including stock price volatility, risk-free interest rate, and expected option term. For performance-based restricted stock units, expense is recognized if and when we conclude that it is probable that the performance condition will be achieved, which requires judgment. Stock-based compensation expense is recorded net of estimated forfeitures. Judgment is required in estimating the stock awards that will ultimately be forfeited. If actual results differ significantly from these estimates, stock-based compensation expense and our results of operations would be impacted.
New Accounting Standards
Information regarding new accounting standards is included in Note 2 to the "Consolidated Financial Statements."
36
Item 7A. Quantitative and Qualitative Disclosures About Market Risk
Our business and financial results are affected by fluctuations in world financial markets, including changes in currency exchange rates and interest rates. We manage these risks through a combination of normal operating and financing activities and derivative financial instruments. We do not use derivative financial instruments for trading or speculative purposes.
Interest Rate Risk
Our exposure to market risk for changes in interest rates relates primarily to our investment portfolio and our long-term debt. Our investment strategy is focused on preserving capital and supporting our liquidity requirements, while earning a reasonable market return. We invest in a variety of fixed-rate debt securities, primarily time deposits, commercial paper, U.S. government and agency securities, asset-backed securities, corporate debt securities, and municipal debt securities. The market value of our investments may decline if current market interest rates rise. As of December 31, 2016, we had $839.2 million of investments in fixed-rate debt securities which had an average remaining term to maturity of approximately 1.1 years. Taking into consideration the average maturity of our fixed-rate debt securities, a hypothetical 0.5% to 1.0% absolute increase in interest rates at December 31, 2016 would have resulted in a $4.8 million to $9.5 million decrease in the fair value of these investments. Such a decrease would only result in a realized loss if we choose or are forced to sell the investments before the scheduled maturity, which we currently do not anticipate.
We are also exposed to interest rate risk on our debt obligations. As of December 31, 2016, we had $600.0 million of Notes outstanding that carry a fixed rate, and also had available a $750.0 million Credit Agreement that carries a variable interest rate based on the London interbank offered rate ("LIBOR"). As of December 31, 2016, borrowings of $225.0 million were outstanding under the Credit Agreement. To diversify our interest rate risk, we entered into interest rate swaps with an aggregate notional amount of $300.0 million. The critical terms of the swaps match the critical terms of $300.0 million of the aggregate principal amount of the Notes, effectively converting that portion of the fixed-rate issue to a floating variable rate based on a 6-month LIBOR benchmark. Based on our year end 2016 variable debt levels, a hypothetical 1.0% absolute increase in our floating market interest rates would increase our interest expense by approximately $5.3 million, most of which would be offset by increased returns on our short-term investments. The impact on net interest would be immaterial to our financial condition and results of operations. As of December 31, 2016, a hypothetical 1.0% absolute increase in market interest rates would decrease the fair value of the fixed-rate debt by approximately $10.4 million. This hypothetical change in interest rates would not impact the interest expense on the fixed-rate debt.
For more information related to outstanding debt obligations, see Note 9 to the "Consolidated Financial Statements."
Currency Risk
We are exposed to foreign currency risks that arise from normal business operations. These risks include the translation of local currency balances and results of our non-United States subsidiaries into United States dollars, currency gains and losses related to intercompany and third-party transactions denominated in currencies other than a location's functional currency, and currency gains and losses associated with intercompany loans. Our principal currency exposures relate to the Euro and the Japanese yen. Our objective is to minimize the volatility of our exposure to these risks through a combination of normal operating and financing activities and the use of derivative financial instruments in the form of foreign currency forward exchange contracts and foreign currency options contracts. The total notional amount of our derivative financial instruments entered into for foreign currency management purposes at December 31, 2016 was $949.7 million. A hypothetical 10% increase/decrease in the value of the United States dollar against all hedged currencies would increase/decrease the fair value of these derivative contracts by $66.0 million. Any gains or losses on the fair value of derivative contracts would generally be offset by gains and losses on the underlying transactions, so the net impact would not be significant to our financial condition or results of operations.
For more information related to outstanding foreign exchange contracts, see Note 2 and Note 11 to the "Consolidated Financial Statements."
Credit Risk
Derivative financial instruments involve credit risk in the event the financial institution counterparty should default. It is our policy to execute such instruments with major financial institutions that we believe to be creditworthy. At December 31, 2016, all derivative financial instruments were with bank counterparties assigned investment grade ratings by national rating agencies. We further diversify our derivative financial instruments among counterparties to minimize exposure to any one of
37
these entities. We have not experienced a counterparty default and do not anticipate any non-performance by our current derivative counterparties.
Concentrations of Risk
We invest excess cash in a variety of fixed-rate debt securities, and diversify the investments between financial institutions. Our investment policy limits the amount of credit exposure to any one issuer.
In the normal course of business, we provide credit to customers in the health care industry, perform credit evaluations of these customers, and maintain allowances for potential credit losses, which have historically been adequate compared to actual losses. In 2016, we had no customers that represented 10% or more of our total net sales or accounts receivable, net.
Investment Risk
We are exposed to investment risks related to changes in the underlying financial condition and credit capacity of certain of our investments. As of December 31, 2016, we had $839.2 million of investments in fixed-rate debt securities of various companies, of which $498.2 million were long-term. In addition, we had $33.9 million of investments in equity instruments of public and private companies. Should these companies experience a decline in financial condition or credit capacity, or fail to meet certain development milestones, a decline in the investments' values may occur, resulting in unrealized or realized losses.
38
Item 8. Financial Statements and Supplementary Data
INDEX TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 2016
Financial Statements: | |
For the Years Ended December 31, 2016, 2015, and 2014: | |
Other schedules are not applicable and have not been submitted. | |
39
Report of Independent Registered Public Accounting Firm
To the Board of Directors and Stockholders of Edwards Lifesciences Corporation:
In our opinion, the consolidated financial statements listed in the accompanying index present fairly, in all material respects, the financial position of Edwards Lifesciences Corporation and its subsidiaries at December 31, 2016 and December 31, 2015, and the results of their operations and their cash flows for each of the three years in the period ended December 31, 2016 in conformity with accounting principles generally accepted in the United States of America. Also in our opinion, the Company maintained, in all material respects, effective internal control over financial reporting as of December 31, 2016, based on criteria established in Internal Control - Integrated Framework (2013) issued by the Committee of Sponsoring Organizations of the Treadway Commission (COSO). The Company's management is responsible for these financial statements, for maintaining effective internal control over financial reporting and for its assessment of the effectiveness of internal control over financial reporting, included in Management's Report on Internal Control over Financial Reporting under Item 9A. Our responsibility is to express opinions on these financial statements and on the Company's internal control over financial reporting based on our integrated audits. We conducted our audits in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audits to obtain reasonable assurance about whether the financial statements are free of material misstatement and whether effective internal control over financial reporting was maintained in all material respects. Our audits of the financial statements included examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements, assessing the accounting principles used and significant estimates made by management, and evaluating the overall financial statement presentation. Our audit of internal control over financial reporting included obtaining an understanding of internal control over financial reporting, assessing the risk that a material weakness exists, and testing and evaluating the design and operating effectiveness of internal control based on the assessed risk. Our audits also included performing such other procedures as we considered necessary in the circumstances. We believe that our audits provide a reasonable basis for our opinions.
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 (i) pertain to the maintenance of records that, in reasonable detail, accurately and fairly reflect the transactions and dispositions of the assets of the company; (ii) 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 (iii) 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.
/s/ PricewaterhouseCoopers LLP
Irvine, California
February 17, 2017
40
EDWARDS LIFESCIENCES CORPORATION
CONSOLIDATED BALANCE SHEETS
(in millions, except par value)
December 31, | |||||||
2016 | 2015 | ||||||
ASSETS | |||||||
Current assets | |||||||
Cash and cash equivalents | $ | 930.1 | $ | 718.4 | |||
Short-term investments (Note 6) | 341.0 | 506.3 | |||||
Accounts receivable, net (Note 5) | 365.5 | 315.4 | |||||
Other receivables | 49.1 | 56.4 | |||||
Inventories (Note 5) | 396.6 | 339.9 | |||||
Prepaid expenses | 45.9 | 45.1 | |||||
Other current assets | 111.8 | 66.4 | |||||
Total current assets | 2,240.0 | 2,047.9 | |||||
Long-term investments (Note 6) | 532.1 | 379.9 | |||||
Property, plant, and equipment, net (Note 5) | 580.0 | 482.5 | |||||
Goodwill (Note 8) | 626.1 | 628.3 | |||||
Other intangible assets, net (Note 8) | 204.8 | 205.4 | |||||
Deferred income taxes | 203.8 | 180.5 | |||||
Other assets | 123.2 | 131.8 | |||||
Total assets | $ | 4,510.0 | $ | 4,056.3 | |||
LIABILITIES AND STOCKHOLDERS' EQUITY | |||||||
Current liabilities | |||||||
Accounts payable | $ | 97.1 | $ | 63.9 | |||
Accrued and other liabilities (Note 5) | 435.4 | 412.3 | |||||
Total current liabilities | 532.5 | 476.2 | |||||
Long-term debt (Note 9) | 822.3 | 596.9 | |||||
Uncertain tax positions (Note 16) | 229.8 | 194.7 | |||||
Other long-term liabilities | 306.4 | 285.4 | |||||
Commitments and contingencies (Notes 9 and 17) | |||||||
Stockholders' equity (Note 13) | |||||||
Preferred stock, $.01 par value, authorized 50.0 shares, no shares outstanding | — | — | |||||
Common stock, $1.00 par value, 350.0 shares authorized, 242.6 and 239.1 shares issued, and 211.6 and 215.4 shares outstanding, respectively | 242.6 | 239.1 | |||||
Additional paid-in capital | 1,167.8 | 946.8 | |||||
Retained earnings | 3,906.3 | 3,336.8 | |||||
Accumulated other comprehensive loss | (198.4 | ) | (182.6 | ) | |||
Treasury stock, at cost, 31.0 and 23.7 shares, respectively | (2,499.3 | ) | (1,837.0 | ) | |||
Total stockholders' equity | 2,619.0 | 2,503.1 | |||||
Total liabilities and stockholders' equity | $ | 4,510.0 | $ | 4,056.3 | |||
The accompanying notes are an integral part of these consolidated financial statements.
41
EDWARDS LIFESCIENCES CORPORATION
CONSOLIDATED STATEMENTS OF OPERATIONS
(in millions, except per share information)
Years Ended December 31, | |||||||||||
2016 | 2015 | 2014 | |||||||||
Net sales | $ | 2,963.7 | $ | 2,493.7 | $ | 2,322.9 | |||||
Cost of sales | 797.4 | 617.2 | 625.6 | ||||||||
Gross profit | 2,166.3 | 1,876.5 | 1,697.3 | ||||||||
Selling, general, and administrative expenses | 904.7 | 850.7 | 858.0 | ||||||||
Research and development expenses | 443.3 | 383.1 | 346.5 | ||||||||
Intellectual property litigation expenses (income), net (Note 3) | 32.6 | 7.0 | (740.4 | ) | |||||||
Special charges (Note 4) | 34.5 | — | 70.7 | ||||||||
Interest expense | 19.2 | 17.2 | 17.2 | ||||||||
Interest income | (10.8 | ) | (7.9 | ) | (6.4 | ) | |||||
Other expense, net (Note 15) | 4.9 | 4.0 | 7.7 | ||||||||
Income before provision for income taxes | 737.9 | 622.4 | 1,144.0 | ||||||||
Provision for income taxes (Note 16) | 168.4 | 127.5 | 332.9 | ||||||||
Net income | $ | 569.5 | $ | 494.9 | $ | 811.1 | |||||
Share information (Note 2): | |||||||||||
Earnings per share: | |||||||||||
Basic | $ | 2.67 | $ | 2.30 | $ | 3.81 | |||||
Diluted | $ | 2.61 | $ | 2.25 | $ | 3.74 | |||||
Weighted-average number of common shares outstanding: | |||||||||||
Basic | 213.0 | 215.5 | 213.0 | ||||||||
Diluted | 217.8 | 220.3 | 217.0 | ||||||||
The accompanying notes are an integral part of these consolidated financial statements.
42
EDWARDS LIFESCIENCES CORPORATION
CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME
(in millions)
Years Ended December 31, | |||||||||||
2016 | 2015 | 2014 | |||||||||
Net income | $ | 569.5 | $ | 494.9 | $ | 811.1 | |||||
Other comprehensive loss, net of tax (Note 14): | |||||||||||
Foreign currency translation adjustments | (16.1 | ) | (65.1 | ) | (96.2 | ) | |||||
Unrealized gain (loss) on cash flow hedges | 4.9 | (20.5 | ) | 28.8 | |||||||
Defined benefit pension plans—net actuarial (loss) gain and other | (6.2 | ) | 5.4 | (5.6 | ) | ||||||
Unrealized gain (loss) on available-for-sale investments | 0.5 | (2.6 | ) | (0.3 | ) | ||||||
Reclassification of net realized investment loss to earnings | 1.1 | 1.1 | — | ||||||||
Other comprehensive loss, net of tax | (15.8 | ) | (81.7 | ) | (73.3 | ) | |||||
Comprehensive income | $ | 553.7 | $ | 413.2 | $ | 737.8 | |||||
The accompanying notes are an integral part of these consolidated financial statements.
43
EDWARDS LIFESCIENCES CORPORATION
CONSOLIDATED STATEMENTS OF CASH FLOWS
(in millions)
Years Ended December 31, | |||||||||||
2016 | 2015 | 2014 | |||||||||
Cash flows from operating activities | |||||||||||
Net income | $ | 569.5 | $ | 494.9 | $ | 811.1 | |||||
Adjustments to reconcile net income to cash provided by operating activities: | |||||||||||
Depreciation and amortization | 71.2 | 65.8 | 68.6 | ||||||||
Stock-based compensation (Notes 2 and 13) | 56.9 | 49.9 | 48.3 | ||||||||
Excess tax benefit from stock plans (Notes 2 and 13) | (64.3 | ) | (41.3 | ) | (49.4 | ) | |||||
Deferred income taxes | (37.4 | ) | (95.0 | ) | (71.1 | ) | |||||
Purchased in-process research and development (Note 4) | 34.5 | — | 10.6 | ||||||||
Other | 7.9 | 11.0 | 13.9 | ||||||||
Changes in operating assets and liabilities: | |||||||||||
Accounts and other receivables, net | (56.7 | ) | (38.3 | ) | (26.8 | ) | |||||
Inventories | (65.6 | ) | (67.7 | ) | (30.5 | ) | |||||
Accounts payable and accrued liabilities | 74.0 | 29.4 | 112.9 | ||||||||
Income taxes | 105.1 | 134.5 | 128.1 | ||||||||
Prepaid expenses and other current assets | (12.6 | ) | (0.2 | ) | (0.9 | ) | |||||
Other | 21.9 | 6.7 | 7.5 | ||||||||
Net cash provided by operating activities | 704.4 | 549.7 | 1,022.3 | ||||||||
Cash flows from investing activities | |||||||||||
Capital expenditures | (176.1 | ) | (102.7 | ) | (82.9 | ) | |||||
Purchases of held-to-maturity investments (Note 6) | (594.7 | ) | (928.5 | ) | (1,956.4 | ) | |||||
Proceeds from held-to-maturity investments (Note 6) | 852.5 | 1,260.1 | 1,611.2 | ||||||||
Purchases of available-for-sale investments (Note 6) | (470.4 | ) | (380.3 | ) | (160.4 | ) | |||||
Proceeds from available-for-sale investments (Note 6) | 232.6 | 179.6 | 1.7 | ||||||||
Investments in unconsolidated affiliates (Note 6) | (7.6 | ) | (5.1 | ) | (11.2 | ) | |||||
Proceeds from unconsolidated affiliates (Note 6) | 1.9 | 3.0 | 2.1 | ||||||||
Investments in trading securities, net | (9.8 | ) | (9.2 | ) | (14.4 | ) | |||||
Acquisitions (Notes 7 and 8) | — | (331.6 | ) | (15.0 | ) | ||||||
Investments in intangible assets and in-process research and development | (41.3 | ) | (3.8 | ) | (10.8 | ) | |||||
Proceeds from sale of assets | 2.4 | 2.4 | 3.1 | ||||||||
Other | (1.2 | ) | — | — | |||||||
Net cash used in investing activities | (211.7 | ) | (316.1 | ) | (633.0 | ) | |||||
Cash flows from financing activities | |||||||||||
Proceeds from issuance of debt | 253.5 | 31.4 | 226.3 | ||||||||
Payments on debt and capital lease obligations | (31.4 | ) | (29.5 | ) | (239.0 | ) | |||||
Purchases of treasury stock | (662.3 | ) | (280.1 | ) | (300.9 | ) | |||||
Proceeds from stock plans | 103.3 | 87.2 | 113.3 | ||||||||
Excess tax benefit from stock plans (Notes 2 and 13) | 64.3 | 41.3 | 49.4 | ||||||||
Other | 4.1 | (8.9 | ) | (2.1 | ) | ||||||
Net cash used in financing activities | (268.5 | ) | (158.6 | ) | (153.0 | ) | |||||
Effect of currency exchange rate changes on cash and cash equivalents | (12.5 | ) | (10.4 | ) | (2.9 | ) | |||||
Net increase in cash and cash equivalents | 211.7 | 64.6 | 233.4 | ||||||||
Cash and cash equivalents at beginning of year | 718.4 | 653.8 | 420.4 | ||||||||
Cash and cash equivalents at end of year | $ | 930.1 | $ | 718.4 | $ | 653.8 | |||||
Supplemental disclosures: | |||||||||||
Cash paid during the year for: | |||||||||||
Interest | $ | 16.1 | $ | 14.1 | $ | 15.5 | |||||
Income taxes | $ | 99.9 | $ | 86.9 | $ | 274.7 | |||||
Non-cash investing and financing transactions: | |||||||||||
Capital expenditures accruals | $ | 22.7 | $ | 15.1 | $ | 8.3 | |||||
Capital additions transferred from inventory | $ | 3.8 | $ | 3.0 | $ | 4.0 | |||||
Capital lease obligations incurred | $ | 0.4 | $ | — | $ | 13.3 | |||||
The accompanying notes are an integral part of these consolidated financial statements.
44
EDWARDS LIFESCIENCES CORPORATION
CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY
(in millions)
Common Stock | Treasury Stock | ||||||||||||||||||||||||||||
Shares | Par Value | Shares | Amount | Additional Paid-in Capital | Retained Earnings | Accumulated Other Comprehensive Loss | Total Stockholders' Equity | ||||||||||||||||||||||
BALANCE AT DECEMBER 31, 2013 | 126.0 | $ | 126.0 | 16.7 | $ | (1,256.0 | ) | $ | 671.2 | $ | 2,030.8 | $ | (27.6 | ) | $ | 1,544.4 | |||||||||||||
Net income | 811.1 | 811.1 | |||||||||||||||||||||||||||
Other comprehensive loss, net of tax | (73.3 | ) | (73.3 | ) | |||||||||||||||||||||||||
Common stock issued under equity plans, including tax benefits | 2.9 | 2.9 | 158.9 | 161.8 | |||||||||||||||||||||||||
Stock-based compensation expense | 48.3 | 48.3 | |||||||||||||||||||||||||||
Purchases of treasury stock | 4.4 | (300.9 | ) | (300.9 | ) | ||||||||||||||||||||||||
BALANCE AT DECEMBER 31, 2014 | 128.9 | 128.9 | 21.1 | (1,556.9 | ) | 878.4 | 2,841.9 | (100.9 | ) | 2,191.4 | |||||||||||||||||||
Net income | 494.9 | 494.9 | |||||||||||||||||||||||||||
Other comprehensive loss, net of tax | (81.7 | ) | (81.7 | ) | |||||||||||||||||||||||||
Common stock issued under equity plans, including tax benefits | 2.0 | 2.0 | 126.7 | 128.7 | |||||||||||||||||||||||||
Stock-based compensation expense | 49.9 | 49.9 | |||||||||||||||||||||||||||
Purchases of treasury stock | 2.6 | (280.1 | ) | (280.1 | ) | ||||||||||||||||||||||||
Stock issued to effect stock split | 108.2 | 108.2 | (108.2 | ) | — | ||||||||||||||||||||||||
BALANCE AT DECEMBER 31, 2015 | 239.1 | 239.1 | 23.7 | (1,837.0 | ) | 946.8 | 3,336.8 | (182.6 | ) | 2,503.1 | |||||||||||||||||||
Net income | 569.5 | 569.5 | |||||||||||||||||||||||||||
Other comprehensive loss, net of tax | (15.8 | ) | (15.8 | ) | |||||||||||||||||||||||||
Common stock issued under equity plans, including tax benefits | 3.5 | 3.5 | 164.1 | 167.6 | |||||||||||||||||||||||||
Stock-based compensation expense | 56.9 | 56.9 | |||||||||||||||||||||||||||
Purchases of treasury stock | 7.3 | (662.3 | ) | (662.3 | ) | ||||||||||||||||||||||||
BALANCE AT DECEMBER 31, 2016 | 242.6 | $ | 242.6 | 31.0 | $ | (2,499.3 | ) | $ | 1,167.8 | $ | 3,906.3 | $ | (198.4 | ) | $ | 2,619.0 | |||||||||||||
The accompanying notes are an integral part of these consolidated financial statements.
45
EDWARDS LIFESCIENCES CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
1. DESCRIPTION OF BUSINESS
Edwards Lifesciences Corporation ("Edwards Lifesciences" or the "Company") conducts operations worldwide and is managed in the following geographical regions: United States, Europe, Japan, and Rest of World. Edwards Lifesciences is focused on technologies that treat structural heart disease and critically ill patients. The products and technologies provided by Edwards Lifesciences are categorized into the following main areas: Transcatheter Heart Valve Therapy, Surgical Heart Valve Therapy, and Critical Care.
2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
Principles of Consolidation
The accompanying consolidated financial statements include the accounts of Edwards Lifesciences and its majority-owned subsidiaries. All intercompany balances and transactions have been eliminated in consolidation. The Company reviews its investments in other entities to determine whether the Company is the primary beneficiary of a variable interest entity ("VIE"). The Company would be the primary beneficiary of the VIE, and would be required to consolidate the VIE, if it has the power to direct the significant activities of the entity and the obligation to absorb losses or receive benefits from the entity that may be significant to the VIE. Based on the Company's analysis, it determined it is not the primary beneficiary of any VIEs; however, future events may require VIEs to be consolidated if the Company becomes the primary beneficiary.
Use of Estimates
The consolidated financial statements of Edwards Lifesciences have been prepared in accordance with Generally Accepted Accounting Principles in the United States of America ("GAAP") which have been applied consistently in all material respects. The preparation of financial statements in conformity with GAAP requires management to make estimates and assumptions that affect the amounts reported in the financial statements. Actual results could differ from those estimates.
Foreign Currency Translation
When the local currency of the Company's foreign entities is the functional currency, all assets and liabilities are translated into United States dollars at the rate of exchange in effect at the balance sheet date. Income and expense items are translated at the weighted-average exchange rate prevailing during the period. The effects of foreign currency translation adjustments for these entities are deferred and reported in stockholders' equity as a component of "Accumulated Other Comprehensive Loss." The effects of foreign currency transactions denominated in a currency other than an entity's functional currency are included in "Other Expense, net."
Revenue Recognition
The Company recognizes revenue when it is realized or realizable and earned. Revenue is considered realized or realizable and earned upon delivery of the product, provided that an agreement of sale exists, the sales price is fixed or determinable, and collection is reasonably assured. In the case of certain products where the Company maintains consigned inventory at customer locations, revenue is recognized at the time the customer has used the inventory.
The Company's principal sales terms provide for title and risk of loss transferring upon delivery to the customer, limited right of return, and no unusual provisions or conditions. When the Company recognizes revenue from the sale of its products, an estimate of various sales returns and allowances is recorded which reduces product sales and accounts receivable. These adjustments include estimates for rebates, returns, and other sales allowances. These provisions are estimated and recorded at the time of sale based upon historical payment experience, historical relationship to revenues, estimated customer inventory levels, and current contract sales terms with direct and indirect customers. Other than in limited circumstances, product returns are not significant because returns are generally not allowed unless the product is damaged at time of receipt. In addition, the Company may allow customers to return previously purchased products for next-generation product offerings. For these transactions, the Company defers recognition of revenue on the sale of the earlier generation product based upon an estimate of the amount of product to be returned when the next-generation products are shipped to the customer.
46
EDWARDS LIFESCIENCES CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (Continued)
The Company's sales adjustment related to distributor rebates given to the Company's United States distributors represents the difference between the Company's sales price to the distributor (at the Company's distributor "list price") and the negotiated price to be paid by the end-customer. This distributor rebate is recorded by the Company as a reduction to sales and a reduction to the distributor's accounts receivable at the time of sale to a distributor. The Company validates the distributor rebate accrual quarterly through either a review of the inventory reports obtained from its distributors or an estimate of its distributor's inventory. This distributor inventory information is used to verify the estimated liability for future distributor rebate claims based on historical rebates and contract rates. The Company periodically monitors current pricing trends and distributor inventory levels to ensure the credit for future distributor rebates is fairly stated.
The Company also offers volume rebates to certain group purchasing organizations ("GPOs") and customers based upon target sales levels. For volume rebates offered to GPOs, the rebates are recorded as a reduction to sales and an obligation to the GPOs, as the Company expects to pay in cash. For volume rebates offered to customers, the rebates are recorded as a reduction to sales and accounts receivable, as the Company expects a net payment from the customer. The provision for volume rebates is estimated based on customers' contracted rebate programs and historical experience of rebates paid. The Company periodically monitors its customer rebate programs to ensure that the allowance and liability for accrued rebates is fairly stated.
Shipping and Handling Costs
Shipping costs, which are costs incurred to physically move product from the Company's premises to the customer's premises, are included in "Selling, General, and Administrative Expenses." Handling costs, which are costs incurred to store, move, and prepare products for shipment, are included in "Cost of Sales." For the years ended December 31, 2016, 2015, and 2014, shipping costs of $64.1 million, $58.8 million, and $60.5 million, respectively, were included in "Selling, General, and Administrative Expenses."
Cash Equivalents
The Company considers highly liquid investments with original maturities of three months or less to be cash equivalents. These investments are valued at cost, which approximates fair value.
Investments
The Company invests its excess cash in fixed-rate debt securities, including time deposits, commercial paper, U.S. government and agency securities, asset-backed securities, corporate debt securities, and municipal debt securities. Investments with maturities of one year or less are classified as short-term, and investments with maturities greater than one year are classified as long-term. Investments that the Company has the ability and intent to hold until maturity are classified as held-to-maturity and carried at amortized cost. Investments that are classified as available-for-sale are carried at fair value with unrealized gains and losses included in "Accumulated Other Comprehensive Loss." The Company determines the appropriate classification of its investments in fixed-rate debt securities at the time of purchase and reevaluates such designation at each balance sheet date.
The Company also has long-term equity investments in companies that are in various stages of development. These investments are designated as available-for-sale. Other investments in unconsolidated affiliates are accounted for under the cost or the equity method of accounting, as appropriate. The Company accounts for investments in limited partne