Boston Scientific Corp (BSX) 2006 Q1 法說會逐字稿

Ladies and gentlemen, thank you for standing by and welcome to the first quarter results conference. [OPERATOR INSTRUCTIONS].

I would now like to turn the conference over to Larry Best, Chief Financial Officer, please go ahead, sir.

Thank you.

Good morning.

Welcome to our first quarter 2006 conference call on quarterly results.

With me today on the call is our Chief Executive Officer, Jim Tobin, our Chief Operating Officer, Paul LaViolette, our Executive Vice President and General Counsel, Paul Sandman.

We will talk about the status of the Guidant transaction.

Paul Donovan, our head of Corporate Communications and myself.

We're going to cover the highlights in the quarter.

Paul LaViolette will give you an update on various FDA status issues and Paul Sandman will ask to give you a brief update on status of the guidance transaction.

Before we begin, because we will have a number of forward-looking statements, I'd like to ask Paul Donovan, our head of Corporate Communications at Boston Scientific, to read the Safe Harbor clause.

Paul?

Thank you Larry.

This call contains forward-looking statements about the merger and timing expectations to complete the merger.

These forward-looking statements are subject to risks and uncertainties that may cause actual results to differ materially, including the satisfaction of other closing conditions contained in the merger agreement and other risk factors relating to our industry as detailed from time to time in each of Boston Scientific's and Guidant's reports filed with the Securities and Exchange Commission, including each Company's Annual Report.

You should not place undue reliance on forward-looking statements.

Thank you, Larry.

Thanks, Paul.

Let me first, if you didn't see the release, read from parts of the release, then I will give you some additional commentary regarding the financial results for the quarter.

A couple of highlights that we were pleased to be able to refer to in the first quarter of 2006, first off, it was a record quarter in terms of recorded net sales for the Company in its history, with $1.62 billion in sales top line.

We also had our highest sales of drug-eluding stents outside the U.S. that we've ever achieved so it was another record for us.

And our quarterly sequential growth in worldwide TAXUS stent sales from $606 million to $633 million, that's a comparison of the fourth quarter of '05 with the first quarter of '06.

So, we were very pleased with the sequential growth and the U.S. grew also from 398 the prior quarter, that would be the fourth quarter of '05 to $419 million in the first quarter of '06.

Net sales for the first quarter of 2006 were 1.620 billion as compared to 1.615 billion in the first quarter of 2005.

Excluding the unfavorable impact of $40 million of foreign currency fluctuations, net sales for the first quarter of 2006 increased 3%.

Worldwide sales of TAXUS coronary stent systems were $633 million for the first quarter of 2006 as compared to $686 million for the first quarter of 2005.

And $606 million for the fourth quarter of 2005.

U.S. sales of TAXUS were $419 million for the first quarter of 2006 as compared to $494 million for the first quarter of 2005 and $398 million for the fourth quarter of 2005.

On the net income side, net income for the first quarter of 2006 was $332 million or $0.40 per diluted share as compared to net income of $358 million or $0.42 per diluted share for the first quarter of 2005.

Reported results for the first quarter of 2006 included charges after tax of $22 million or $0.03 per share for stock-based compensation, due to the adoption of the new standard 123-R.

And $27 million -- or $0.03 a share -- associated with the investment writedown due to determination of the gene therapy trial recently reported.

Reported results for the first quarter of 2005 of the prior year included charges after tax of $73 million or $0.09 per share for the purchased research and development.

Let me give you some additional overview highlights of the quarter.

We came in, as I just mentioned, at $1.62 billion in sales, up 3% from the prior year, but if you factor the -- the size and shape and dynamics of the coronary stent market out of those numbers and so if you look at our sales results for the first quarter without coronary stents, actually we achieved double-digit growth.

We -- the other parts of our business grew 10% in the quarter, so, we were pleased to see on a constant currency basis a solid 10% growth outside of coronary stents.

Our international business grew 10% and we were pleased to see double-digit growth in our international markets.

That includes coronary stents and then the domestic or U.S. business was flattish at down 1%.

If we look at the divisional numbers on a worldwide basis, the highlight in the quarter was that we saw double-digit -- solid double-digit growth on constant currency basis for the six divisions outside of our cardiovascular business.

And to highlight those, electro physiology grew 11% during the first quarter, our neurovascular business grew 20% in the first quarter.

Oncology grew 11%.

Endoscopy grew 11%.

Urology grew 27%.

And our neuromodulation or Advanced Bionics group grew 49%, all on a constant currency basis.

So, very strong results throughout the business.

If you look at the endosurgery group by itself, including oncology, endoscopy and neurology, the overall endosurgery group grew a solid 15% in the quarter on a constant currency basis.

So, we're feeling very good about the tone of business and the momentum we see in our business as we look to close the Guidant transaction and move forward from there.

If you look at, again, on the worldwide sales base, if you take coronary stents out, we saw solid double-digit growth at 10%.

Just for those who need some additional detail for their analysis, let me give you the domestic sales numbers for the quarter.

And then you can back into the international numbers.

Interventional cardiology came in at 578 for the quarter, peripheral interventions, $101 million.

Vascular surgery, 12.

For an overall cardiovascular group of 691.

Electrophysiology came in at $25 million.

Neurovascular at $30 million for an overall cardiovascular group of 746.

On the oncology domestic business, $34 million.

Endoscopy, $99 million.

Urology, $72 million.

Overall endosurgery group $205 million for a total domestic business before Advanced Bionics or neuromodulation of 951.

Our neuromodulation business came in domestically for -- at $40 million.

That was compared to $24 million in the prior year.

So our overall domestic number is $991 million U.S.

Now, as I look at the domestic numbers, again, solid double-digit growth in many of our divisions.

In the U.S., electrophysiology was up 16%.

Neurovascular was up 33%.

Oncology was up 13%.

Endoscopy up 10%.

Urology up 32%.

And our neuromodulation group up 64%.

So, very solid growth throughout the U.S. during the first quarter and a nice way to start the year.

Paul LaViolette will give you more clarity on our coronary stent business so I won't do that at this time.

Let's look at the income statement for a moment.

Attached to the press release today.

We showed on a GAAP basis, our net income per share, $0.40 a share versus the prior year of $0.42 per share and let me give you some additional reflection on that.

If you take the $0.40 a share relative to the prior year, you include stock compensation that now is recorded as expense.

That adds $0.03 a share.

And then near the end of the quarter, as you know, we decided to writedown our investment in our gene therapy investment because of a termination of a trial.

That was $0.03 a share.

That would bring your $0.40 a share up to $0.46 a share and that gets close to our new adjusted EPS that we'll be reporting going forward post the Guidant transaction, and if you add the amortization in the quarter from purchased amortization, that's $0.03 a share or our new adjusted EPS number going forward that we'll report out in addition to our GAAP will be $0.49 a share for the first quarter.

And keep in mind that we give you all the components, reconciling from GAAP to our adjusted EPS, which is how we measure ourselves at Boston Scientific.

Of course, in the prior year, you did have a $0.09 a share purchased R&D and on an adjusted EPS basis, the amortization would also have been $0.03 a share or $0.54 a share in the prior year.

And then the only other comment I would make or on a highlight basis, if you look at our cash flow generated in the first quarter, we had a very strong cash flow number.

Our free operating carb flow in the quarter was $514 million and obviously on a quarterly basis, that's a run rate of over $2 billion a year in free operating cash flow.

And that's from our stand-alone business pre-closing of the Guidant transaction, so, from a financial flexibility and a cash flow position, we go into this transaction, the closing of the Guidant transaction with roughly a $2 billion run rate in cash flow before the transaction, which we feel very good about.

So, with that brief overview, allow me to turn it over to Paul LaViolette to give you some further insight on business conditions.

Paul?

Sure, thanks, Larry and good morning, everybody.

I will focus first on some drug-eluding stent comments and then a little bit broader on the rest of the business and conclude with an update on our warning letter status.

The market which we've heard now reported sales from both Johnson and Johnson and Boston Scientific this morning, the market, I think, is demonstrating great share stability.

We came in at 53.5%, which makes now three quarters in a row with less than a half a point from quarter-to-quarter.

So, that to our eyes is a very good sign.

We're also seeing pricing strengthening and, in fact, our average annual change in pricing for the first quarter is now down to just 3%.

That's one-third the rate of a year ago.

And I think we're also starting to see some procedural rebound, perhaps 2 to 3% procedural growth in the first quarter.

We still expect that to accelerate toward the end of the year.

Such that procedural growth rates should exceed ASP declines and will actually begin a restoration of overall market growth.

As unit growth begins to outpace price decline.

Internationally, we saw a great strength, as well.

Larry already conveyed those numbers, but TAXUS had sequential growth in the first quarter versus Q4 and double digit growth over prior year, despite new competitive entrants.

We see that based on the strength of TAXUS Liberte, which is now 70% converted in our own product mix and has -- where it has been converted demonstrated consistent growth of 10 to 15% on a same-store basis, if you will, versus TAXUS Express.

So, as TAXUS Liberte continues to roll out, we expect to see continuous strength from that technology upgrade.

And bear in mind, we still have key markets such as Canada, Brazil, Australia, still pending approval and still to have a positive effect on TAXUS revenues internationally through the rest of 2006.

As you're also aware, just on the TAXUS program, generically, we filed our TAXUS PMA module in the first quarter, so, we have reason to believe our Q4 U.S. launch timeline, pending corporate warning letter of remediation remains reasonable and, of course, our TAXUS Japan filing is under way and in review and our first quarter of 2007 status remains unchanged.

So, overall from drug-eluding stents, we have a strong franchise, a strong market position, a market that appears to be looking to accelerate in growth and in our view, we have a superior pipeline as demonstrated by -- in the first step, the performance of TAXUS Liberte and that is not yet beginning to factor in the value of the technology and pipeline going forward.

Just a few other broader CV cardiovascular comments.

The business continues to perform very well, our bare metal stent business is now up to 27% U.S. market share, which I think is just further evidence of the strength of that stent platform.

We've had very strong balloon sales, based on very strong shares and increasing usage of pre- and post-dilatation for balloons in drug-eluding stent cases.

The peripheral business overall enjoyed its first ever $100 million quarter and we have a number of launches throughout the rest of 2006 that will continue to strengthen that.

You heard now that our electrophysiology business restored double-digit growth and our neurovascular business exceeded 20% and again we're likely to see that continued strength based on competitor coil problems this quarter and next.

So, we expect, actually, a bump up in neurovascular performance in the coming months.

In our other businesses, urology remains very robust, U.S. growth over 30%.

Very strong stone management business, double-digit stone management growth.

Very rapid BPH growth and our market share in the BPH market is now over 20%.

And our gynecology performance is very, very strong on multiple fronts.

Larry already commented that endoscopy and oncology both enjoyed double-digit growth and our pain management business continues very rapid growth, based on market share gains and those are based, in our view, of continuous excellence and sales force execution and accelerating uptake our rechargeable technology.

So, overall, cardiovascular, endosurgery, neuromodulation, domestic, international, we enjoyed very strong quarter one performance.

I'd like to shift gears for a minute now and provide an update on the warning letter status with the FDA.

Without question, this remains our top priority.

And we believe we are making measured progress on all fronts.

We did recently meet with the FDA and we reviewed our comprehensive remediation plans, our systems changes and our strategy for long-term compliance.

We've had a substantial internal and external resource effort.

We're piloting and launching various changes and new systems virtually daily.

We are continuing to work toward completion of these changes and obviously for those things that we control, our overall state of readiness for reinspection continues to be targeted toward the end of the summer.

For the next several months, we will update FDA monthly on our overall progress and refine our timing plans for reinspection.

Suffice it to say, our company goal continues to be to complete this remediation effort in time for the TAXUS Liberte approval by Q4 and we're working very diligently toward that end.

And with that, Larry, I will turn it back over to you.

Okay.

Why don't we ask Jim Tobin for his remarks on the quarter.

Jim?

I will be very brief.

I wanted to highlight a few things.

One is that we had strong results across the business.

It's not just a stent business these days.

We're doing well across the business, across geographies.

I think steady share in a coded stent market that has a somewhat better tone to it is a good sign.

Very strong cash flow.

I think that's our second largest cash flow quarter ever.

A transforming acquisition that's coming soon, a full pipeline, particularly in DES and we're gaining ground on the FDA issues.

So, we're doing pretty well and we're just about, though, to face one of the most daunting tasks anybody can face, which is incorporating a very large acquisition into the flow of things as we go forward.

So, this is kind of the last quarter you will see us look like this, we will look different from here forward.

Let me just stop there.

All right, Jim, thanks.

Let me ask Paul Sandman to give you some update on where we stand with the closing of the Guidant transaction.

Paul?

Certainly.

As we had previously announced, the shareholders at Boston Scientific and Guidant approved the transaction on March 21st.

We subsequently received the approval of the European commission for the transaction and at this point, the only remaining thing that has to happen to enable us to close is the receipt of approval from the FTC.

We have been pleased with the process there and we expect to receive that approval at any time.

Once the approval is in hand, we should be able to complete the closing within a couple of days.

And I think that's because in our agreement with Abbott, they have a two-day -- we would close probably the same day -- or the day after, but we did give Abbott the right to two days' notice for them to line up their -- their lenders to close the transaction.

That's why there could be maybe a two-day additional time period from when we actually could close anyway.

Thank you, Paul.

On that issue for -- because we will -- we don't plan to have a separate analyst call based on the mere closing of the Guidant transaction, let me give you some share count for you to perhaps be -- maybe helpful for you to use in your analysis going forward.

As you know, in Q1 of '06, as a stand-alone, our average shares outstanding were about 830.4 million shares outstanding, that's 830.4 million shares outstanding.

Post-close, we will -- additional shares we will be issuing -- again, some of this is still estimation, but we will be selling shares to Abbott under our agreement and right now it looks like close to 60 -- we'll be issuing close to 65 million shares in that sale to Abbott, to Guidant shareholders we will be issuing somewhere around 575 million shares.

And then our own count at that point will, in terms of closing, we will have about 821, 1 million -- call it 822 million shares outstanding versus fully diluted.

So, the share count -- the best guess we have right now, share count of outstanding shares will be 1.462 billion call it, will be the shares outstanding at the time of closing or post-closing, I should say.

So, hopefully that helps.

And the conversion and the shares in the Guidant transaction is 1.6774.

The only other thing I wanted to comment on was our current plans in terms of analyst meeting, we do plan to schedule an analyst meeting, probably now, sometime in the fall.

We figure we will give roughly a six-month period on post-close, let the dust settle, let the integration begin and we will update you then in the fall on how things are going six-months post-close.

Additionally, I want to point out that our priorities, as we move into closing this transaction on the part of the management team, is the first and foremost deal with the FDA issues that we've talked about over the last several weeks and month or so, I should say.

So, deal with the FDA issues in the warning letter that we -- we wanted to see lifted.

That's our top priority.

Our second priority is going after smooth integration of the Guidant organization and that will be a challenge for us over the next six months to 12 months.

And then also seek out the synergies in the transaction and going from there.

So, we have a lot to do over the next 6 to 12 months.

We will be reporting on a quarterly basis our results and we will have our analyst meeting sometime this fall.

Jim, do you have any other remarks that you'd like to make?

No, I think that covers it, Larry.

I think probably we'd just move on.

We'll now ask the moderator to facilitate the question and answer session.

Thank you. [ OPERATOR INSTRUCTIONS ] Our first question is from Dhulsini De Zoysa with Cowen.

Go ahead.

Thank you.

Larry, I understand -- will you be issuing '06 through '08 guidance post-closing as you had initially plan?

Or were you waiting until the fall for that?

I think we're going to wait until the fall, until we have six months -- roughly five, six months under our belt.

Keep in mind ma our pro forma projections are, in fact, in the S4 and that really represents our current pro forma guidance.

So, that is what it is and we'll be shooting to meet or exceed that guidance or those projections that are in the S4.

We probably won't be speaking to the quarters in -- in the short-term, mainly because most of our effort is going to deal with the FDA issue and then deal with the integration of Guidant.

We will have our hands full and we're not trying to manage to any one particular point in the first couple three or four quarters.

We're trying to do what's needed to have this a huge -- huge success and also, obviously, do what's needed to satisfy the FDA.

So, the first time that we will be speaking frankly about updating our pro forma projections will be in the fall and we'll be focusing most likely on 2007 and what the outlook looks like for the ensuing 12-month period.

Okay.

Then if I could ask about the Guidant business, you have to be quite pleased with how resilient Guidant's CRM franchise seemed to be in Q1.

Your assumptions for ICD market growth over the next few years?

And guidance in your combined market share in -- in the ICD segment and then I have a follow-up on the CMS proposed rules.

I think all of that's pretty much outlined in our S4.

I will say that in the first quarter, Guidant exceeded the numbers that we were basing our projections on in the first quarter.

So, we were pleased with the rebound -- the management team of Guidant led to us believe that they would see a rebound and do better than our number projected and we were pleased to see that.

In -- in the S4, we talk about market shares and we talk about our numbers a bit, give you a ballpark, in 2006, our assumptions that are the basis of our projections is 20% CRM market share.

In 2007, our projections are based on assumption of 22% CRM market share and on 2008, I believe it was 26% market share.

In 2009, 28% market share.

Now, that's CRM, not specifically ICD.

Okay.

And if you could, have you had a chance at this point to sit down with Guidant and maybe look through the CMS-proposed inpatient rates for fiscal '07 as they pertain to some of the ICD, DRGs and craft a joint response to CRS?

Let me ask Paul LaViolette to comment on that.

The answer is yes and, of course, we would have done that independently anyway.

And so, you know, let me just elaborate for a second on CMS.

I think everyone is well aware, DRGs haven't changed much for the past 23 years.

The same methods have been in place since the early '80s.

There is very little question change was in order and we all understand that there were two real goals, one was to rebalance the system, to shift more toward medical procedures and one was -- the second was to prevent, you know, in a word, skimming with a focus on lucrative procedures being done at specialty hospital.

So, we don't have any argument those objectives.

We do have an argument and a disagreement with the methods used to substantiate the changes.

First of all, the data that was gathered was gathered only from 48 hospitals and secondly, there was a -- there was a concurrent switch in the method used to weight the data from a cost basis-system to a charge-based system.

We believe that creates real data gaps.

We believe we have a lot to talk about.

As you're aware, we're entering a comment period, which will remain open for the next several months.

In working with our own economics team, as well as guidance, suffice it to say the rule that's been issued is complex.

So, we are performing a very comprehensive analysis on it and along with the industry, this is beyond Guidant and Boston together, we will be generating what I think will be clear alignment.

We will generate comments and we will generate advocacy to bring to bear an impact the final rule, which, of course, is scheduled for -- for August.

In that process, we're clearly going to look at the methods that have been used to achieve these market, reshaping objectives and whether or not there are different methods that can be used to achieve the same outcome.

We're going to certainly look at the percentages that have been recommended and the timing of implementation that have been recommended.

So,lot of work going on.

We are working collaboratively, again, within Boston and guidance, but most importantly industry-wide and we will update you on our thinking between now and when the final ruling is issued in August.

Okay, great, thank you.

Your next question is from Tom Weinstein with JPMorgan.

Please go ahead.

Is that Tom?

I'm sorry, MIke Weinstein!

I just wanted to be sure we had the right person!

Good morning, everybody.

A couple of questions here.

First question, is that the non-stent business is where you back out the impact of the stent franchise from the rest of the company.

The fourth quarter had been soft and you bounced back a little bit this quarter.

Our map is you're up just over 6% reported and I guess closer to 10% constant currency.

How are you thinking about those businesses from a -- a gross standpoint going forward?

The traditional Boston Scientific businesses, what's the appropriate growth profile there?

Mike, it's Paul.

Just, we're targeting double-digit growth for basically all franchises outside of core cardiology.

Core cardiology will be in the low single digits, obviously due primarily to procedural growth and just the overall influence of DES, which tends to pull value out of the other product lines, but our endosurgery business has demonstrated, I think, quarter-after-quarter, the ability to grow double digits, outside cardiology.

Neurovascular now leading the way has been able to demonstrate fairly routine double-digit.

I think our peripheral business is rebounding now at something like 7% and I think double-digit by the end of the year and of course, neuromodulation much faster than that.

So, we clearly have a double-digit growth outlook for all the businesses outside of core cardiology.

I thought I missed it, but did you say what pricing did in the you'd and Europe versus fourth quarter year-over-year?

I didn't say that explicitly but I can get that for you.

The changes were, as I mentioned, very modest and we've moderated down to a 3% annual change --

As reported -- do you want to go to constant? --

While Paul is looking at that, Larry, maybe circle back to the math you were doing and understand your rationale -- your arguing that the Street should back out stock-based compensation expense as well as the amortization from prior transactions, not just the Guidant transaction.

I just want to understand why we should do that for Boston Scientific?

And if so, shouldn't we be doing that for the rest of the company that we follow?

Thanks.

Well, I'm not suggesting you do anything.

I'm just suggesting that's how we're managing our business.

So, you shouldn't be confused about why we're reporting the way we are.

We're reporting the GAAP EPS, which is pretty clear, and we're reporting our adjusted EPS, which reflects how we're managing the business and it takes into consideration the underlying strength of our cash flow -- cash flows and financial flexibility and also takes into consideration that we will be taking on close to $10 billion in debt.

So, for a shareholder, who's trying to understand the fundamentals of Boston Scientific, in light of the size and shape and the leverage that we will have for at least some period of time, we have looked at how we're going to manage ourselves, the business, and also how we're going to measure ourselves and this is not too different with regards to how other companies report out their adjusted EPS.

When they have had one or more large acquisitions.

And as you know, over the years, we've basically grown and built Boston Scientific to where it will be at the end of 2006 by acquisitions.

And if you look at other life sciences companies, like Genentech, BioGen, Amgen.

I think some of the pharmas.

Pfizer.

I don't know if you're familiar with how Pfizer reports, Mike, but if you look at Pfizer's reporting, they back out amortizations and they show more of a cash EPS.

So, where there has been mega transactions or large transactions or a series of transactions, the Companies are moving to more of a cash EPS because they believe that that better reflects the foundation and condition of their business.

So, we're basically not pioneering here.

We're following the flow of many of the larger-cap companies who are reporting closer to a cash EPS, an additional and over and above, obviously, the GAAP presentation that's required.

And, Mike, just back on your dES sequential pricing change question, it's basically been either 1% or less.

If you look at the U.S., Q4 was off 1% relative to Q1 -- well, reverse that, Q1 versus Q4.

And international, I don't have is a weighted average across all geographies, but it's roughly 1% off in Europe and roughly even in Intercontinental.

So, across the three regions, we're selling drug-eluded stents, it's basically 0 to 1.

Thanks, Paul, and Larry, when you say you're managing the business, are there stock options or stock grants that are tied to cash EPS numbers?

Going forward there is going to be factored into everyone's bonuses and performance, their contribution and ability to manage to cash flow.

That is something that is beginning this year, for obvious reasons and the benefit of that is that it also helps you manage the -- the profitability of the business other than just in GAAP reporting format.

So, we're hoping to rapidly pay down our debt, meaning over the next 36 to 60 months.

Then it becomes a very powerful incentive to maximize our financial flexibility as a company and then it obviously opens up a whole wide range of new opportunities for Boston Scientifics to grow and add to its current base.

So, I think you're going to see the -- the -- you know, that this combination with Guidant and our continued strategic build, representing and delivering powerful financial flexibility for the shareholders of Boston Scientific and so it's -- it's probably going to be our key measure as we move forward.

Thanks, Larry, I will let somebody else jump in.

Rick Wise with Bear Stearns, please go ahead.

Good morning, everybody.

Larry, maybe you start -- since you're talking about cash flow and the debt pay down, can you highlight or give us any perspective on possible potential asset sales that could accelerate debt pay down and what we might look for the next 6, 12 months?

Well, right now we have no required, if you will, or compelling need to sell anything.

We presented to the Board recently the coverage that we have with cash flow, the strength of our cash flow and also how we structured our debt.

The material or significant maturities are pretty far out.

So, we are going to be able to frankly -- I mean our -- our design here is to prepay our debt down.

And prepay it pretty rapidly and so we can do that without any asset sales.

Longer term, meaning over the next year to three years, we will always look at as are assets that have been strategic, no longer will be strategic in light of the new Boston Scientific.

We will continue to look at those, so far there's no clear nonstrategic business.

We like all of our businesses, all of our businesses Paul LaViolette has pointed to are growing double digits and throwing out nice gross profits and cash flow.

So, if you look at sale versus contributing over the next three to five years, most likely we will keep our businesses intact and -- because they do generate high profitability and cash flows to help us rapidly pay down the debt.

However, if any point in time, if we needed to, if things didn't go as planned, we could obviously liquidate a fair amount of assets and back ourselves up.

So it's more of a financial flexibility area of -- of discussion as opposed to a strategic need or a financing need.

You know, our CapEx, for example, in our numbers, is pretty sizeable and we will probably back down on the CapEx, the investments that we do in our new business development strategy that are in the numbers are pretty high.

We probably won't spend those.

So, we plan on churning out some additional cash flow over and above what we have projected in our S4, just from some discipline and spending that I think we'll probably go after.

I've gotten calls from all over the world from unbelievable number of parties wanting to buy certain assets that we have and I will just tell you that we've basically said no to most of those and we have -- I should say all of those.

We're not in any discussions at this time regarding any asset sales.

Okay.

Gross margins, despite the strength in the stent business and the strength elsewhere, were some of the weakest we've seen in many quarters.

Is this -- mix -- for some reason I don't understand or some unusual costs?

And maybe related to that, the cost of increased compliance with the warning letter, maybe you can quantify what that's likely to be this year and sort of give us a sense of what we might lose in '07 when it goes away, I guess?

Well, we're -- we've been at record-setting gross margins for some time.

But it interest you specifically, let me take you through the gross margin change in the last year.

First quarter to first quarter 2005.

If you look at the gross margin percentages, it reconciles as follows: First off, you had an unfavorable foreign currency effect that represented 0.35%.

So, that's a piece of it.

That's on the plus side.

It was a negative on top line, but actually a plus side.

And then you have mix representing about 3%.

Cost-related is about, you know,0.95 -- 0.93.

We had bonus increases, 0.15.

Stock comp that we now have to report is -- is a pretty significant piece of the gross margin scenario.

When you have to book stock compensation, some of that goes through cost of sales and so the stock comp component is 0.37%.

And then price was around 0.2%.

When you add all of that up, that's how you reconcile it.

I see.

And the incremental costs?

Unknown at this time.

I think we just have to flush that out post-closing integration, take a look at how we're going to manage the combined business.

Take a look at the issues that you've outlined and see what that cost will be and see what offsets there are.

Because at the same time we incurring a greater cost in the area of quality.

For example, we have offsetting cost savings in other areas.

So, it's a mix and obviously we don't know all that's on the table welcome the CRM business and cardiac surgery business.

I would ask you to wait until we update you in the fall, be more specific and accurate.

I'm going to sneak in one last one on Endovations.

Could you update us with what's happening there and the launch and the impact?

Thank you.

Much.

Rick, this is Paul.

We're making excellent progress in Endovations.

The system is coming together in some ways better than we had planned.

We're building finished goods right now.

The finished goods are going to go into final validation testing.

Now, that's a process where we're expecting to gather something on the order of 35,000 data points on how the system performances.

So, we have every reason to believe we will find a thing or two in there.

We've already been through a preliminary round of that testing and the system checked out on 99.4% of all of its checks.

So, we think this final build and final validation test is likely to go very positively.

And then -- that's over the next 60 to 80 days.

And first human use will follow that, obviously first human use is dependent upon completion of the validations, but we have every indication to believe that our builds are on schedule, our tests will come out favorably and basically the commercialization timeline is unchanged from what we've -- what we've indicated previously.

Thank you.

Your next question is from Thom Gunderson with Piper Jaffray.

Please go ahead.

Hi, good morning.

I wanted to focus in on Europe and the drug-cutted stent business a little more.

That seems to be a good proving ground for what might happen in the U.S.

And let me just go through a couple of points and see, Paul, if you can react to all of these.

On the J&J call, it was suggested that the European year-over-year procedure market might have grown 30%, priced down 10% for a net revenue of 20%.

Those are a little too evenly-divided by 10 for me.

I wonder if you have got more granularity there, whether you agree or disagree.

Second, we've been hearing strong numbers from the U.K. and Scandinavia for endeavor.

I wonder what's -- [ Loss of audio ]

Hello?

Hello?

Something happened.

Sounds like we lost Thom.

Did we lose the call?

Is the operator on?

This is a first.

Okay, I'm sorry for the inconvenience.

I lost my ability to talk.

Just one moment and we will be back.

Okay.

With you.

And we will go to the line of Katherine Martinelli with Merrill Lynch.

Thank you, do you hear me okay?

Yes.

Okay.

I just had a few quick questions.

One was just on the warning letters and the FDA.

Clarification: Has the FDA signed off on your proposed remediation and the meetings now are just status reports?

Or are we still waiting for clarity that the remediation plan that you've offered up, they're okay with?

Katherine, this is Paul.

There is no official sign-off, but we have met with the FDA.

We have reviewed the remediation plans in detail.

And we are, just as you described, now working against those plans.

Suffice it to say, the FDA's plans and I agree with them, is the plans are fine.

It depends on how well you execute those plans and they're interested in how we do that and how we generate a trail of evidence to prove that.

All of which, of course, will be finally assessed during their return audit.

So, the plan is the easy part.

The implementation is where the real effort and the real proof resides and that's the phase that we're in.

Okay.

That's very helpful.

And then just with the follow-up on some of the questions about Guidant and I know, Larry, you said you're not going to be providing updates to the guidance in the S4 until the fall timeframe.

Should we assume then that even though Q1 looked weaker than most of us expected for the high power market, you're not changing what you think the market can grow or assuming any increased spending in building the referral channel, given where the market shook out in the first quarter?

No, I think, you know, to clarify, first off, we need to close the transaction and really get a good handle on the condition and tone of business, with all the dynamics that you follow as an analyst.

Once we have that knowledge base, in a more specific way, we will then compare that to our assumptions that are in the S4 -- that were in the S4 and if there is a direction that's negative, relative to our projections for '06, we certainly would update the Street on that, but it would only be if trends and tone of the business is not consistent with what we expected as highlighted and put forth -- set forth in the S4.

Okay, great.

Thank you.

Sure.

Thank you.

And Mr. Gunderson, I apologize, we will go back to your line now.

Hi, thanks.

I think the long question, God struck me down!

Europe, J&J's comments, Medtronic and U.K. and Scandinavia, what some of the other smaller players in Europe might be doing?

And Paul, on bare metal mix in Europe versus U.S., not on a national basis, but on a procedure basis, could you comment on that a little bit?

On a procedure basis in Europe bare metal?

Yep.

Yeah, I will give you the penetration rates.

We're basically at 50% now in Europe.

So, that's on a procedure basis. --

I mean on an individual -- the average person is getting how many drug-cutted stents and how many bare metal --

In Europe?

Yep.

I don't have that number.

Not enough!

Just a couple of comments, our units in Europe are up 33% first quarter versus first quarter.

You indicated a 30% -- did you say a 30% number?

Yes.

We're slightly above that.

I would say pricing is probably down a little bit below the number you gave.

So, close on each of those roundoffs, if you will.

In terms of U.K. and Scandinavia, when you hear about individual countries, there's probably a reason for that.

I would say the lone locale for strength of Endeavor is probably the U.K. and I think it's safe to say, at least in our data and some of this is validated by the European version of MRG data, it does appear as it Endeavor has peaked and their share of around 9% is probably real and I'm not sure that that matches up with what has been described previously from Medtronic.

I would say the only other comments are, you know, the others, as a general category, still remain below 5% and specifically we don't see any material activity from Connor to date.

Thanks.

Next we will go to Timothy Lee with Kaufman Brothers.

Go ahead, please.

Good morning.

Follow up on the ICD front.

Based on Guidant's ICD numbers, should we tie that to the worst of the share erosion behind them and the current share has a new base you guys can build off of?

And in the Guidant integration front are some of the sales reps already locked up with contracts?

Let me take the first one, I think we're going to wait until we actually close the transaction and get some time under our belt.

Guidant has had a series of recalls.

They have an FDA warning level and they have a recovery plan and I don't think today, preclosing that we want to speculate whether the ICD business has seen the low or the bottom and everything is going to be upside from here.

So, I think we're going to plead for prudence and update you later when we know more and have a better handle around what the tone of business and condition of business is.

On the second question --

Well, it's real -- I won't comment on individual contracts.

I will say that sales force stability has been a very positive and very impressive throughout our entire process of working with Guidant, so that dates back to early Q1 and there's no change to that and I think the -- to the extent, and I believe this bears out over time, that sales force attitude and optimism is is a leading indicator for the business.

I would say the Guidant CRM team right now is very strong, very stable and very optimistic.

And just a follow-up, just in aggregate, then, we can assume there's instruments in place to keep -- inhibit poaching by competitors.

There are.

And poaching, to use your phrase, is something that has been present in the business for a long time and I don't know that we have any way to prevent it, other than run the business well, provide the sales force with reliable products and great sales programs and give them a sense that management is committed to leadership over time.

I can assure you that's exactly what we're going to do.

Great, thank you.

Thank you.

Our next question is from Bob Hopkins with Lehman Brothers.

Please go ahead.

Thank you, just a couple of quick ones.

For Paul LaViolette.

Paul, Medicare is proposing a 30% cut to stent reimbursement.

At this point, from your regulatory people, do we have any way to assign be probabilities on where you think this might ultimately end up?

Could we see a complete eradication of this?

Is it more like 5%, 15%, do we have any way of predicting at this point?

It's -- the answer is no, Bob.

It's too early to say.

We can speculate but it would be without any real merit because we're not dealing with a system that has a lot of precedent and has a lot of transparency.

So, as I mentioned, we see real flaws in the method.

I don't think there's any question that there's a disproportionate impact to the prices that we're talking about, in particularly these technology dependent procedures.

We think that that is overdone and we think there is a lot of basis for further discussion.

We're going to factor that into our comment round one and then into our discussions with CMS.

Okay.

And on the plant inspections for Boston Scientific and Guidant, you said you expected the plant inspections by the FDA to take place around the mid-summertime frame.

Is that, to be specific, is that still a good timeframe to think about --

Well, we don't have any commitment from the FDA.

It would be premature for us to ask for a commitment from the FDA.

Our -- what we're focused on is our deliverables, our controllables.

And we still do have, in our internal timeline, a mid- to late summer state of readiness.

So, that is unchanged and then as we share that plan and timeline in more granularity with the FDA, and then as they begin to piece together their own schedule, we will, you know, we will update you on that.

But that's our timeline.

And we have articulated that at least in summary fashion so far to the FDA.

Okay, thank you.

And lastly for Paul Sandman, if he's still on the call, Judge Robinson seems to be awakening from her slumber and has presented some rulings in the last couple of months.

Any update on when we might hear anything on the ding patent?

No.

No indication there at all, Bob.

Okay.

Thanks so much for your time, guys.

Thank you.

We will now go to Joanne Wuensch with Harris Nesbitt.

Please go ahead.

Thank you very much.

Two quick questions, one, as you talked about in the U.S., if I understood this correctly, procedural growth is likely to rebound.

What do you think will be driving that procedural rebound?

And then my second question has to do with the integration of Guidant.

It seems as if that's paramount to making the next couple of years work for you.

Can you please outline as briefly or as much detail as you can what you internally will be going through over the next six months, while we wait until fall for our first peek at how you think this is working.

Thank you.

The DES rebound, it's really based on the good, positive growth drivers of the market, be it demographics or diagnosis or just the overall intervention rate and the high rate of DES utilization.

No longer being suppressed as they had been by the positive effect of DES.

So, we're really just earning our way through the final TVR impact and starting to see organic growth pick back up.

So, I think that's -- you know, that's positive.

We've been projecting that, it's been a little bit difficult to project exactly when that effect was going to take place.

Now we're beginning to see it and expect that that will flush through with a few more percentage points of upside, bringing the procedural growth rate from plus two to three to plus five, if you will, by the -- over the next three quarters.

In terms of integration, I won't go into much detail other than to say we're going to be focused on the key drivers.

We're going to be focused on doing everything possible to enable the CRM team their continued rebound.

We're going to be focused on obviously integrating the science technology platform, which we think is extremely important that we get our arms around early.

We're going to be looking at obviously the synergies that we've described in the early goings and making sure that we're executing on those but we're, we're running the business.

The Guidant team, certainly within CRM, is running the business within cardiac surgery is running the business.

We will be primarily focused on day-to-day operations.

Thanks.

And one last follow-up, Johnson and Johnson talked about their first additional new line, for CYPHER coming up in the first quarter.

They've been talking about this for a while.

Anything you're experiencing and/or anything you're preparing for?

And then thank you.

We're just aggressively defending our share and trying to grow the business and plus or minus a line, frankly doesn't make that much different.

And working on pipeline and we're excited about Liberte coming to the market.

Thanks.

The other -- just in closing on that one, Joanne, the other thing to remember, maybe people don't realize, Jim Tobin is, you know, basically his top priority after the FDA is, our -- our Minneapolis and St. Paul -- I should say our St. Paul CRM franchise, and he's spending -- he plans to spend a lot of time helping out the team there and overseeing it, so, we're putting our -- a lot of resources on the CRM business.

So, we will have a better idea of how things are going to unfold here in the next six months.

Next question?

Thank you.

That will come from John Calcagnini with CIBC World Markets.

Hi, everybody.

I wondered if you could talk a little bit about -- in the fiscal '06 CMS proposal, they talked about tracking multiple DES use and in consideration of coverage of multiple DES.

Can you give us an update on where that stands, and second, Paul, is there any statutory limit on how much they can cut reimbursement for a given procedure in a year?

I'm not aware of any statutory limitation beyond 100%. [ laughter ] So, no -- and there is evidence between inpatient and the outpatient rulings in the past of significant individual DRG shifts.

Significant.

So, I'm not aware that there is any limitation.

CMS has a big challenge and they're trying to balance their budget and they're generally trying to shift expenses from one category to another without dealing with macro change at the top.

So, we're sympathetic to their issues, just trying to be sure they factor in all the information we think they should.

Regarding '06 plans for DES, we are actually fairly pleased that tracking codes have been established and, in fact, in the new rule, the one that was issued the other day, further tracking code will be established for bifurcation stenting as well.

That's a mechanism, as you may be aware, basically for establishing a precursor set of data gathering so that, in effect, without commitment, preplanning for DRG specificity can be -- can be provided.

So, if there is a chance to create a multivessel DRG or a bifurcation DRG in the future, they go into a data gathering mode.

Typically for a year or two before that.

Data gathered for '06, '07 could be potentially in a proposed rule in the '08 timeframe.

I don't think we will see anything on multistent DRGs until then.

Okay.

And then on just a follow-up, just for that, I think some people were thinking, you know, maybe there was some limit, and it sounds like there's not.

The Zion's launched timing in Europe, can we get an update on the timing of launch, how you will do that launch and what are the required changes in the agreement with Abbott?

Let me deal with the required changes in the Abbott agreement.

It really speaks to Europe first, and that is where the EU didn't like a five-year supply agreement so they reduced it to three.

The other changes really have to do with the difference between access and ownership by Boston Scientific.

It had to do more with IP and who really has the ability to license and enforce IP and generally speaking, the agreement was amended to make it clear that Abbott really does have the right to sublicense the IP that they purchased from us.

So, I mean those are the two issues that were -- that was resolved without any real pain or suffering.

Go ahead, Paul.

Regarding the Zion's launch, we're obviously still pending a number of details and some of our uncertainty was magnified when Guidant announced that they had to remake their launch quantities for Zion, but suffice it to say, there are a few mechanical things we have to do, including initiate some minor labeling changes to distinguish the product that will be sold by Abbott versus the product that will be sold by Boston Scientific.

We expect to make those changes in the systems, in the computer systems, shortly after the close.

We would then begin, we, through Abbott, through our supply agreement, building launch quantities and we've already conveyed what our launch quantity requirements would be through essentially an order.

And then inventory would be produced.

So, all of that, we expect, will lead to a launch somewhere toward the second half of -- of the second half.

So, end of Q3, into Q4, but suffice it to say, we have quite a few details we have to hear about before we can really target that launch date.

Larry, as a follow-up as an ability to enforce IP, so, Abbott exclusively has the right to enforce IP on Zion's?

No, no, they purchased -- or they will purchase the Company and we have access to all the IP relative to the DES portfolio, whether it be balloons, stents, polymer, drug, et cetera.

However, there's a lot -- there's additional IP having to do with the interventional business.

They have the right to sub license that.

We had it in the agreement that they had the right, but it was -- they had some rights but it was only with our consent and the regulators didn't really like that.

If we're selling a business, we should be selling a business and putting a competitor in place.

So, that -- that we amended it for that.

Now, I want to make it clear, this does not include [ever olomist].

Ever olomist cannot be sub licensed.

That will convert into a co-exclusive, if you will, and both of us had our discussions with Novartis and that really is not in the same category as what I just outlined.

Okay, thanks, guys.

All right.

Why don't we have one more question and wrap it up for the day.

Thank you.

That comes from Glenn Reicin with Morgan Stanley.

Good afternoon, folks.

Hi, Glenn.

Just two quick questions.

I don't think you've talked a little -- I don't think you've talked about the FDA and Guidant and I just want to know if you can give us an update, what's happening there?

And then there were a couple of questions, Paul, related to the stent market, I think people are a little bit amazed that we've had $100 million of sequential growth from the fourth quarter to the first quarter.

And I'm wondering when J&J says they opened up the line and they are filling back orders, is there, in fact, some stocking involved in growth quarter-over-quarter?

Maybe you can give us your view of sort of organic growth quarter-over-quarter and whether that is, in fact sustainable over the next couple of quarters.

Do you or Jim want to talk to --

I'm actually going to ask Jim to talk about the FDA with Guidant and regarding stocking, you know, in my discussions with my field team literally this morning, in the last -- in regard to the last couple of days and weeks' activity, we really are not seeing much unusual in the form of inventory, in the form of accounts.

There really isn't much going on.

That's not to say that new inventory won't be rushing down the pipeline as we speak for an impact in the next week or two.

But I would say -- I don't see unusual stocking.

Okay.

So --

So, if we went from 1.53 billion to a $1.62 billion run rate it was 63 billion run rate from Q4 to Q1, that's the entire market, including Bear, we should include -- we should be thinking going forward at least a $1.6 billion run rate for the next three quarters.

You mean our top line -- overall top line?

I'm sorry, no, all of -- the entire stent market.

The run rate of the stent market.

I think we've seen a little bit of rebound if the market.

Pricing has stabilized.

I don't think -- and I'm not aware of, I guess I would know, any unusual events.

So, is that a run rate for the market?

I think it's a pretty accurate run rate for the market.

The other thing, Glenn, you know, there was no -- I didn't sense when we closed the quarter out that there was any stretching, you know to sell as many stents as we can to the last day.

It was a pretty smooth, even quarter and the beginning of this quarter looks very stable and strong.

So, there was no -- we didn't reach to the heavens to get to our stent number.

It really was pretty even close and pretty much base business.

That's great.

We were pleased.

As far as Guidant and the warning letter goes, they're making progress with the FDA.

The relationship seems good and everybody is working, I think collaboratively to -- to get through all of this.

It will be a while yet.

I don't think that it would be realistic to think that they'd be out from under this before the end of this year.

But things seem to be going pretty well and heading in the right direction --

What is the -- what's the FDA looking for because the citations from the 483s don't look particularly serious.

They look less serious, ironically, than your issues, but obviously there's a whole political element that is in play here.

What are they looking for?

Just a change in people?

A change in process?

Because it doesn't seem like they're asking for a change of process.

Maybe you can give us a little bit of insight there.

The issues that were flagged in the plants had to do -- were pretty detailed and had to do with how information was looked at and what was done with it and, for instance, when you would rework and would not rework, things that had failed on the first pass and those kinds of things.

They look pretty benign on the surface, but they're fundamental about what comes out the other end.

Okay.

And so, you know, and they've been reinspected once, they had one remaining 483, but it was very fundamental.

Fixable.

But fundamental.

So, you know, it -- it is -- there is work to be done yet.

It's happening.

It will get done but these things take time.

I don't think it will tap before the end of the year.

That's fair.

Thank you.

Okay.

Well, appreciate all the questions today.

We will continue to keep you up to date and the next scheduled time for an update would be at the end of Q2, sometime in July.

So, thank you very much for your interest and have a good day.

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