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Boston Scientific 10-Q 2015
10-Q
UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-Q
þ
QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
For the quarterly period ended September 30, 2015
OR
o
TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
Commission File No. 1-11083
BOSTON SCIENTIFIC CORPORATION
(Exact name of registrant as specified in its charter)
DELAWARE
04-2695240
(State or other jurisdiction of incorporation or organization)
(I.R.S. Employer Identification No.)
300 BOSTON SCIENTIFIC WAY, MARLBOROUGH, MASSACHUSETTS 01752-1234
(Address of principal executive offices) (zip code)
(508) 683-4000
(Registrant’s telephone number, including area code)

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes þ No o
Indicate by check mark whether the registrant has submitted electronically and posted on its corporate website, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).Yes þ No o
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company. See the definitions of “large accelerated filer,” “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act.
Large accelerated filer þ
Accelerated filer o
Non-Accelerated filer o
Smaller reporting company o
 
 
(Do not check if a smaller reporting company)
 
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act). Yes o No þ
Indicate the number of shares outstanding of each of the issuer’s classes of common stock, as of the latest practicable date.

 
 
Shares outstanding
Class
 
as of October 30, 2015
Common Stock, $.01 par value
 
1,345,195,041



TABLE OF CONTENTS

 
 
Page No.
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 

2


PART I
FINANCIAL INFORMATION

ITEM 1. CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

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

 
Three Months Ended
September 30,
 
Nine Months Ended
September 30,
in millions, except per share data
2015
2014
 
2015
2014
 
 
 
 
 
 
Net sales
$
1,888

$
1,846

 
$
5,499

$
5,493

Cost of products sold
539

550

 
1,600

1,651

Gross profit
1,349

1,296

 
3,899

3,842

 
 
 
 
 
 
Operating expenses:
 
 
 
 
 
Selling, general and administrative expenses
729

741

 
2,095

2,150

Research and development expenses
221

212

 
632

609

Royalty expense
17

21

 
53

86

Amortization expense
131

109

 
361

327

Intangible asset impairment charges
10

12

 
19

177

Contingent consideration expense (benefit)
40

(4
)
 
86

(122
)
Restructuring charges
7

2

 
16

37

Litigation-related charges (credits)
457

139

 
649

399

Pension termination charges
36


 
44


Gain on divestiture


 

(12
)
 
1,648

1,232

 
3,955

3,651

Operating income (loss)
(299
)
64

 
(56
)
191

 
 
 
 
 
 
Other income (expense):
 
 
 
 
 
Interest expense
(58
)
(54
)
 
(225
)
(161
)
Other, net
(10
)
(7
)
 
(31
)
15

Income (loss) before income taxes
(367
)
3

 
(312
)
45

Income tax expense (benefit)
(169
)
(40
)
 
(215
)
(135
)
Net income (loss)
$
(198
)
$
43

 
$
(97
)
$
180

 
 
 
 
 
 
Net income (loss) per common share — basic
$
(0.15
)
$
0.03

 
$
(0.07
)
$
0.14

Net income (loss) per common share — assuming dilution
$
(0.15
)
$
0.03

 
$
(0.07
)
$
0.13

 
 
 
 
 
 
Weighted-average shares outstanding
 
 
 
 
 
Basic
1,344.0

1,325.5

 
1,339.7

1,323.5

Assuming dilution
1,344.0

1,347.6

 
1,339.7

1,347.3


See notes to the unaudited condensed consolidated financial statements.


3


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

 
Three Months Ended
September 30,
 
Nine Months Ended
September 30,
(in millions)
2015
 
2014
 
2015
 
2014
Net income (loss)
$
(198
)
 
$
43

 
$
(97
)
 
$
180

Other comprehensive income (loss):
 
 
 
 
 
 
 
Foreign currency translation adjustment
(12
)
 
(15
)
 
(42
)
 
(23
)
Net change in unrealized gains and losses on derivative financial instruments, net of tax
(27
)
 
83

 
(42
)
 
28

Net change in certain retirement plans, net of tax
16

 

 
21

 
(1
)
Total other comprehensive income (loss)
(23
)
 
68

 
(63
)
 
4

Total comprehensive income (loss)
$
(221
)
 
$
111

 
$
(160
)
 
$
184


See notes to the unaudited condensed consolidated financial statements.


4


BOSTON SCIENTIFIC CORPORATION AND SUBSIDIARIES
CONDENSED CONSOLIDATED BALANCE SHEETS
 
As of
 
September 30,
 
December 31,
in millions, except share and per share data
2015
 
2014
 
(Unaudited)
 
 
ASSETS
 
 
 
Current assets:
 
 
 
Cash and cash equivalents
$
350

 
$
587

Trade accounts receivable, net
1,274

 
1,183

Inventories
1,086

 
946

Deferred and prepaid income taxes
367

 
447

Other current assets
385

 
443

Total current assets
3,462

 
3,606

Property, plant and equipment, net
1,479

 
1,507

Goodwill
6,468

 
5,898

Other intangible assets, net
6,228

 
5,606

Other long-term assets
578

 
425

TOTAL ASSETS
$
18,215

 
$
17,042

 
 
 
 
LIABILITIES AND STOCKHOLDERS’ EQUITY
 
 
 
Current liabilities:
 
 
 
Current debt obligations
$
63

 
$
403

Accounts payable
210

 
262

Accrued expenses
1,605

 
1,950

Other current liabilities
360

 
231

Total current liabilities
2,238

 
2,846

Long-term debt
5,796

 
3,859

Deferred income taxes
770

 
1,214

Other long-term liabilities
3,001

 
2,666

 
 
 
 
Commitments and contingencies

 

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


 


 
 
 
 
Common stock, $.01 par value - authorized 2,000,000,000 shares -
 issued 1,592,429,606 shares as of September 30, 2015 and
1,575,018,236 shares as of December 31, 2014
16

 
16

 
 
 
 
Treasury stock, at cost - 247,566,270 shares as of September 30, 2015
and 247,566,270 shares as of December 31, 2014
(1,717
)
 
(1,717
)
Additional paid-in capital
16,815

 
16,703

Accumulated deficit
(8,785
)
 
(8,689
)
Accumulated other comprehensive income (loss), net of tax
81

 
144

Total stockholders’ equity
6,410

 
6,457

TOTAL LIABILITIES AND STOCKHOLDERS' EQUITY
$
18,215

 
$
17,042


5


See notes to the unaudited condensed consolidated financial statements.

6


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

 
Nine Months Ended
September 30,
in millions
2015
 
2014
 
 
 
 
Cash provided by (used for) operating activities
$
271

 
$
829

 
 
 
 
Investing activities:
 
 
 
Purchases of property, plant and equipment
(162
)
 
(180
)
Purchases of privately held securities
(209
)
 
(6
)
Purchases of notes receivable
(1
)
 
(12
)
Proceeds from sales of publicly traded and privately held equity securities and collections of notes receivable

 
12

Payments for acquisitions of businesses, net of cash acquired
(1,642
)
 
(487
)
Payments for investments and acquisitions of certain technologies
(2
)
 
(1
)
Proceeds from business divestitures, net of costs

 
12

 
 
 
 
Cash provided by (used for) investing activities
(2,016
)
 
(662
)
 
 
 
 
Financing activities:
 
 
 
Payments on long-term borrowings
(1,000
)
 

Proceeds from long-term borrowings, net of debt issuance costs
2,580

 

Payment of contingent consideration
(102
)
 
(15
)
Proceeds from borrowings on credit facilities
565

 
810

Payments on borrowings from credit facilities
(565
)
 
(810
)
Payments for acquisitions of treasury stock

 
(125
)
Cash used to net share settle employee equity awards
(62
)
 
(48
)
Proceeds from issuances of shares of common stock
97

 
52

 
 
 
 
Cash provided by (used for) financing activities
1,513

 
(136
)
 
 
 
 
Effect of foreign exchange rates on cash
(5
)
 
(2
)
 
 
 
 
Net increase (decrease) in cash and cash equivalents
(237
)
 
29

Cash and cash equivalents at beginning of period
587

 
217

Cash and cash equivalents at end of period
$
350

 
$
246

 
 
 
 
Supplemental Information
 
 
 
Stock-based compensation expense
$
79

 
$
79

Fair value of contingent consideration recorded in purchase accounting
31

 


See notes to the unaudited condensed consolidated financial statements.


7


NOTES TO THE CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)

NOTE A – BASIS OF PRESENTATION

The accompanying unaudited condensed consolidated financial statements of Boston Scientific Corporation have been prepared in accordance with accounting principles generally accepted in the United States (U.S. GAAP) and with the instructions to Form 10-Q and Article 10 of Regulation S-X. Accordingly, they do not include all of the information and footnotes required by U.S. GAAP for complete financial statements. In the opinion of management, all adjustments (consisting only of normal recurring adjustments) considered necessary for fair presentation have been included. Operating results for the three and nine month periods ended September 30, 2015 are not necessarily indicative of the results that may be expected for the year ending December 31, 2015. For further information, refer to the consolidated financial statements and footnotes thereto included in Item 8 of our 2014 Annual Report on Form 10-K.

Subsequent Events

We evaluate events occurring after the date of our most recent accompanying unaudited condensed consolidated balance sheets for potential recognition or disclosure in our financial statements. We did not identify any material subsequent events requiring adjustment to our accompanying unaudited condensed consolidated financial statements (recognized subsequent events) for the three and nine month periods ended September 30, 2015. Those items requiring disclosure (unrecognized subsequent events) in the financial statements have been disclosed accordingly. Refer to Note J - Commitments and Contingencies for more information.

NOTE B – ACQUISITIONS AND STRATEGIC INVESTMENTS

2015 Acquisitions

AMS Portfolio Acquisition

On August 3, 2015, we completed the acquisition of the American Medical Systems male urology portfolio (AMS Portfolio Acquisition), which includes the men's health and prostate health businesses, from Endo International plc. Total consideration was comprised of $1.616 billion in up-front cash plus related fees and expenses, and a potential additional $50 million in consideration based on 2016 sales. The AMS male urology portfolio is being integrated with our formerly named Urology and Women's Health business, and the joint businesses have become Urology and Pelvic Health. In addition, as part of the acquisition agreement, we made a $60 million Series B non-voting preferred stock investment in the women's health business of Endo Health Solutions, a wholly owned subsidiary of Endo International, plc., representing the remaining Women's Health business of the American Medical Systems' Portfolio.

Xlumena, Inc.

On April 2, 2015, we acquired Xlumena, Inc. (Xlumena), a medical device company that developed minimally invasive devices for Endoscopic Ultrasound (EUS) guided transluminal drainage of targeted areas within the gastrointestinal tract. The purchase agreement called for an upfront payment of $63 million, an additional payment of $13 million upon FDA clearance of the HOT AXIOS™ product, and further sales-based milestones based on sales achieved through 2018. We are in the process of integrating Xlumena into our Endoscopy business, and expect the integration to be substantially complete by the end of 2016.

Purchase Price Allocation

We accounted for these acquisitions as business combinations and, in accordance with Financial Accounting Standards Board (FASB) Accounting Standards Codification® (ASC) Topic 805, Business Combinations, we have recorded the assets acquired and liabilities assumed at their respective fair values as of the acquisition dates. The components of the aggregate preliminary purchase prices are as follows (in millions):
Cash, net of cash acquired, including amounts payable as of September 30, 2015
$
1,659

Fair value of contingent consideration
31

 
$
1,690



8


The following summarizes the aggregate preliminary purchase price allocation for the 2015 acquisitions as of September 30, 2015 (in millions):
Goodwill
$
568

Amortizable intangible assets
992

Inventory
102

Property, Plant and Equipment
42

Other net assets
39

Deferred income taxes
(53
)
 
$
1,690


We allocated a portion of the purchase price to specific intangible asset categories as follows:
 
Amount
Assigned
(in millions)
 
Weighted
Average
Amortization
Period
(in years)
 
Range of Risk-
Adjusted Discount
Rates used in
Purchase Price
Allocation
Amortizable intangible assets:
 
 
 
 
 
Technology-related
$
358

 
11-12
 
13.5% - 15%
Customer relationships
616

 
12
 
13.5%
Other intangible assets
18

 
13
 
13.5%
 
$
992

 
 
 
 

2014 Acquisitions

Interventional Business of Bayer AG

On August 29, 2014, we completed the acquisition of the Interventional Division of Bayer AG (Bayer), for total cash consideration of $414 million. We believe that this acquisition enhances our ability to offer physicians and healthcare systems a more complete portfolio of solutions to treat challenging vascular conditions. The transaction includes the AngioJet® Thrombectomy System and the Fetch® 2 Aspiration Catheter, which are used in endovascular procedures to remove blood clots from blocked arteries and veins, and the JetStream® Atherectomy System, used to remove plaque and thrombi from diseased arteries. We are in the process of integrating Bayer into our Peripheral Intervention and Interventional Cardiology businesses, and expect the integration to be substantially complete by the middle of 2016.
IoGyn, Inc.

On May 7, 2014, we completed the acquisition of the remaining fully diluted equity of IoGyn, Inc. (IoGyn). Prior to the acquisition, we held approximately 28 percent minority interest in IoGyn in addition to notes receivable of $8 million. Total consideration was comprised of a net cash payment of $65 million at closing to acquire the remaining 72 percent of IoGyn equity and repay outstanding debt. IoGyn developed the SymphionTM System, a next generation system for hysteroscopic intrauterine tissue removal including fibroids (myomas) and polyps. We have substantially completed the process of integrating the operations of the IoGyn business with our gynecological surgery business, which is part of our Urology and Pelvic Health business.

Purchase Price Allocation

We accounted for these acquisitions as business combinations and, in accordance with FASB ASC Topic 805, Business Combinations, we have recorded the assets acquired and liabilities assumed at their respective fair values as of the acquisition dates. The components of the aggregate purchase prices are as follows (in millions):
Cash, net of cash acquired
$
479

Fair value of prior interests
31

 
$
510



9


We re-measured our previously held investments to their estimated acquisition-date fair value of $31 million and recorded a gain of $19 million in Other, net, in the accompanying condensed consolidated statements of operations during the second quarter of 2014. We measured the fair values of the previously held investments based on the liquidation preferences and priority of the equity interests and debt, including accrued interest.

The following summarizes the aggregate purchase price allocation for the 2014 acquisitions as of September 30, 2014 (in millions):
Goodwill
$
210

Amortizable intangible assets
263

Inventory
23

Property, Plant and Equipment
17

Prepaid Transaction Service Agreements
5

Other net assets
(1
)
Deferred income taxes
(7
)
 
$
510


We allocated a portion of the purchase price to specific intangible asset categories as follows:
 
Amount
Assigned
(in millions)
 
Weighted
Average
Amortization
Period
(in years)
 
Range of Risk-
Adjusted Discount
Rates used in
Purchase Price
Allocation
Amortizable intangible assets:
 
 
 
 
 
Technology-related
$
233

 
10 - 14
 
14 - 18 %
Customer relationships
29

 
10
 
18%
Other intangible assets
1

 
2
 
14%
 
$
263

 
 
 
 

Our technology-related intangible assets consist of technical processes, intellectual property, and institutional understanding with respect to products and processes that we will leverage in future products or processes and will carry forward from one product generation to the next. We used the income approach to derive the fair value of the technology-related intangible assets, and are amortizing them on a straight-line basis over their assigned estimated useful lives.

Customer relationships represent the estimated fair value of non-contractual customer and distributor relationships. Customer relationships are direct relationships with physicians and hospitals performing procedures with the acquired products, and distributor relationships are relationships with third parties used to sell products, both as of the acquisition date. These relationships were valued separately from goodwill because there is a history and pattern of conducting business with customers and distributors. We used the income approach or the replacement cost and lost profits methodology to derive the fair value of the customer relationships. The customer relationships intangible assets are amortized on a straight-line basis over their assigned estimated useful lives.

Other intangible assets primarily include acquired tradenames. These tradenames include brand names that we expect to continue using in our product portfolio and related marketing materials. The tradenames are valued using a relief from royalty methodology and are amortized on a straight-line basis over their assigned estimated useful lives.

We believe that the estimated intangible asset values represent the fair value at the date of acquisition and do not exceed the amount a third party would pay for the assets. These fair value measurements are based on significant unobservable inputs, including management estimates and assumptions and, accordingly, are classified as Level 3 within the fair value hierarchy prescribed by FASB ASC Topic 820, Fair Value Measurements and Disclosures.


10


We recorded the excess of the aggregate purchase price over the estimated fair values of the identifiable assets acquired as goodwill. Goodwill was established due primarily to synergies expected to be gained from leveraging our existing operations as well as revenue and cash flow projections associated with future technologies, and has been allocated to our reportable segments based on the relative expected benefit. Of the goodwill recorded, approximately $500 million, based on preliminary estimates, related to our 2015 acquisitions and approximately $150 million related to our 2014 acquisitions is deductible for tax purposes. See Note D - Goodwill and Other Intangible Assets for more information related to goodwill allocated to our reportable segments.

Contingent Consideration

Certain of our acquisitions involve contingent consideration arrangements. Payment of additional consideration is generally contingent on the acquired company reaching certain performance milestones, including attaining specified revenue levels, achieving product development targets and/or obtaining regulatory approvals. In accordance with U.S. GAAP, we recognize a liability equal to the fair value of the contingent payments we expect to make as of the acquisition date. We re-measure this liability each reporting period and record changes in the fair value through a separate line item within our consolidated statements of operations.

We recorded a net expense related to the change in fair value of our contingent consideration liabilities of $40 million during the third quarter of 2015 and $86 million during the first nine months of 2015. We recorded net benefits of $4 million during the third quarter of 2014 and $122 million during the first nine months of 2014. We paid contingent consideration of $15 million during the third quarter of 2015 and $125 million during the first nine months of 2015. We made no payments of contingent consideration during the third quarter of 2014 and we made payments of $15 million during the first nine months of 2014.

Changes in the fair value of our contingent consideration liability were as follows (in millions):
Balance as of December 31, 2014
$
274

Amounts recorded related to new acquisitions
31

Other amounts recorded related to prior acquisitions

Net fair value adjustments
86

Payments made
(125
)
Balance as of September 30, 2015
$
266


As of September 30, 2015, the maximum amount of future contingent consideration (undiscounted) that we could be required to pay was approximately $1.893 billion.

Contingent consideration liabilities are re-measured to fair value each reporting period using projected revenues, discount rates, probabilities of payment and projected payment dates. The recurring Level 3 fair value measurements of our contingent consideration liability include the following significant unobservable inputs:
Contingent Consideration Liability
Fair Value as of September 30, 2015
Valuation Technique
Unobservable Input
Range
Revenue-based Payments
$84 million
Probability Weighted Discounted Cash Flow
Discount Rate
11.5% - 15%
Projected Year of Payment
2015 - 2019
$182 million
Monte Carlo
Revenue Volatility
11% - 20%
Risk Free Rate
LIBOR Term Structure
Projected Year of Payment
2015 - 2018


11


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

Strategic Investments

On April 30, 2015, we acquired a 27 percent ownership interest in Preventice, Inc. (Preventice), which includes 18.5 percent of Preventice's common stock. Preventice is a privately-held company headquartered in Minneapolis, MN, and a leading developer of mobile health solutions and services. Preventice offers a full portfolio of wearable cardiac monitors, including Holter monitors, cardiac event monitors and mobile cardiac telemetry. In addition to the equity agreement, we entered into a commercial agreement with Preventice, under which we will become Preventice’s exclusive, worldwide sales and marketing representative. We believe this partnership strengthens our portfolio of cardiac monitoring and broader disease management capabilities.

On April 13, 2015, we acquired 25 percent of the common stock of Frankenman Medical Equipment Company (Frankenman). Frankenman is a private company headquartered in Suzhou, China, and is a local market leader in surgical staplers. Additionally, we entered into co-promotional and co-selling agreements with Frankenman to jointly commercialize selected products in China. We believe this alliance will enable us to reach more clinicians and treat more patients in China by providing access to training on less invasive endoscopic technologies with clinical and economic benefits.

We are accounting for our investments in Preventice and Frankenman as equity method investments, in accordance with FASB ASC Topic 323, Investments - Equity Method and Joint Ventures. As of September 30, 2015, the book value of our equity method investments exceeded our share of the book value of the investees’ underlying net assets by approximately $40 million, which represents amortizable intangible assets and corresponding deferred tax liabilities, and goodwill. During the three and nine months ended September 30, 2015, the net losses from our equity method adjustments, presented within the Other, net caption of our condensed consolidated statement of operations were de minimis.

We did not close any material strategic investments in the third quarter or first nine months of 2014.

NOTE C – DIVESTITURES AND PENSION TERMINATION

In January 2011, we closed the sale of our Neurovascular business to Stryker Corporation for a purchase price of $1.500 billion in cash. We received $1.450 billion during 2011, an additional $10 million during 2012, $30 million during 2013 and the final amount due to us in 2014. At the time of divestiture, due to our continuing involvement in the operations of the Neurovascular business following the transaction, the divestiture did not meet the criteria for presentation as a discontinued operation. We recorded a gain of $12 million during the first nine months of 2014 associated with the Neurovascular divestiture.

Following our 2006 acquisition of Guidant Corporation, we sponsored the Guidant Retirement Plan, a frozen noncontributory defined benefit plan covering a select group of current and former employees. The plan was partially frozen as of September 25, 1995 and completely frozen as of May 31, 2007, and was terminated effective December 1, 2014. During 2015, we finalized the termination process and settled the plan’s obligations, and as a result, we have recorded pension termination charges of $36 million and $44 million during the third quarter and first nine months of 2015.

12


NOTE D – GOODWILL AND OTHER INTANGIBLE ASSETS

The gross carrying amount of goodwill and other intangible assets and the related accumulated amortization for intangible assets subject to amortization and accumulated write-offs of goodwill as of September 30, 2015 and December 31, 2014 are as follows:
 
As of
 
September 30, 2015
 
December 31, 2014
 
Gross Carrying
 
Accumulated
Amortization/
 
Gross Carrying
 
Accumulated
Amortization/
(in millions)
Amount
 
Write-offs
 
Amount
 
Write-offs
Amortizable intangible assets
 
 
 
 
 
 
 
Technology-related
$
8,874

 
$
(3,952
)
 
$
8,406

 
$
(3,697
)
Patents
519

 
(354
)
 
519

 
(342
)
Other intangible assets
1,512

 
(584
)
 
875

 
(533
)
 
$
10,905

 
$
(4,890
)
 
$
9,800

 
$
(4,572
)
Unamortizable intangible assets
 
 
 
 
 
 
 
Goodwill
$
16,368

 
$
(9,900
)
 
$
15,798

 
$
(9,900
)
In-process research and development (IPR&D)
93

 

 
181

 

Technology-related
120

 

 
197

 

 
$
16,581

 
$
(9,900
)
 
$
16,176

 
$
(9,900
)

During the third quarter of 2015, we reclassified approximately $77 million of core technology not previously subject to amortization to amortizable intangible assets due to projected changes in the market for this technology. We tested the intangible asset for impairment prior to this reclassification and determined that the asset was not impaired.

In addition, during the third quarter of 2015, we reclassified $1 million of IPR&D not previously subject to amortization to amortizable intangible assets, as a result of regulatory approvals, for a total of $77 million of IPR&D assets not previously subject to amortization reclassified as amortizable intangible assets during the first nine months of 2015. The IPR&D reclassified to amortizable intangible assets during the first nine months of 2015 primarily related to the receipt of FDA approval of the WATCHMAN® device.

The following represents our goodwill balance by global reportable segment:
(in millions)
Cardiovascular
 
Rhythm Management
 
MedSurg
 
Total
Balance as of December 31, 2014
$
3,426

 
$
290

 
$
2,182

 
$
5,898

Purchase price adjustments

 
2

 

 
2

Goodwill acquired

 

 
568

 
568

Balance as of September 30, 2015
$
3,426

 
$
292

 
$
2,750

 
$
6,468


Goodwill Impairment Testing

We test our goodwill balances during the second quarter of each year for impairment, or more frequently if indicators are present or changes in circumstances suggest that an impairment may exist.

In the second quarter of 2015, we performed our annual goodwill impairment test for all of our reporting units and concluded the fair value of each reporting unit exceeded its carrying value. As a result of the 2015 annual goodwill impairment test, we identified our global Electrophysiology reporting unit as being at higher risk of potential failure of the first step of the goodwill impairment test in future reporting periods. As of the date of our annual goodwill impairment test, our global Electrophysiology reporting unit had excess fair value over carrying value of approximately 28 percent and held $292 million of allocated goodwill. Also, as of the date of our annual goodwill impairment test, our global Cardiac Rhythm Management (CRM) reporting unit had excess fair value over carrying value of approximately 26 percent; however, due to goodwill impairment charges in prior years, no goodwill remains within our CRM reporting unit. Changes in our reporting units or in the structure of our business as a result of future reorganizations, acquisitions or divestitures of assets or businesses could result in future impairments of goodwill within our reporting units. Refer to Critical Accounting Policies and Estimates within our Management's Discussion and Analysis of Financial Condition and Results of Operations contained in Item 2 of this Quarterly Report on Form 10-Q for a discussion of key assumptions used in our testing.


13


On a quarterly basis, we monitor the key drivers of fair value to detect events or other changes that would warrant an interim impairment test of our goodwill. The key variables that drive the cash flows of our reporting units and amortizable intangibles are estimated revenue growth rates and levels of profitability. Terminal value growth rate assumptions, as well as the Weighted Average Cost of Capital (WACC) rate applied are additional key variables for reporting unit cash flows. These assumptions are subject to uncertainty, including our ability to grow revenue and improve profitability levels. Relatively small declines in the future performance and cash flows of a reporting unit or asset group or small changes in other key assumptions may result in the recognition of significant goodwill impairment charges. For example, as of the date of our annual goodwill impairment test, keeping all other variables constant, a combined increase of 50 basis points in the WACC along with a simultaneous decrease of 150 basis points in the long term growth rate applied would require that we perform the second step of the goodwill impairment test for our global Electrophysiology reporting unit. The estimates used for our future cash flows and discount rates represent management's best estimates, which we believe to be reasonable, but future declines in business performance may impair the recoverability of our goodwill.

Future events that could have a negative impact on the levels of excess fair value over carrying value of our reporting units include, but are not limited to:

decreases in estimated market sizes or market growth rates due to greater-than-expected declines in procedural volumes, pricing pressures, reductions in reimbursement levels, product actions, and/or competitive technology developments;

declines in our market share and penetration assumptions due to increased competition, an inability to develop or launch new and next-generation products and technology features in line with our commercialization strategies, and market and/or regulatory conditions that may cause significant launch delays or product recalls;

decreases in our forecasted profitability due to an inability to successfully implement and achieve timely and sustainable cost improvement measures consistent with our expectations;

negative developments in intellectual property litigation that may impact our ability to market certain products or increase our costs to sell certain products;

the level of success of ongoing and future research and development efforts, including those related to recent acquisitions, and increases in the research and development costs necessary to obtain regulatory approvals and launch new products;

the level of success in managing the growth of acquired companies, achieving sustained profitability consistent with our expectations, establishing government and third-party payer reimbursement, supplying the market, and increases in the costs and time necessary to integrate acquired businesses into our operations successfully;

changes in our reporting units or in the structure of our business as a result of future reorganizations, acquisitions or divestitures of assets or businesses; and

increases in our market-participant risk-adjusted WACC, and increases in our market-participant tax rate, and/or changes in tax laws or macroeconomic conditions.

Negative changes in one or more of these factors, among others, could result in impairment charges.

The following is a rollforward of accumulated goodwill write-offs by global reportable segment:
(in millions)
Cardiovascular
 
Rhythm Management
 
MedSurg
 
Total
Accumulated write-offs as of December 31, 2014
$
(1,479
)
 
$
(6,960
)
 
$
(1,461
)
 
$
(9,900
)
Goodwill written off

 

 

 

Accumulated write-offs as of September 30, 2015
$
(1,479
)
 
$
(6,960
)
 
$
(1,461
)
 
$
(9,900
)


14


Intangible Asset Impairment Testing

2015 Charges

During the third quarter of 2015, we performed our annual impairment test of all IPR&D projects and our indefinite-lived core technology assets. Indefinite-lived intangible assets are tested for impairment on an annual basis during the third quarter of each year, or more frequently if impairment indicators are present, in accordance with U.S. GAAP and our accounting policies described in our 2014 Annual Report on Form 10-K. In addition, as a result of revised estimates in conjunction with our annual operating plan, we performed an interim impairment test of certain definite-lived core technology associated with certain of our acquisitions. Based on the results of our testing, we recorded impairment charges of $10 million in the third quarter of 2015.

During the second quarter of 2015, in conjunction with our annual strategic planning process and annual goodwill impairment test, we performed an interim impairment test on certain of our IPR&D projects and core technology assets. Based on our impairment assessment, we recorded an impairment charge of $9 million in the second quarter of 2015.

2014 Charges

During the third quarter of 2014, we performed our annual impairment test of all IPR&D projects, and our indefinite-lived core technology assets. Based on the results of our annual test, we recorded total impairment charges of $4 million to write-down the balances of certain in-process projects to their fair value. In addition, as a result of revised estimates in conjunction with our annual operating plan, we performed an interim impairment test of core technology associated with certain of our acquisitions, and we recorded an impairment charge of $8 million, for a total of $12 million of impairment charges in the third quarter of 2014.

During the second quarter of 2014, as a result of revised estimates developed in conjunction with our annual strategic planning process and annual goodwill impairment test, we performed an interim impairment test of our IPR&D projects and core technology associated with certain of our acquisitions. Based on our impairment assessment, and lower expected future cash flows associated with our intangible assets, we recorded pre-tax impairment charges of $110 million in the second quarter of 2014. As a result of changes in our clinical strategy and lower estimates of the European and global hypertension markets, and the resulting amount of future revenue and cash flows associated with the technology acquired from Vessix Vascular Inc. (Vessix), we recorded impairment charges of $67 million related to technology intangible assets during the second quarter of 2014. In addition, in the second quarter of 2014, due to revised expectations and timing as a result of the announcement of a third FDA Circulatory System Devices Panel, we recorded impairment charges of $35 million related to the IPR&D intangible assets acquired from Atritech, Inc. (Atritech). We also recorded an additional $8 million intangible asset impairment charge associated with changes in the amount of the expected cash flows related to certain other acquired IPR&D projects.

During the first quarter of 2014, as a result of lower estimates of the resistant hypertension market following the announcement of data from a competitor's clinical trial, we performed an interim impairment test of our IPR&D projects and core technology associated with our acquisition of Vessix. The impairment assessments were based upon probability-weighted cash flows of potential future scenarios. Based on our impairment assessment, and lower expected future cash flows associated with our Vessix-related intangible assets, we recorded pre-tax impairment charges of $55 million in the first quarter of 2014 to write-down the balance of these intangible assets to their calculated fair value.


15


The nonrecurring Level 3 fair value measurements of our intangible asset impairment analysis included the following significant unobservable inputs:
Intangible Asset
Valuation Date
Fair Value
Valuation Technique
Unobservable Input
Rate
Core Technology
September 30, 2015
$8 million
Income Approach -Excess Earnings Method
Discount Rate
10%
In-Process R&D
June 30, 2015
$6 million
Income Approach - Excess Earnings Method
Discount Rate
 16.5 - 20%
In-Process R&D
September 30, 2014
$16 million
Income Approach - Excess Earnings Method
Discount Rate
 16.5 - 20%
In-Process R&D
June 30, 2014
$83 million
Income Approach - Excess Earnings Method
Discount Rate
 16.5 - 20%
Core Technology
June 30, 2014
$8 million
Income Approach - Excess Earnings Method
Discount Rate
15%
In-Process R&D
March 31, 2014
$6 million
Income Approach - Excess Earnings Method
Discount Rate
20%
Core Technology
March 31, 2014
$64 million
Income Approach - Excess Earnings Method
Discount Rate
15%

NOTE E – FAIR VALUE MEASUREMENTS

Derivative Instruments and Hedging Activities

We address market risk from changes in foreign currency exchange rates and interest rates through a risk management program that includes the use of derivative financial instruments, and we operate the program pursuant to documented corporate risk management policies. Our derivative instruments do not subject our earnings or cash flows to material risk, as gains and losses on these derivatives generally offset losses and gains on the item being hedged. We do not enter into derivative transactions for speculative purposes, and we do not have any non-derivative instruments that are designated as hedging instruments pursuant to FASB ASC Topic 815, Derivatives and Hedging (Topic 815).


16


Currency Hedging

We are exposed to currency risk consisting primarily of foreign currency denominated monetary assets and liabilities, forecasted foreign currency denominated intercompany and third-party transactions and net investments in certain subsidiaries. We manage our exposure to changes in foreign currency exchange rates on a consolidated basis to take advantage of offsetting transactions. We use derivative instruments, and non-derivative transactions to reduce the risk that our earnings and cash flows associated with these foreign currency denominated balances and transactions will be adversely affected by foreign currency exchange rate changes.

Currently or Previously Designated Foreign Currency Hedges

All of our designated currency hedge contracts outstanding as of September 30, 2015 and December 31, 2014 were cash flow hedges under Topic 815 intended to protect the U.S. dollar value of our forecasted foreign currency denominated transactions. We record the effective portion of any change in the fair value of foreign currency cash flow hedges in other comprehensive income (OCI) until the related third-party transaction occurs. Once the related third-party transaction occurs, we reclassify the effective portion of any related gain or loss on the foreign currency cash flow hedge to earnings. In the event the hedged forecasted transaction does not occur, or it becomes no longer probable that it will occur, we reclassify the amount of any gain or loss on the related cash flow hedge to earnings at that time. We had currency derivative instruments currently or previously designated as cash flow hedges outstanding in the contract amount of $1.517 billion as of September 30, 2015 and $2.178 billion as of December 31, 2014.

We recognized net gains of $54 million in earnings on our cash flow hedges during the third quarter of 2015 and $156 million for the first nine months of 2015, as compared to net gains of $25 million during the third quarter of 2014 and $68 million for the first nine months of 2014. All currency cash flow hedges outstanding as of September 30, 2015 mature within 36 months. As of September 30, 2015, $171 million of net gains, net of tax, were recorded in accumulated other comprehensive income (AOCI) to recognize the effective portion of the fair value of any currency derivative instruments that are, or previously were, designated as foreign currency cash flow hedges, as compared to net gains of $217 million as of December 31, 2014. As of September 30, 2015, $114 million of net gains, net of tax, may be reclassified to earnings within the next twelve months.

The success of our hedging program depends, in part, on forecasts of transaction activity in various currencies (primarily Japanese yen, Euro, British pound sterling, Australian dollar and Canadian dollar). We may experience unanticipated currency exchange gains or losses to the extent that there are differences between forecasted and actual activity during periods of currency volatility. In addition, changes in foreign currency exchange rates related to any unhedged transactions may impact our earnings and cash flows.

Non-designated Foreign Currency Contracts

We use currency forward contracts as a part of our strategy to manage exposure related to foreign currency denominated monetary assets and liabilities. These currency forward contracts are not designated as cash flow, fair value or net investment hedges under Topic 815; are marked-to-market with changes in fair value recorded to earnings; and are entered into for periods consistent with currency transaction exposures, generally less than one year. We had currency derivative instruments not designated as hedges under Topic 815 outstanding in the contract amount of $1.947 billion as of September 30, 2015 and $2.470 billion as of December 31, 2014.

Interest Rate Hedging

Our interest rate risk relates primarily to U.S. dollar borrowings, partially offset by U.S. dollar cash investments. We have historically used interest rate derivative instruments to manage our earnings and cash flow exposure to changes in interest rates by converting floating-rate debt into fixed-rate debt or fixed-rate debt into floating-rate debt.

We designate these derivative instruments either as fair value or cash flow hedges under Topic 815. We record changes in the value of fair value hedges in interest expense, which is generally offset by changes in the fair value of the hedged debt obligation. Interest payments made or received related to our interest rate derivative instruments are included in interest expense. We record the effective portion of any change in the fair value of derivative instruments designated as cash flow hedges as unrealized gains or losses in OCI, net of tax, until the hedged cash flow occurs, at which point the effective portion of any gain or loss is reclassified to earnings. We record the ineffective portion of our cash flow hedges in interest expense. In the event the hedged cash flow does not occur, or it becomes no longer probable that it will occur, we reclassify the amount of any gain or loss on the related cash flow hedge to interest expense at that time.


17


In the fourth quarter of 2013, we entered into interest rate derivative contracts having a notional amount of $450 million to convert fixed-rate debt into floating-rate debt, which we designated as fair value hedges. During the first quarter of 2015, we terminated these hedges and we received total proceeds of approximately $35 million, which included approximately $7 million of net accrued interest receivable. We assessed at inception, and re-assessed on an ongoing basis, whether the interest rate derivative contracts were highly effective in offsetting changes in the fair value of the hedged fixed-rate debt. We recognized no gains or losses in interest expense, related to fair value hedges, during the third quarter of 2015. During the first nine months of 2015, we recognized, in interest expense, an $8 million loss on our hedged debt and an $8 million gain on the related interest rate derivative contract. During the third quarter of 2014, we recognized, in interest expense, a $1 million gain on our hedged debt and a $1 million loss on the related interest rate derivative contract. During the first nine months of 2014, we recognized, in interest expense, a $17 million loss on our hedged debt and a $17 million gain on the related interest rate derivative contract.

During the second quarter of 2015, we entered into forward starting interest rate derivative contracts having a notional amount of $450 million to hedge interest rate risk associated with a planned issuance of fixed-rate senior notes, which we designated as cash flow hedges. These hedges were terminated during the second quarter at the time we issued the fixed-rate senior notes and we received total proceeds of approximately $11 million. We had no amounts outstanding under these hedges as of September 30, 2015. We assessed, at inception, and re-assessed, on an ongoing basis, whether the cash flow derivative contracts were highly effective in offsetting changes in interest rates. The gain on this derivative contract was recorded within accumulated other comprehensive income, and is being amortized into earnings as a credit to interest expense over the life of the related senior notes.

We are amortizing the gains and losses on previously terminated interest rate derivative instruments, including fixed-to-floating interest rate contracts designated as fair value hedges and forward starting interest rate derivative contracts and treasury locks designated as cash flow hedges upon termination into earnings as a component of interest expense over the remaining term of the hedged debt, in accordance with Topic 815. The carrying amount of certain of our senior notes included unamortized gains of $66 million as of September 30, 2015 and $45 million as of December 31, 2014, and unamortized losses of $1 million as of September 30, 2015 and $2 million as of December 31, 2014 related to the fixed-to-floating interest rate contracts that we terminated in prior periods. In addition, we had pre-tax net gains within AOCI related to terminated forward starting interest rate derivative contracts and treasury locks of $10 million as of September 30, 2015 and $2 million as of December 31, 2014. We recorded approximately $3 million during the third quarter of 2015 and $10 million during the first nine months of 2015 as a reduction to interest expense, resulting from the amortization of terminated interest rate derivative contracts. As of September 30, 2015, $13 million of pre-tax net gains may be reclassified to earnings within the next twelve months as a reduction to interest expense from amortization of our terminated interest rate derivative contracts.

Counterparty Credit Risk

We do not have significant concentrations of credit risk arising from our derivative financial instruments, whether from an individual counterparty or a related group of counterparties. We manage the concentration of counterparty credit risk on our derivative instruments by limiting acceptable counterparties to a diversified group of major financial institutions with investment grade credit ratings, limiting the amount of credit exposure to each counterparty, and actively monitoring their credit ratings and outstanding fair values on an ongoing basis. Furthermore, none of our derivative transactions are subject to collateral or other security arrangements and none contain provisions that are dependent on our credit ratings from any credit rating agency.

We also employ master netting arrangements that reduce our counterparty payment settlement risk on any given maturity date to the net amount of any receipts or payments due between us and the counterparty financial institution. Thus, the maximum loss due to counterparty credit risk is limited to the unrealized gains in such contracts net of any unrealized losses should any of these counterparties fail to perform as contracted. Although these protections do not eliminate concentrations of credit risk, as a result of the above considerations, we do not consider the risk of counterparty default to be significant.

18



Fair Value of Derivative Instruments

The following presents the effect of our derivative instruments designated as cash flow hedges under Topic 815 on our accompanying unaudited condensed consolidated statements of operations during the third quarter and first nine months of 2015 and 2014 (in millions):
 
Amount of Pre-tax
Gain (Loss)
Recognized in OCI
(Effective Portion)
 
Amount of Pre-tax Gain (Loss) Reclassified from AOCI into Earnings
(Effective Portion)
 
Location in Statement of
Operations
Three Months Ended September 30, 2015
 
 
 
 
 
Currency hedge contracts
$
13

 
$
54

 
Cost of products sold
 
$
13

 
$
54

 
 
Three Months Ended September 30, 2014
 
 
 
 
 
Currency hedge contracts
$
156

 
$
25

 
Cost of products sold
 
$
156

 
$
25

 
 
Nine Months Ended September 30, 2015
 
 
 
 
 
Currency hedge contracts
$
81

 
$
156

 
Cost of products sold
Interest rate derivative contracts
11

 
2

 
Interest Expense
 
$
92

 
$
158

 
 
Nine Months Ended September 30, 2014
 
 
 
 
 
Currency hedge contracts
$
115

 
$
68

 
Cost of products sold
 
$
115

 
$
68

 
 

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

Net gains and losses on currency hedge contracts not designated as hedging instruments were offset by net losses and gains from foreign currency transaction exposures, as shown in the following table:
in millions
 
Location in Statement of Operations
 
Three Months Ended
 
Nine Months Ended
 
 
September 30,
 
September 30,
 
 
2015
 
2014
 
2015
 
2014
Gain (loss) on currency hedge contracts
 
Other, net
 
$
32

 
$
40

 
$
46

 
$
20

Gain (loss) on foreign currency transaction exposures
 
Other, net
 
(36
)
 
(45
)
 
(64
)
 
(31
)
Net foreign currency gain (loss)
 
Other, net
 
$
(4
)
 
$
(5
)
 
$
(18
)
 
$
(11
)

Topic 815 requires all derivative instruments to be recognized at their fair values as either assets or liabilities on the balance sheet. Generally, we use inputs that include quoted prices for similar assets or liabilities in active markets; quoted prices for identical or similar assets or liabilities in markets that are not active; other observable inputs for the asset or liability; and inputs derived principally from, or corroborated by, observable market data by correlation or other means. As of September 30, 2015, we have classified all of our derivative assets and liabilities within Level 2 of the fair value hierarchy prescribed by FASB ASC Topic 820, Fair Value Measurements and Disclosures (Topic 820), as discussed below, because these observable inputs are available for substantially the full term of our derivative instruments.


19


The following are the balances of our derivative assets and liabilities as of September 30, 2015 and December 31, 2014:
 
 
As of
 
 
September 30,
 
December 31,
(in millions)
Location in Balance Sheet (1)
2015
 
2014
Derivative Assets:
 
 
 
 
Currently or Previously Designated Hedging Instruments
 
 
 
Currency hedge contracts
Other current assets
$
152

 
$
178

Currency hedge contracts
Other long-term assets
89

 
141

Interest rate contracts
Other current assets

 
3

Interest rate contracts
Other long-term assets

 
22

 
 
241

 
344

Non-Designated Hedging Instruments
 
 
 
 
Currency hedge contracts
Other current assets
49

 
100

Total Derivative Assets
 
$
290

 
$
444

 
 
 
 
 
Derivative Liabilities:
 
 
 
 
Currently or Previously Designated Hedging Instruments
 
 
 
Currency hedge contracts
Other current liabilities
$
1

 
$
1

 
 
1

 
1

Non-Designated Hedging Instruments
 
 
 
 
Currency hedge contracts
Other current liabilities
29

 
35

Total Derivative Liabilities
 
$
30

 
$
36


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

Other Fair Value Measurements

Recurring Fair Value Measurements

On a recurring basis, we measure certain financial assets and financial liabilities at fair value based upon quoted market prices, where available. Where quoted market prices or other observable inputs are not available, we apply valuation techniques to estimate fair value. Topic 820 establishes a three-level valuation hierarchy for disclosure of fair value measurements. The categorization of financial assets and financial liabilities within the valuation hierarchy is based upon the lowest level of input that is significant to the measurement of fair value. The three levels of the hierarchy are defined as follows:

Level 1 – Inputs to the valuation methodology are quoted market prices for identical assets or liabilities.

Level 2 – Inputs to the valuation methodology are other observable inputs, including quoted market prices for similar assets or liabilities and market-corroborated inputs.

Level 3 – Inputs to the valuation methodology are unobservable inputs based on management’s best estimate of inputs market participants would use in pricing the asset or liability at the measurement date, including assumptions about risk.

20


Assets and liabilities measured at fair value on a recurring basis consist of the following as of September 30, 2015 and December 31, 2014:
 
September 30, 2015
 
As of December 31, 2014
(in millions)
Level 1
 
Level 2
 
Level 3
 
Total
 
Level 1
 
Level 2
 
Level 3
 
Total
Assets
 
 
 

 
 
 
 
 
 
 
 

 
 
 
 
Money market and government funds
$
27

 
$

 
$

 
$
27

 
$
151

 
$

 
$

 
$
151

Currency hedge contracts

 
290

 

 
290

 

 
419

 

 
419

Interest rate contracts

 

 

 

 

 
25

 

 
25

 
$
27

 
$
290

 
$

 
$
317

 
$
151

 
$
444

 
$

 
$
595

Liabilities
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Currency hedge contracts
$

 
$
30

 
$

 
$
30

 
$

 
$
36

 
$

 
$
36

Accrued contingent consideration

 

 
266

 
266

 

 

 
274

 
274

 
$

 
$
30

 
$
266

 
$
296

 
$

 
$
36

 
$
274

 
$
310


Our investments in money market and government funds are generally classified within Level 1 of the fair value hierarchy because they are valued using quoted market prices. These investments are classified as cash and cash equivalents within our accompanying unaudited condensed consolidated balance sheets, in accordance with U.S. GAAP and our accounting policies.

In addition to $27 million invested in money market and government funds as of September 30, 2015, we had $115 million in short-term time deposits and $208 million in interest bearing and non-interest bearing bank accounts. In addition to $151 million invested in money market and government funds as of December 31, 2014, we had $255 million in short-term deposits and $181 million in interest bearing and non-interest bearing bank accounts.

Our recurring fair value measurements using significant unobservable inputs (Level 3) relate solely to our contingent consideration liabilities. Refer to Note B - Acquisitions and Strategic Investments in this Quarterly Report on Form 10-Q, for a discussion of the changes in the fair value of our contingent consideration liabilities.

Non-Recurring Fair Value Measurements

We hold certain assets and liabilities that are measured at fair value on a non-recurring basis in periods subsequent to initial recognition. The fair value of a cost method investment is not estimated if there are no identified events or changes in circumstances that may have a significant adverse effect on the fair value of the investment. The aggregate carrying amount of our cost method investments was $121 million as of September 30, 2015 and $27 million as of December 31, 2014.

We recorded $10 million of losses to adjust our intangible assets to their fair value during the third quarter of 2015 and $19 million of losses for the first nine months of 2015. We recorded $12 million of losses to adjust our intangible assets to their fair value during the third quarter of 2014 and $177 million of losses for the first nine months of 2014. Refer to Note D - Goodwill and Other Intangible Assets in this Quarterly Report on Form 10-Q, for further information related to these charges and significant unobservable inputs (Level 3).

The fair value of our outstanding debt obligations was $6.080 billion as of September 30, 2015 and $4.613 billion as of December 31, 2014, which was determined by using primarily quoted market prices for our publicly registered senior notes, classified as Level 1 within the fair value hierarchy. Refer to Note F – Borrowings and Credit Arrangements in this Quarterly Report on Form 10-Q, for a discussion of our debt obligations.


21


NOTE F – BORROWINGS AND CREDIT ARRANGEMENTS

We had total debt of $5.859 billion as of September 30, 2015 and $4.262 billion as of December 31, 2014. The debt maturity schedule for the significant components of our debt obligations as of September 30, 2015 is as follows:
 
 
 
 
(in millions)
2015
 
2016
 
2017
 
2018
 
2019
 
Thereafter
 
Total
Senior notes
$

 
$

 
$
250

 
$
600

 
$

 
$
3,800

 
$
4,650

Term loan

 
80

 
155

 
390

 
150

 
375

 
1,150

 
$

 
$
80

 
$
405

 
$
990

 
$
150

 
$
4,175

 
$
5,800

 
Note:
The table above does not include unamortized discounts associated with our senior notes, or amounts related to interest rate contracts used to hedge the fair value of certain of our senior notes.

Revolving Credit Facility

On April 10, 2015, we entered into a new $2.000 billion revolving credit facility (the 2015 Facility) with a global syndicate of commercial banks and terminated our previous $2.000 billion revolving credit facility. The 2015 Facility matures on April 10, 2020. Eurodollar and multicurrency loans under the 2015 Facility bear interest at LIBOR plus an interest margin of between 0.900 percent and 1.500 percent, based on our corporate credit ratings and consolidated leverage ratio (1.300 percent as of September 30, 2015). In addition, we are required to pay a facility fee based on our credit ratings, consolidated leverage ratio and the total amount of revolving credit commitment, regardless of usage, under the credit agreement (0.200 percent per year as of September 30, 2015). The 2015 Facility contains covenants which, among other things, require that we maintain a minimum interest coverage ratio of 3.0 times consolidated EBITDA and a maximum leverage ratio of 4.5 times consolidated EBITDA for the first four fiscal quarter-ends following the closing of the AMS Portfolio Acquisition on August 3, 2015, and decreasing to 4.25 times, 4.0 times, and 3.75 times consolidated EBITDA for the next three fiscal quarter-ends after such four fiscal quarter-ends, respectively, and then to 3.5 times for each fiscal quarter-end thereafter. There were no amounts borrowed under our current and prior revolving credit facilities as of September 30, 2015 or December 31, 2014.
 
Covenant Requirement
as of September 30, 2015
 
Actual as of
September 30, 2015
Maximum leverage ratio (1)
4.5 times
 
3.1 times
Minimum interest coverage ratio (2)
3.0 times
 
6.7 times

(1)
Ratio of total debt to consolidated EBITDA, as defined by the credit agreement, for the preceding four consecutive fiscal quarters.
(2)
Ratio of consolidated EBITDA, as defined by the credit agreement, to interest expense for the preceding four consecutive fiscal quarters.

The credit agreement for the 2015 Facility provides for an exclusion from the calculation of consolidated EBITDA, as defined by the credit agreement, through the credit agreement maturity, of any non-cash charges and up to $620 million in restructuring charges and restructuring-related expenses related to our current or future restructuring plans. As of September 30, 2015, we had $584 million of the restructuring charge exclusion remaining. In addition, any cash litigation payments (net of any cash litigation receipts), as defined by the agreement, are excluded from the calculation of consolidated EBITDA and any new debt issued to fund any tax deficiency payments is excluded from consolidated total debt, as defined in the agreement, provided that the sum of any excluded net cash litigation payments and any new debt issued to fund any tax deficiency payments not exceed $2.000 billion in the aggregate. As of September 30, 2015, we had $1.633 billion of the combined legal and debt exclusion remaining.

As of and through September 30, 2015, we were in compliance with the required covenants.


22


Term Loans

As of September 30, 2015, we had an aggregate of $1.150 billion outstanding under our unsecured term loan facilities and $400 million outstanding as of December 31, 2014. This includes $400 million outstanding under an unsecured term loan facility (2013 Term Loan) as of September 30, 2015 and December 31, 2014. Term loan borrowings under this facility bear interest at LIBOR plus an interest margin of between 1.00 percent and 1.75 percent (currently 1.50 percent), based on our corporate credit ratings and consolidated leverage ratio. The term loan borrowings are payable over a five-year period, with quarterly principal payments of $20 million commencing in the first quarter of 2016 and the remaining principal amount due at the final maturity date in August 2018, and are repayable at any time without premium or penalty. Our term loan facility requires that we comply with certain covenants, including financial covenants with respect to maximum leverage and minimum interest coverage, consistent with our revolving credit facility. The maximum leverage ratio requirement is 4.5 times, and our actual leverage ratio as of September 30, 2015 is 3.1 times. The minimum interest coverage ratio requirement is 3.0 times, and our actual interest coverage ratio as of September 30, 2015 is 6.7 times.

On April 10, 2015, we entered into a new $750 million unsecured term loan credit facility (2015 Term Loan) which matures on August 3, 2020. The 2015 Term Loan was funded on August 3, 2015 and was used to partially fund the AMS Portfolio Acquisition, including the payment of fees and expenses. Term loan borrowings under this facility bear interest at LIBOR plus an interest margin of between 1.00 percent and 1.75 percent (currently 1.50 percent), based on our corporate credit ratings and consolidated leverage ratio. The 2015 Term Loan requires quarterly principal payments of $38 million commencing in the third quarter of 2017, and the remaining principal amount is due at the final maturity date of August 3, 2020. The 2015 Term Loan agreement requires that we comply with certain covenants, including financial covenants with respect to maximum leverage and minimum interest coverage, consistent with our revolving credit facility. The maximum leverage ratio requirement is 4.5 times, and our actual leverage ratio as of September 30, 2015 is 3.1 times. The minimum interest coverage ratio requirement is 3.0 times, and our actual interest coverage ratio as of September 30, 2015 is 6.7 times.

Senior Notes

We had senior notes outstanding of $4.650 billion as of September 30, 2015 and $3.800 billion as of December 31, 2014. In May 2015, we completed the offering of $1.850 billion in aggregate principal amount of senior notes consisting of $600 million in aggregate principal amount of 2.850% notes due 2020, $500 million in aggregate principal amount of 3.375% notes due 2022 and $750 million in aggregate principal amount of 3.850% notes due 2025. The net proceeds from the offering of the notes, after deducting underwriting discounts and estimated offering expenses, were approximately $1.831 billion. We used a portion of the net proceeds from the senior notes offering to redeem $400 million aggregate principal amount of our 5.500% notes due November 2015 and $600 million aggregate principal amount of our 6.400% notes due June 2016. The remaining senior notes offering proceeds, together with the 2015 Term Loan, were used to fund the AMS Portfolio Acquisition. We recorded a charge of $45 million in interest expense for premiums, accelerated amortization of debt issuance costs, and investor discount costs net of interest rate hedge gains related to the early debt extinguishment.

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

Other Arrangements

We maintain a $300 million credit and security facility secured by our U.S. trade receivables maturing on June 9, 2017. The credit and security facility requires that we maintain a maximum leverage covenant consistent with our revolving credit facility. The maximum leverage ratio requirement is 4.5 times, and our actual leverage ratio as of September 30, 2015 is 3.1 times. We had no borrowings outstanding under this facility as of September 30, 2015 and December 31, 2014.


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We have accounts receivable factoring programs in certain European countries that we account for as sales under FASB ASC Topic 860, Transfers and Servicing. These agreements provide for the sale of accounts receivable to third parties, without recourse, of up to approximately $387 million as of September 30, 2015. We have no retained interests in the transferred receivables, other than collection and administrative responsibilities and, once sold, the accounts receivable are no longer available to satisfy creditors in the event of bankruptcy. We de-recognized $173 million of receivables as of September 30, 2015 at an average interest rate of 2.5 percent, and $167 million as of December 31, 2014 at an average interest rate of 3.2 percent. Within Italy, Spain, Portugal and Greece, the number of days our receivables are outstanding has remained above historical levels. We believe we have adequate allowances for doubtful accounts related to our Italy, Spain, Portugal and Greece accounts receivable; however, we continue to monitor the European economic environment for any collectability issues related to our outstanding receivables. As of September 30, 2015, our net receivables in these countries greater than 180 days past due totaled $28 million, of which $13 million were past due greater than 365 days.

In addition, we have uncommitted credit facilities with a commercial Japanese bank that provide for borrowings, promissory notes discounting and receivables factoring of up to 21.000 billion Japanese yen (approximately $176 million as of September 30, 2015). We de-recognized $135 million of notes receivable as of September 30, 2015 at an average interest rate of 1.7 percent and $134 million of notes receivable as of December 31, 2014 at an average interest rate of 1.8 percent. De-recognized accounts and notes receivable are excluded from trade accounts receivable, net in the accompanying unaudited condensed consolidated balance sheets.

As of September 30, 2015 we had outstanding letters of credit of $65 million, as compared to $59 million as of December 31, 2014, which consisted primarily of bank guarantees and collateral for workers' compensation insurance arrangements. As of September 30, 2015 and December 31, 2014, none of the beneficiaries had drawn upon the letters of credit or guarantees; accordingly, we did not recognize a related liability for our outstanding letters of credit in our consolidated balance sheets as of September 30, 2015 or December 31, 2014. We believe we will generate sufficient cash from operations to fund these arrangements and intend to fund these arrangements without drawing on the letters of credit.

NOTE G – RESTRUCTURING-RELATED ACTIVITIES

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

2014 Restructuring Plan

On October 22, 2013, our Board of Directors approved, and we committed to, a restructuring initiative (the 2014 Restructuring plan). The 2014 Restructuring plan is intended to build on the progress we have made to address financial pressures in a changing global marketplace, further strengthen our operational effectiveness and efficiency and support new growth investments. Key activities under the plan include continued implementation of our ongoing Plant Network Optimization (PNO) strategy, continued focus on driving operational efficiencies and ongoing business and commercial model changes. The PNO strategy is intended to simplify our manufacturing plant structure by transferring certain production lines among facilities. Other activities involve rationalizing organizational reporting structures to streamline various functions, eliminate bureaucracy, increase productivity and better align resources to business strategies and marketplace dynamics. These activities were initiated in the fourth quarter of 2013 and are expected to be substantially completed by the end of 2015, with the exception of certain ongoing actions associated with our PNO strategy. These ongoing actions associated with our PNO strategy will be substantially completed by the end of 2016.


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We estimate that the implementation of the 2014 Restructuring plan will result in total pre-tax charges of approximately $250 million to $300 million, and approximately $235 million to $285 million of these charges are estimated to result in cash outlays, of which we have made payments of $159 million through September 30, 2015. We have recorded related costs of $204 million since the inception of the plan, and recorded a portion of these expenses as restructuring charges and the remaining portion through other lines within our consolidated statements of operations.

The following table provides a summary of our estimates of costs associated with the 2014 Restructuring plan by major type of cost:
Type of cost
Total estimated amount expected to
be incurred
Restructuring charges:
 
Termination benefits
$115 million to $135 million
Other (1)
$25 million to $35 million
Restructuring-related expenses:
 
Other (2)
$110 million to $130 million
 
$250 million to $300 million

(1) Consists primarily of consulting fees and costs associated with contract cancellations.
(2) Comprised of other costs directly related to the 2014 Restructuring plan, including program management, accelerated depreciation, and costs to transfer product lines among facilities.

2011 Restructuring Plan

On July 26, 2011, our Board of Directors approved, and we committed to, a restructuring initiative (the 2011 Restructuring plan) designed to strengthen operational effectiveness and efficiencies, increase competitiveness and support new investments. Key activities under the 2011 Restructuring plan included standardizing and automating certain processes and activities; relocating select administrative and functional activities; rationalizing organizational reporting structures; leveraging preferred vendors; and other efforts to eliminate inefficiency. Among these efforts, we expanded our ability to deliver best-in-class global shared services for certain functions and businesses at several locations in emerging markets. On January 25, 2013, our Board of Directors approved, and we committed to, an expansion of the 2011 Restructuring plan (the Expansion). The Expansion was intended to further strengthen our operational effectiveness and efficiencies and support new investments. Activities under the 2011 Restructuring plan were initiated in the third quarter of 2011 and all activities, including those related to the Expansion, were substantially completed by the end of 2013.

The 2011 Restructuring plan, including the Expansion, resulted in net pre-tax charges of