Boston Scientific Corp (BSX) 2016 Q2 法說會逐字稿

Ladies and gentlemen, thank you for standing by. Welcome to the second-quarter 2016 Boston Scientific earnings conference call.

(Operator Instructions)

As a reminder, this conference is being recorded. I would now like to turn the conference over to your host, Susie Lisa. Please go ahead.

Thank you, Greg. Good morning, everyone, and thanks for joining us. With me on today's call are Mike Mahoney, Chairman and Chief Executive Officer; and Dan Brennan, Executive Vice President and Chief Financial Officer.

We issued a press release earlier this morning announcing our Q2 2016 results, which included reconciliations of the non-GAAP measures used in the release. We have posted a copy of that release, as well as reconciliations of the non-GAAP measures used in today's call, to the investor relations section of our website under the heading Financial Information.

The duration of this morning's call will be approximately one hour. Mike will provide strategic and revenue highlights of Q2 2016. Dan will review the financials for the quarter, and then Q3 2016 and full-year 2016 guidance, and then we'll take your questions. During today's Q&A session, Mike and Dan will be joined by our Chief Medical Officers, Dr. Keith Dawkins and Dr. Ken Stein.

Before we begin, I'd like to remind everyone that on the call, organic revenue growth is defined as excluding the impact of changes in foreign currency exchange rates and sales from the acquisition of the American Medical Systems, AMS, male urology portfolio over the prior-year period.

Also of note, this call contains forward-looking statements within the meaning of federal securities laws, which may be identified by words like "anticipate", "expect", "believe", "estimate" and other similar words. They include, among other things, statements about our growth and market share; new product approvals and launches; clinical trials; cost savings and growth opportunities; our cash flow and expected use; our financial performance, including sales, margins, earnings and other Q2 2016 results and Q3 and full-year 2016 guidance; as well as our tax rates, R&D spend and other expenses.

Actual results may differ materially from those discussed in the forward-looking statements. Factors that may cause such differences include those described in the risk factors section of our most recent 10-K and subsequent 10-Qs filed with the SEC. These statements speak only as of today's date, and we disclaim any intention or obligation to update them. At this point, I will turn it over to Mike for his comments. Mike?

Thank you, Susie, good morning, everyone. We continue to beat our long-range strategic, planned goals and execute very well as a global team. The success of our category leadership strategy is helping us gain share in our core markets, expand into faster growth adjacencies and deliver solutions that address unmet clinical needs.

Our consistent results continue to demonstrate that Boston Scientific is uniquely positioned to deliver differentiated long-term shareholder value. With long-term visibility to mid-single digit organic revenue growth, complemented by ongoing operating margin improvement initiatives, our goal is to consistently drive double-digit adjusted EPS growth.

We're very excited about our excellent second-quarter performance, first-half results, and most importantly, our plans for the future. In Q2, we drove total operational revenue growth of 16% and organic revenue growth of 10%, excluding the impact of the AMS urology acquisition.

We had strong results across all regions, and five of our seven business units grew revenue double digits organically. We leveraged that revenue growth to drive adjusted operating income growth of 22%, resulting in adjusted operating margin of 23.4% and a 130-basis-point improvement year over year. We delivered adjusted EPS of $0.27, achieving the high end of guidance, and representing 25% growth, including a negative $0.015 impact from foreign currency.

So given our strong performance, we're increasing our 2016 guidance for revenue and adjusted EPS. We're increasing our full-year organic revenue growth guidance from 6% to 8% to 8% to 9%; full-year operational revenue growth guidance, which includes the benefit of AMS, is increased from 9% to 11% to 11% to 12%. We're maintaining our full-year adjusted operating margin guidance of 24% to 24.5%, which at the midpoint is roughly 200 basis points of improvement over 2015.

We're also increasing our adjusted EPS guidance by $0.01 over our prior range to $1.07 to $1.11, which represents 15% to 19% growth. Importantly, this adjusted EPS guidance includes an expected $0.05 negative impact from foreign exchange.

I'll now provide some highlights on Q2 results and our 2016 outlook. In my remarks, all references to growth are on a constant currency, organic, year-over-year basis and they exclude the benefit of AMS.

Our second-quarter revenue growth of 10% was broad-based across businesses and regions, led again, by exciting new product launches, continued global expansion, and execution of our category leadership strategy. We drove double-digit growth in five businesses: Endoscopy, Urology Pelvic Health, Neuromodulation, Interventional Cardiology and Peripheral Interventions.

In addition, each region accelerated sequentially. The US grew 8%, Europe grew 9%, and Asia-Pac delivered 16% growth, with every major country in the Asia-Pac region up double digits this quarter. The emerging markets also continued to deliver as sales grew 20%, including China revenue at 21%.

Our MedSurg businesses, Endoscopy, Urology Pelvic Health and Neuromodulation, continue to be a priority focus area for the Company, and each of the businesses maintained or accelerated growth from first quarter. These three businesses represent 40% of our operating income in the second quarter and they delivered adjusted operating margin of 32.8%. This is up 20 basis points sequentially and 240 basis points year over year.

Our global Endoscopy continues to grow at a high level, with revenue growing 11% in second quarter. We continue to see strong growth in our core Endoscopy business, supported by our innovative portfolio and broad-based global expansion initiatives. Key Endoscopy growth drivers include the single-use SpyGlass DS visualization system; the Axios stent for drainage of pancreatic fluid; and our next-generation hemostasis clip, the Resolution 360.

High single-digit growth in US Endoscopy was complemented by double-digit growth in every region outside the U.S., as we continue to develop commercial and physician training capabilities in emerging markets and add focus in pulmonary, which helped drive 25% growth in BT, broncho-thermoplasty, led by the US, Japan, and China.

In Urology and Pelvic Health, our investments to become the clear market leader and category leader are being rewarded, as growth, excluding AMS, accelerated to 18%. The business is performing at a high level across the various regions and segments, including kidney stone, BPH, ED, and gyn/surg.

Our global commercial footprint and focus on physician education has helped us to convert a meaningful portion of the market opportunity created by Astora's exit from the market at the end of March. AMS sales strengthened in the quarter, and importantly, remediation and integration efforts remain on track.

An exciting new growth platform in our urology business is the launch of the LithoVue platform. LithoVue is an innovative, single-use digital scope for treatment of kidney stones that provide customers with enhanced visualization and navigation capabilities. LithoVue resonates with the physicians and hospitals due to less OR down-time for [stale] processing of reusable scopes. Performance navigation characteristics that allow physicians to tackle tougher procedures and the ability to schedule full day of procedures without the fear of cancellation due to reusable scopes being down.

In Neuromodulation, we continue to invest in the fast-growing micro-electronics market, where we enjoy innovation and supply-chain leverage between our CRM and Neuromodulation business. Neuromodulation revenues grew 12%. Sales were driven by the US market-leading Spectra platform; the launch of Precision Montage, which offers full-body MRI capability, and our Vercise deep-brain stimulation platform.

Our US DBS trial continues to progress and we expect a launch in the US in first-quarter 2018. Additionally, early this week, we announced the acquisition of Cosman Medical, a technology leader in the field of radiofrequency ablation systems for the treatment of chronic pain. This acquisition broadens our Neuromodulation portfolio and is highly synergistic with our US commercial team. We're excited to offer physicians treating patients with chronic pain another non-opioid therapeutic option earlier in the treatment continuum.

Now turning to Cardiovascular, which includes our Peripheral and Interventional Cardiology businesses. Overall, this segment grew sales 13% in the quarter and delivered adjusted operating margin of 32.2%, up more than 170 basis points year over year. Our peripheral business delivered exceptional results of strong global sales across all regions, fueled by an innovative portfolio.

Sales grew 14%, as strong results across all regions and segments, including stents, thrombectomy, and our emerging drug-eluting portfolio. We also delivered strong growth in interventional oncology where the integration of interventional radiology business of CeloNova remains on track.

In our venous segment, we continue to see strong demand for our Zelante deep vein thrombosis system. We're the only company developing leading drug-eluting technology globally on multiple platforms in order to treat complex, peripheral vascular disease. The Eluvia peripheral drug-eluting stent trial, called IMPERIAL, is on track to complete enrollment by year-end 2016.

In interventional Cardiology, we're focused on gaining share in our core businesses while expanding in faster growth segments that leverage our capabilities. This strategy is working. In the second quarter, Interventional Cardiology grew 12%, led by structural heart, drug-eluting stents, and PCI guidance.

Synergy had an excellent quarter as we grew DES sales 9%. Synergy is now the market-leading premium DES platform and it's on track to represent 50% to 60% of our US DES revenue mix by the end of 2016. PCI guidance grew mid-teens and continued share gains in intravascular ultrasound, and we're encouraged by strong early feedback on the ease of use of our Comet Fractional Flow Reserve system.

Our leading portfolio of solutions for complex, high-risk PCI of patients also contributed to global growth. The 12% IC revenue growth was fueled by our strengthening structural heart business, which includes our Lotus transcatheter aortic valve and Watchman left atrial appendage closure. We believe we are well-positioned to drive long-term growth in these two fast-growing markets via our differentiated platforms and expanded capabilities. We also aim to deliver at the high end of our 2016 structural heart guidance range of $175 million to $200 million.

Our Lotus Valve continues to gain share in Europe, and we're investing significantly in clinical studies, R&D, and our global supply chain to develop our capabilities further. We remain on track to launch Lotus Edge at PCR London Valves in September.

The Lotus Edge delivery system features a 14 French expandable sheath called iSleeve and is designed for more flexibility and simplified deployment. It also offers our new DepthGuard technology, which limits the depth of the valve in a left ventricular outflow tract. Lotus also offers best-in-class paravalvular leakage rates, and we aim to enhance Lotus with studies to demonstrate improved permanent patient pacemaker rates with Lotus Edge and DepthGuard.

So our goal is to provide initial Lotus Edge data at PCR London Valves. We do expect a slight delay in our expanded Lotus Valve matrix in Europe, with a 21-millimeter valve estimated CE Mark timing first-quarter 2017, and a 29-millimeter valve in Europe in mid-2017. We continue to invest and plan for a US launch with the Lotus Edge platform in late 2017.

Also, in structural heart Watchman sales were strong on procedure growth and new account openings. We are developing additional Watchman capabilities and field clinical support, market development, and physician training courses. Implant success rates and patient outcomes remain very high, as evidenced by the 98.5% success rate in the EWOLUTION registry detailed at HRS in May.

We continue to expand Watchman into new markets, and we're pleased with the recent reimbursement approval and launch in France. Importantly, the unique clinical benefits of Watchman are being rewarded, as evidenced by the French reimbursement at a meaningful premium to competitive LAAC devices.

Post a limited market release of our next-generation Watchman FLX device, we have decided to pursue design enhancements before returning the next-gen platform to market. Importantly, we anticipate this delay will have no impact on our current Watchman product and thus, no change to our market outlook for LAAC.

Rhythm management sales increased 5% in the quarter and delivered adjusted operating margin of 16.9%, up [280] (corrected by company after the call) basis points year over year, as improving profitability remains a core focus. In CRM, we improved our global performance and delivered 4% growth in second quarter. Our European and Asia-Pac CRM businesses continue to grow faster than the market, offset by slower growth in US CRM. Pacemaker sales grew 15% globally with excellent US performance, fueled by our ACCOLADE MRI launch and growth from our X4 CRT-D quad device.

Worldwide ICD sales are flat, as we delivered above-market growth internationally that was offset by weaker sales in the US. In the US, we faced some near-term headwinds due to a Tachy MRI product gap and replacement-cycle headwinds. However, we recently earned FDA approval of our ACUITY X4 quad CRT lead and the early results are promising.

Importantly, EMBLEM S-ICD is a key differentiator and growth continues to accelerate globally. We continue to expand global S-ICD utilization with more long-term data from the effortless registry, growing physician implant experience, geographic expansion, and the recent second-quarter 2016 EU launch of EMBLEM MRI, which contributed to our solid international growth.

Due to a change in protocol of our US ENABLE MRI clinical trial, we are revising our goal for transvenous Tachy MRI US approval by year-end 2017, but continue to expect to gain MRI labeling for both new and previously implanted ICDs and CRT-Ds with the new time line.

The continued cadence of data proving the superiority of ENDURALIFE batteries and the pending FDA approval of EMBLEM MRI S-ICD, which is expected in third quarter, will help us offset the near-term headwinds from the US MRI high-voltage segment. In the second quarter, European CRM sales grew 5%, representing nine straight quarters of above-market growth, giving us further confidence in our long-term CRM outlook.

Our EP business grew 6% in second quarter and encouraged by double-digit growth in Europe, led by new Rhythmia installs and the recent launches of IntellaNav OI and IntellaTip MiFI OI ablation catheters. The US launch in the late first quarter of BLAZER OI catheter will be augmented in Q3, with the upcoming launch of the NAV-enabled version of this catheter.

So to wrap up, our company delivered another excellent quarter. Our second-quarter performance reflects the strength of our global team, the depth and breadth of our portfolio, our globalization efforts, and our ongoing investments in the faster growth markets. Importantly, we believe we are well-positioned to deliver continued strong results in the second half of 2016 and beyond. I really want to thank our employees globally for their winning spirit and their strong commitment to Boston Scientific. Now let me turn the call over to Dan for a more detailed review of our financial results.

Thanks, Mike. In Q2, we generated organic revenue growth of 10% versus our 6% to 8% guidance range, and adjusted EPS of $0.27, representing 25% year-over-year growth and the high end of our guidance range of $0.25 to $0.27. The strong adjusted EPS growth performance in Q2 was driven primarily by revenue growth upside and a lower SG&A rate versus prior year. And given the strong performance in the first half of 2016, we are, again, raising full-year guidance for revenue growth and adjusted EPS.

Consolidated revenue of $2.126 billion represented operational revenue growth of 16%, exceeding the high end of guidance and excludes the impact of a $24 million headwind from foreign exchange, which was in line with guidance. Excluding an approximate 500-basis-point contribution from the AMS male urology portfolio acquisition, organic revenue growth was 10% in the quarter and 15% on an as-reported basis.

Adjusted gross margin for the second quarter was 70.7%, decreasing 60 basis points year over year, and unfortunately, 130 basis points below the midpoint of Q2 guidance due to a few factors that I will detail. The year-over-year decrease is due to the unfavorable impact of foreign exchange, which was a 120-basis-point headwind, as well as cost related to our new Malaysia manufacturing plant the AMS integration, including the AMS quality remediation expense. Compared to guidance, the shortfall is due to inventory charges in advance of new product launches, inventory write-offs related to Watchman FLX, and more unfavorable FX.

We now expect Q3 and full-year 2016 adjusted gross margin to be in the range of 71.5% to 72.5%, which includes an expected 75 to 100 basis points of unfavorable foreign exchange. A key element in the second-half increase is lower expected inventory charges, and we will also benefit fully from the lower 2016 standard cost of our products, as we will have sold through all of the inventory valued at last year's higher standards.

Adjusted SG&A expenses were $763 million, or 35.9% of sales in Q2, down 140 basis points year over year. We continue to believe our full-year rate will be between 35.5% and 36.5%, which at the midpoint would be a 140-basis-point improvement compared to last year.

Adjusted research and development expenses were $222 million in the second quarter, or 10.4% of sales, which is down 50 basis points year over year. As a result of a slightly lower R&D rate in the first half, we expect our full-year 2016 adjusted R&D rate to be between 10.5% and 11.5% of sales, or 50 basis points lower than prior guidance.

Royalty expense was 0.9% of sales in Q2, roughly flat year over year. Our Q2 2016 adjusted operating margin of 23.4% was in line with our guidance and represents a 130-basis-point improvement over Q2 last year, which marks the eighth consecutive quarter in which we will have expanded adjusted operating margin by 100 basis points or more. As a reminder, we signaled a sequential decrease in adjusted operating margin from Q1's rate, as we experienced the usual increase in SG&A from Q1 to Q2 due to seasonal trade-show activity and began to ramp reinvestment of the medical device excise tax suspension.

Our first-half 2016 adjusted operating margin of 24.2% positions us well to achieve our full-year adjusted operating margin guidance of 24% to 24.5%, and we remain on track to reach 25% plus in 2017. Q2 adjusted operating income grew 22% year over year, with all three reportable segments expanded -- expanding adjusted operating margin by at least 170 basis points over Q2 2015.

Specific to Rhythm Management, the team delivered an adjusted operating margin of 16.9%, up 280 basis points year over year. In the second half of 2016, we expect Rhythm Management adjusted operating margin to continue to improve and be 18% to 19%. This second-half gain is expected to result from realizing the full benefit of 2016 product costs, leveraging the improved top-line performance expected of the global CRM and EP businesses, and we continue to believe Rhythm Management is on track to deliver an adjusted operating margin of 20% in 2017.

Turning to the balance sheet, we had some key developments in the quarter that helped reduce future uncertainties. Before I get into the details of the activity in the quarter, let me try to frame out the next three years of expected cash flow at a high level.

From 2017 through 2019, we believe we can generate cumulative adjusted free cash flow after CapEx approaching $6 billion. We expect to allocate roughly two-thirds of that $6 billion to a combination of M&A and share repurchases.

As you are aware, the two most significant liabilities on our balance sheet are our IRS transfer pricing case and the mesh litigation. During the quarter, we took two important steps to manage these liabilities.

First, we reached a stipulation of settled issues with the IRS for the 2001 to 2007 tax years. And importantly, this stipulation also provides a framework to settle the remaining years, 2008 through 2015 as well. While there's work to do to conclude all of the years, we are confident we will bring these to conclusion over the coming quarters. With a payment in 12 to 24 months, this would eliminate one of the most significant liabilities on our balance sheet.

With regards to mesh, we increased our reserve by $608 million during the quarter. With the same goal of managing our liabilities, we've reached conditional or final settlements on 12,000 claims and made significant progress towards reaching agreement in principal on another 7,000 claims, for a total of 19,000 claims. This represents approximately half of the roughly 40,000 known claims, and we expect to make even more progress during the remainder of 2016.

As you know, every quarter we assess all four key components involved in calculating the reserve and make any necessary adjustments for all probable and estimable charges, including the volume of known claims, the estimated cost to resolve each claim, an estimate of future claims, and the cost to defend each claim.

Our total legal reserve, of which mesh is included, was $2.375 billion as of June 30, 2016, and we believe it reflected our best estimate of what is probable and estimable. Of note, as well, is that included in this reserve is the Mirowski judgment, which we have paid in full subsequent to quarter end. So as of today, the reserve would be closer to $2 billion.

As a reminder, this $2 billion includes a number of claims we have agreed in principal to settle but have not yet paid. Once those settlements are funded, the amount of the reserve will be adjusted accordingly.

Now I'll move on to interest expense. Interest expense for the quarter was $59 million compared to $106 million in Q2 of last year. The decrease is primarily due to the pretax, one-time charge of approximately $45 million associated with the senior note refinancing in Q2 of last year. Excluding this charge, Q2 2015 interest expense was $61 million.

Our average interest expense rate was 4% in Q2 this year compared to 8% in Q2 last year. The lower interest rate expense in Q2 of 2016 was primarily due to lower average cost of debt resulting from the senior notes refinancing and the inclusion of the pretax one-time charge in Q2 of last year that I mentioned. Excluding this charge, Q2 2015 interest expense would have been 4.6%. Our tax rate for the second quarter was 47.8% on a reported basis and 14.2% on an adjusted basis.

As reported last week, we're pleased with the conditional settlement reached with the IRS Council regarding our transfer pricing litigation, and plan to use some of the current benefits to repatriate overseas cash. Thus, we continue to expect our full-year 2016 adjusted tax rate to be approximately 14%. We believe this IRS settlement, in addition to recent progress we've made towards reaching agreements in principal to settle additional mesh claims, as I mentioned, are prudent actions to take in the management of our balance sheet.

Finally, Q2 2016 adjusted EPS of $0.27 includes approximately $0.015 of unfavorable FX and represents 25% year-over-year growth, or 32% growth excluding the impact of foreign exchange. On a reported GAAP basis, Q2 2016 EPS was a loss of $0.15 and includes net charges and amortization expense totaling $580 million after tax.

Adjusted free cash flow for the quarter was $464 million compared to $406 million in Q2 of last year. Given the strong adjusted free cash flow generation in the first half of this year, we are raising our full-year adjusted free cash flow guidance from $1.5 billion to $1.6 billion, which was formally our stretch goal. Achieving adjusted free cash flow of $1.6 billion would represent 17% growth, and we continue to pursue inventory management initiatives designed to improve the working capital contribution to cash flow.

In Q2, we used cash primarily to repay $250 million of bank term loans, as well as fund previously agreed legal settlements. As of June 30th, 2016, we had cash on hand of $438 million. Near term, our capital allocation priorities are to manage contingencies and pursue tuck-in M&A.

We ended Q2 with 1.375 billion fully diluted weighted average shares outstanding. Consistent with our prior guidance, we expect our share count to increase by roughly 5 million per quarter through the end of 2016, as we plan to keep the buybacks suspended for the balance of this year. We expect this to result in a fully diluted weighted average share count of approximately 1.380 billion shares for full-year 2016.

I'll now walk through guidance for Q3 and full-year 2016. For the full year, we now expect consolidated revenue to be in a range of $8.270 billion to $8.370, which represents year-over-year growth of 8% to 9% on an organic basis and 11% to 12% on both an operational and reported basis. As a result of a stronger dollar, at current rates, we expect foreign exchange to be a headwind of approximately $70 million for the full-year 2016.

Turning to adjusted EPS, we now expect full-year 2016 adjusted EPS to be in a range of $1.07 to $1.11, representing 15% to 19% adjusted earnings growth. Our previous guidance assumed the unfavorable FX on full-year adjusted EPS would be between $0.05 and $0.06. Given the fact that Q2 saw slightly less unfavorable impact than expected, we now believe the full-year impact will be closer to $0.05, which assumes $0.02 to $0.03 in the second half of this year. On a GAAP basis, we expect EPS to be in a range of $0.30 to $0.35.

Now turning to Q3 2016, we expect consolidated revenues to be in a range of $2.35 billion to $2.85 billion. This represents year-over-year growth in a range of 7% to 9% organically and 8% to 10% operationally. We expect the foreign-exchange headwind on Q3 revenue to be negligible.

For the third quarter, adjusted EPS is expected to be in a range of $0.25 to $0.27 per share and GAAP EPS is expected to be in a range of $0.13 to $0.15 per share. Please check our investor relations website for Q2 2016 financial and operational highlights, which outlines Q2 results, as well as Q3 and full-year 2016 guidance, including P&L line-item guidance.

So with that, I'll turn it back over to Susie who will moderate the Q&A.

Thanks, Dan. Greg, let's open it up to questions for the next 30 minutes. In order to enable us to take as many questions as possible, please limit yourself to one question and one quick follow-up. Greg, please go ahead.

Thank you.

(Operator Instructions)

Your first question comes from the line of Mike Weinstein from JPMorgan. Please go ahead.

Good morning. First off, can you hear me okay?

Good morning, Mike. We can hear you fine, Mike. Thanks.

First off, fantastic quarter, obviously. So congratulations. Let me just clarify just on a few items. So, number one, the pacemaker performance being as strong as it is on the back of the MRI launch. One question I've already got from people is, is that a clean number? Is there any stocking in that number that we should be aware of?

Second, the move in the structural heart guidance to the high end of the range, is that Watchman more than Lotus? If you could share any insights into that and then I'll follow up. Thanks.

Sure. Good morning, Mike. On the pacemaker, our team has been waiting for a long time for that product approval. We've had some slow quarters in our pacemaker business in the US; outside the US has done quite well with that product for a while. So that's not a stocky number. We were ready for that launch for quite a while, and our commercial teams did an excellent job executing it.

So we think it's very innovative product and long in coming. And the US team essentially did what the OUS teams have done with that product for a while.

In structural heart, we continue to be really excited about the future for structural heart. It continues to be our largest investment area of the company. We're comfortable with the high end of our guidance that we provided at $175 million to $200 million. We continued to invest long term in R&D capabilities, clinical capabilities, and commercial capabilities to prepare ourselves for the launch in the US. And we're really excited about the upcoming data that we expect to see in London Valves on our pacemaker rate with the addition of Lotus Edge and depth guard.

So it's really an important category for us. As you know, we outlined at investor day back in, 2013 and 2015 our focus to continue to grow in our core businesses and take share, which we're doing. And importantly, expand into faster growth markets. And that's exactly what you're seeing as a company. And structural heart investment really is leading the pack there.

Mike, I apologize, the question was within structural heart, Watchman is what's driving to the high end of the range there?

What's driving the high end range there is we just continue to open up new accounts. We continue to improve our account utilization, and we continue to build up our commercial capabilities in the US.

Okay. The gross margin issues in the quarter, I think you did a good job of, Dan, walking through what those are. So if we look at the back half of the year and expect an improvement in the gross margin, that's because, one, your inventory issues from the AMS transaction basically you get to a better standard cost on those products. And then the FX headwind that you saw this quarter on the gross margin should dissipate. Is that accurate?

No. Well, somewhat. Let me just make sure we're clear on that. So we're at 70.7% in the quarter. The guidance range for Q3 and the full year is 71.5% to 72.5%. So it implies the uptick that you mentioned in the second half. I think the two key drivers of that are the inventory charges for the CRM products related to the better uptake of MRI safe Brady and quad in the US, as well as the Watchman FLX, we don't believe that those repeat themselves.

And then, secondly, we will get the full benefit in the second half of the lower manufacturing cost that we have for 2016 standards. Because we'll now be selling all of the inventory at the new standards, and we will have sold off all of the inventory at last year's standards. Those are the two main drivers that put us back into the 71.5 to 72.5 range.

FX we actually assume is probably somewhat in the same range as where it was in Q2. That's really the reason -- if you think back to last quarter, our guidance for FX in gross margin would have implied about 70 to 75 basis points each quarters for Q2, Q3, and Q4. Now it's 120, so that's a 50-basis-point difference, and that's the reason why the guidance for the full year came from 72 to 73 to 71.5 to 72.5.

Got it. All right. I had a long list of questions, but I'll let some others jump in. Thank you.

Thanks, Mike.

Your next question comes from the line of David Lewis from Morgan Stanley. Please go ahead.

Good morning.

Good morning.

Very strong revenue quarter, guys. I hate to ask something as banal as cash flow, Dan, but you don't give us multi-year cash flow expense that often. I noticed that your $6 billion free cash estimate over the next three years is 10% higher than what we were looking for. Can you just walk us through why that would be and some of the components? I imagine one component is CapEx and perhaps the other is margins. But our margin numbers are pretty high, and you're still 10% above us. What could be driving that significant upside?

I think you answered your own question there, David; it's margins and CapEx. So one of the things we have this year, is as we detailed in our guidance at the beginning of the year, is a CapEx number at $350 million that's $100 million higher than we think we need to effectively run each year. So we get that back hopefully each of the next three years. And then expanding margins.

So our goal next year is 25% plus. And as we've given guidance for -- or long-term goals for 27% to 28% by 2020, the combination of those two factors and the CapEx I think get you a long way there.

And then the other piece is that we're going to continue to try from a working capital perspective to make that be our friend. We have a lot of inventory initiatives in place to really hopefully lead the industry in that regard and be best-in-class. And when we do that, that will turn something that's going to drag on cash flow into a positive and hopefully see the beginnings of that this year. You see that from us taking our guidance from 1.5 to 1.6, a piece of that as the inventory initiatives.

Very helpful. Mike, maybe a couple product questions. The first is just the forgotten business for Boston, MedSurg, is no longer forgotten, given the organic growth. And specifically, Endoscopy has gone from mid-single growth last year to double-digit growth this year. I wonder if you'd just give us a sense of where we are in the product cycles. Is it share gain from competitors? Is it product cycles that is driving that?

And then secondarily on DES on Synergy, where do you think we are on share versus mix? Obviously, you're growing dramatically ahead of market, so what are some of the factors that are driving that? And I'll jump back in queue. Thanks. Great quarter.

Thanks, David. We've definitely never forgot about Endo. It's really an incredibly high-performing business, and it has been for a number of years. And they really are just continuing to grow and expand.

So our endo business enjoys a strong market. A bit fewer competitors in our endoscopy markets than some of our others. It has very strong growth profile in terms of the market growth in OUS expansion, and we are a very strong category leader. Across the globe when we continue to expand, particularly in the emerging markets.

The portfolio is really driving a lot of the launch -- a lot of the success you're seeing in 2016, led by our SpyGlass digital DS platform, which is driving solid double-digit growth and helps pull to the core portfolio. We also launched a product called the AXIOS stent, which is doing well, as well as a hemostasis clip.

So the portfolio cadence for Endo is very strong, it's very well led, it's very globally-oriented, and they also do a great job of laying out the economic value proposition for hospitals beyond the portfolio. So they continue to perform very well.

And intentionally, some of my comments with Mike in his first question, we're intentionally focusing on investing greater; in faster growth markets, in faster growth businesses, and they represent 40% of our operating income, the medsurg sector does now for BSC. So more to come there.

DES is doing excellent. We had a few critics early on in our launch saying we weren't being aggressive enough. We've signaled all along that we're going to drive an appropriate premium price for this product, because we believe it is the best product available in the marketplace and the data is proving that out. And maybe Keith can comment in a minute.

So we believe it's the premium product. We do offer a premium price for it, and so we've been smart in our rollout of it. And I think physicians and customers have seen the value of the ease of use and the clinical data of SYNERGY. And we expect the US penetration to be probably above 50%, probably closer to 50% to 60% in the US in 2016. And we continue to roll it out globally.

So the team is doing a nice job there. But, again, it's part of the overall story in intervention cardiology, again pointing to faster growth segments, our DES doing well, a lot of investments in complex coronary and imaging which are part of the portfolio, and in clearly our structural heart. So Kevin Ballinger and the team are doing a nice job.

Yes, David, I think the SYNERGY stent operators around the world are appreciating the best-in-class acute performance. Because obviously, if you can't deliver the stent, that's really the end of the discussion. And we have a lot of data now, including the EVOLVE 2 pivotal data, the EVOLVE five-year data, and the real-world SCAAR data from Europe confirming the safety.

Everybody, both patients and physicians, are interested in stent thrombosis, and the stent thrombosis as you know, from the data is very low. We have 20,000 patients in investigator-sponsored trials with SYNERGY, and these trials are beginning to release their data. And you'll see more flows of data at the meetings during the rest of this year and next year.

Great. Thank you very much.

Thank you. Thanks, David.

Your next question comes from the line of Larry Biegelsen from Wells Fargo. Please go ahead.

Good morning, guys. Thanks for taking the question and congratulations on a really strong quarter. Dan, you raised the organic growth from 6% to 8% to 8% to 9%, but you only raised the EPS guidance by $0.01. And so can you talk about why you're not getting better leverage on the incremental revenue? You kept the operating margin guidance the same. And then I had one follow-up.

Sure, Larry. I think probably the best way to explain that is to just do a quick summary of the increase in revenue. So the revenue is $170 million higher at the midpoint of guidance. And that breaks down into three things: $20 million comes from FX, $75 million comes from revenue that already came in Q2, and then $75 million comes in the second half.

I think the main factor that's offsetting is if you look at our R&D rate, our R&D rate in the first half was 10.5%. And looking at the second half, it's going to be 11.5% to get to the full-year rate of 11%. So that's a 100-basis point increase in R&D, largely related to timing and the investments in structural heart that Mike had mentioned. So that, for the most part, offsets the additional flow through in the revenue that you get. The additional $75 million of revenue you get in the second half.

Got it. Sorry.

As you look at it, still very pleased to be at 15% to 19% full-year EPS growth, which would be four years straight of double-digit adjusted EPS growth.

Got it. Sorry to interrupt there. And then for my for follow-up, at the 2015 analyst meeting, the organic revenue goal was 3% to 6% in 2016 and 2017. You're now guiding 8% to 9% in 2016. How should we think about the sustainability of the 8% to 9% and your goals in 2017 and beyond? And I recognize you're not giving guidance here, but you're way outperforming what you expected to do at your analyst meeting last year. Thanks for taking the questions.

Thank you. Yes, the team is outperforming. It's part of the high-performance culture that we have as a company. We're very excited about the full-year guidance at 8% to 9%. As you said, it compares to 3% to 6% we laid out, so it's pretty strong beat there. And strong momentum across really each region and each business.

So we're not going to provide any outlook into 2017. Clearly outperforming the market at this level is not likely sustainable each year. But that being said, we're confident we'll continue to outperform the market. We're investing in faster growth businesses, and we're very confident in our ability long term to drive mid-single-digit revenue growth, improve margins, and drive double-digit EPS growth.

Thanks for taking the questions, guys.

Thanks, Larry.

Your next question comes from the line of Bob Hopkins from Bank of America. Please go ahead.

Hi. Thanks. Can you hear me okay?

Yes. We can hear you fine, Bob.

Good morning.

Great, good morning. So obviously, you've got best revenue growth here for Boston Scientific, essentially since the financial crisis. Higher absolute level of revenues than I think any of us thought, so congratulations on the unbelievable progress.

My first question is really philosophical in terms of the long term, now that you got this higher level of revenues and higher level of revenue growth, you guys have given some long-term guidance on operating margin targets and goals. So now that you're outperforming on revenues, what's the thought on those operating margin targets?

Is the thought that you'll take an opportunity to spend more and continue to keep those operating margin targets? Or is it more likely that with this higher level of growth, that you could be towards the high end or higher of the long-term targets that you've set previously?

Thanks, Bob. Yes, I don't think we'll be changing the trajectory in terms of the margin guidance we've given. As we always say, it's about striking a balance between delivering durable, consistent revenue growth and expanding operating margins. If you look at the numbers and see what we've done for the last three years relative to revenue growth, and particularly on the margin expansion month, looking at 27% to 28% adjusted operating margin by 2020, and a consistent durable growing top line through that period and the goal of double-digit adjusted EPS growth each of those years, I think we're going to stick with that as our targets.

No, I understand you're sticking with the targets, but I'm just trying to understand philosophically, because you're outperforming so nicely here. Is the bias more towards opportunities to invest more or let some of that through? Because, again, these levels are just so much higher than we originally thought.

Again, it's striking a balance. We do have a lot of investment, as Mike mentioned, relative to structural heart. That's a lot of investment to get to the US market and be successful there. And it's always about striking that balance.

Yes. And I think, also, we'll do an investor day 2017. We haven't nailed down yet. But we're making significant investments in platforms and markets that will have a big impact on the growth rate of the business in 2018, 2019, and 2020. And so you look at our launch in the US of TAVR, our launch in the US in the future of deep-brain stimulation, launching -- only one that will have a drug-eluting stent and a drug-coated balloon for peripheral vascular, and we continue to expand into pulmonary and other areas across the Company. So we definitely are investing for long-term growth, and a lot of it is big clinical investments in R&D that will impact the company, particularly in 2018, 2019 and 2020.

Great. And then on structural heart just real quickly, what was the driver of you guys providing guidance at the high end of the range? Is that Lotus or Watchman or both?

It's both. Both are doing quite well.

Great. Thanks for taking the questions.

Thank you.

Your next question comes from the line of Brooks West with Piper Jaffray. Please go ahead.

Good morning. Can you hear me?

Yes. We can hear you fine, Brooks.

Great. Thanks, guys. Just to put a cap on the gross margin discussion, so, Dan, those all seem like transient issues with the inventory. And I'm not trying to push for guidance for next year, but as I look at my model, we have got you at about 73% gross margin for 2017. I don't see anything that I really need to flow through into 2017 from this. Is that the correct way to think about it? You're a little lower for 2016, but in terms of thinking about the forward model, that should resolve itself and we should go back to where we thought we were going, correct?

Yes. I wouldn't talk specifically about a rate for 2017. Obviously, the goal is to continually increase the gross margin rate, and it will be part of what we believe is 25% plus adjusted operating margin for next year,, so with that as the goal. The FX in the back half is really the only thing that we really believe is consistent from the Q2 performance. The other things I mentioned relative to inventory charges and the benefit from the standards hopefully, to your point, is a transient thing. So the FX is the only one that continues into the second half.

Okay. Perfect. And then maybe piggybacking on Bob's question, but also thinking about some of the questions around medsurg, you conditioned us in terms of the long-term operating margin progression to think about Rhythm Management. And obviously, you're making great progress there.

But given the growth we're seeing in medsurg and interventional cardiology, it seems like that equation maybe needs to change a little bit. And if we allocate a little bit more of the strength in medsurg to that equation, it seems like we push up to and through those targets maybe more quickly than if we were just relying on rhythm management. Is that also a fair way to look at your business?

Yes. I think the focus on rhythm management has really been just because of where they were. Starting off in the high single-digits, it's gotten a lot of focus over the last three or four years. I think Joe and team have made tremendous progress getting it to the 16.9 that it is in Q2, the 18 to 19 that it will be in the second half of this year, and then ultimately the 20 next year and beyond that in 2018 and beyond.

All the while, to your point, medsurg and cardiovascular have continued to grow their margins as well. So I think it goes back to what Mike said to the answer to the last question, which is there's investments that we're making to ensure that durable growth, 2018, 2019, 2020 and beyond. And it's not just one business that has that investment; we're investing in all of the businesses. We spend a lot of time looking at each of the individual segments and the profitability there, and the math adds up to what we've given for our goals.

Perfect. And if I could sneak in just one product question. I'm wondering if Mirviss has decided whether to bring drug coated balloons to the US or not?

Yes. We'll likely be providing additional insights on our clinical strategy with our balloon at the next quarterly call.

Perfect. Thanks, guys.

Your next question comes from the line of Rick Wise from Stifel. Please go ahead.

Good morning, everybody. Maybe let me start off with Lotus. Mike, you talked about gaining U share in the quarter. Maybe give us a little more color on that. Are you ready to quantify that at all? You've talked about penetration or share of greater than 30% in your selected accounts. And maybe just add some more color on the Edge launch coming up in September. Is this a share gain or that's going to require more time and those additional sizes that are coming in the first half of 2017?

Yep, sure. Again, the big investment for us in structural heart are with WATCHMAN and TAVR. And we're planning for the long term here, particularly with our TAVR given the market growth profile and how large the market is. And our view that we have a very differentiated platform from the other market contenders, given the controlled release of our Lotus Valve and the lowest paravalvular leakage rates. So we think we truly have a differentiated platform in a very large market.

We're a bit hand strung in the near term in Europe without having all five sizes. We have three of them today. So that hurts us a bit. But we'll solve that with a 21-millimeter in first-quarter 2017 and eventually the largest size probably first half 2017. So that will help. So in the meantime, we continue to do very well with the three valve sizes that we have.

We won't provide any additional guidance in terms of number of accounts or penetration, but clearly it is a share-taking strategy. The market is already large. The market is growing, and we're quite confident that we're currently the strong number three player. But that's not going to be our aspiration over the years, particularly as we launch Lotus Edge and depth-guard.

Turning to a bigger picture question, Dan obviously is emphasizing the growth in free cash flow this year, the $6 billion number you threw out over the next few years. You're also saying, Dan, that, I think correctly, that with the settling or going a long way towards settling the IRS -- a major uncertainty is off the table. All of that suggests to me that might give you more flexibility in thinking about M&A or portfolio additions. You just announced Cosman.

How are you thinking about this, Mike and Dan, and should we be thinking that there is more possibility for M&A as a result? Any color would be appreciated. Thank you.

Sure, Rick. I'll hit it from a financial perspective, maybe Mike can jump in on the strategic side. The goal, and I think you framed it out very well, that's our goal is to eliminate the uncertainties that we have on the balance sheet. I think we've taken a lot of good steps in the quarter to do that, and that's going to give us more financial flexibility in the future. And that's the goal.

So we should hopefully free up more of that cash flow for the long term. We gave you the numbers hopefully as goals for the next three years. And the goal is to have as much of that available to fuel the business from an M&A and share repurchase perspective. So I don't know if there's anything specific. Yes. That's really the goal is to eliminate the uncertainties and give us as much financial flexibility as we can have.

Thank you.

Your next question comes from the line of Matt Taylor from Barclays. Please go ahead.

Thanks for taking the question. The first question I wanted to clarify when you talked about MRI safe time lines, could you just inform us what revising the goal for tachy MRI time line entailed? What the change was there?

And then S-ICD is still on track. Can you talk about how that is doing and how you expect MRI safe approval to potentially improve the sales for S-ICD?

Absolutely. We'll ask Dr. Stein to comment on this question.

Yes, Matt. On the MRI, not going to get into any of the details of the change in the protocol. But in the course of conduct of our ENABLE MRI trial, we have made a decision that we do need to revise the protocol with respect to patient screening and eligibility. And the process of getting that protocol or vision through is what's going to cause the push in the time line. We still have a goal of getting that approved by the end of 2017.

Great. And on S-ICD?

I'm sorry. Could you clarify the question on S-ICD?

Yes. I was just curious, I may have missed the comment here because the comments went by fast. But do you still have the same time line for S-ICD MRI approval, and just how is S-ICD performing today?

Yes. We still have the same time line, anticipating approval Q3 of this year. And really couldn't be more pleased with what we've seen in terms of uptake of EMBLEM MRI where it's been launched in Europe and the existing EMBLEM device in the US and globally.

We expect MRI approval in the US in third quarter.

Q3 this year.

Yes.

Great, and could you just talk about broader utilization. Obviously, your results were phenomenal this quarter. Are you seeing something going on in either the US market or some of the emerging markets that you plan that's contributing to higher levels of utilization that may not continue going forward? Or do you think you're really just outperforming your markets from good execution?

Well, thanks, Matt. It's Mike. I also don't want to be a broken record here, but I think I want to just reinforce, consistent with our investor day presentations in 2013 and 2015, we continued to invest our portfolio into faster growth markets. So in the maybe the 2011 time frame, we called our market growth profile about 3% in the markets we compete in.

So as we've shifted our portfolio over time in the faster growth markets, we think the markets that we compete in now are in the 4% to 5% growth range. If you look at the composite of BSC. So we are pleased that we're outperforming the market, but we'll strive to continue to do so. But we think we have fundamentally shifted the markets that we play in to about a 4% to 5% growth market versus maybe a 2% to 3% growth market four or five years ago. So the markets are stronger that we compete in, and the team is doing a really nice job of outperforming.

Okay. Thanks for the time.

Greg, we'll take one more question, please.

Okay. That question comes from the line of Glenn Novarro from RBC Capital Markets. Please go ahead.

Hi. Thanks for squeezing me in, two questions. One, drug-eluting stents in the quarter up high single-digits, significantly outpacing the market. You have Abbott launching Absorb. So my question is, is this high single-digit sustainable, given Absorb coming into the market, or should we anticipate a little moderation going forward? And then I had a quick follow-up.

So we're not giving DES guidance for the third quarter or fourth quarter. We're going to continue to run the play, which is we believe we have the best product in the market and Keith can comment a bit more on the clinical data. And we've been competing with Absorb in Europe for quite a while. We would put it at the BBS at probably less than the 7% of the global market, and it's been in the market for quite a while.

So we feel like we're in the position of strength in terms of our product portfolio. And we continue to look at BBS. It's an interesting technology. And we've got a number of bets. And if, in fact, in the future we can look at a second-gen or a third-generation device, then we'll eventually bring that to market. But at this time, we believe that Synergy is the premium device, and we'll continue to focus on driving that.

And then with Keith on the line, I'd love to get his thoughts on SYNERGY versus Absorb. And then my follow-up was on Eluvia, which was just launched in Europe and the data is very strong. And once you come to the US, you'll be the second DES on the market for peripherals but with by far the best data. So how is Eluvia doing in Europe? It just seems like this is one product that has a significant opportunity that's flying under the radar screen. Just thoughts on Eluvia as well. Thanks.

Glenn, in terms of SYNERGY and BBS, obviously, there's not a lot of head-to-head data between the two. But BBS has been available in Europe, it has had CE Mark for five-and-a-half years and the penetration, as Mike said, is mid-single-digits. And you, and everybody else on the call is well aware of the Absorb 2 and Absorb 3 data.

The safety profile of a drug-eluting stent is paramount. So safety profile is more important than efficacy, and with a stent thrombosis rate that is at least 2x SYNERGY, we feel that the first generation fully resorbable scaffold the safety profile is open to question.

We do have an interest in the space. Obviously, in a leader in DESK we have to have that. And as you know also, we have three shots on goal. And our own internal fast program, which is a thinner strap, more deliverable stent, more compliant, less malposition is in first human-use trials now, and we are still anticipating commercialization in Europe in 2018.

And then just your thoughts on Eluvia, how it's performing in Europe, and your thoughts on how it will perform in the United States once launched.

Sure. So we're early with our Eluvia platform. It's a large investment. We'll be announcing additional data sets on both our balloon and our set and our stent at CIRSE which I think is in Barcelona in September third quarter this year. So we'll continue to lay out our clinical data there.

But I think just, again, the strength of having a drug-coated balloon in Europe and a differentiated drug-eluting stent for the peripheral vascular offers physicians more options. And so it uniquely positions us in the SFA and it also helps us pull through our core portfolio. I think these investments are paying off in Europe based on the growth, and we've got to wrap up our clinical trial of Eluvia, which we anticipate by year-end 2016. And so we look forward to that finishing, and then we'll provide additional comments on our balloon at our third quarter on this call.

Okay. Thank you for taking the questions.

Thanks, Glenn.

Great. With that, we'd like to conclude the call. Thanks for joining us today, and we appreciate your interest in Boston Scientific. Before you disconnect, Greg will give you all of the pertinent details for the replay.

Thank you, ladies and gentlemen, this conference will be available for replay after 10:30 Eastern time today through August 11th. You may access the AT&T teleconference replay system at any time by dialing 1-800-475-6701 and entering the access code 356158. International participants dial 320-365-3844. Those numbers once again are 1-800-475-6701 or 320-365-3844 with the access code 39-6158. That does conclude your conference for today. Thank you for your participation and for using AT&T executive teleconference. You may now disconnect.