Acquisitions and Strategic Investments

9 Months Ended

Sep. 30, 2019

Business Combinations [Abstract]

ACQUISITIONS AND STRATEGIC INVESTMENTS

NOTE B – ACQUISITIONS AND STRATEGIC INVESTMENTS

Our unaudited condensed consolidated financial statements include the operating results for acquired entities from the respective date of acquisition. With the exception of the acquisition of BTG, which was completed on August 19, 2019, we have not presented supplemental pro forma financial information for acquisitions given their results are not material to our unaudited condensed consolidated financial statements. Transaction costs for all acquisitions in 2019 and 2018 were immaterial to our unaudited condensed consolidated financial statements and were expensed as incurred.

2019 Acquisitions

We recorded immaterial purchase price adjustments to the preliminary purchase price allocations of previous acquisitions during the measurement period in the first nine months of 2019.

BTG plc

On August 19, 2019, we announced the closing of our acquisition of BTG, a public company organized under the laws of England and Wales. BTG has three key portfolios, the largest of which is its interventional medicine portfolio (Interventional Medicine) that encompasses interventional oncology therapeutic technologies for patients with liver and kidney cancers, as well as a vascular portfolio for treatment of deep vein thrombosis, pulmonary embolism, deep venous obstruction and superficial venous disease. In addition to the Interventional Medicine product lines, the BTG portfolio also includes a specialty pharmaceutical business (Specialty Pharmaceuticals) comprised of acute care antidotes to treat overexposure to certain medications and toxins and a licensing portfolio (Licensing) that generates net royalties related to BTG intellectual property and product license agreements.

The transaction price consisted of upfront cash in the aggregate amount of £3.312 billion for the entire issued ordinary share capital of BTG (or $4.023 billion based on the exchange rate of U.S. $1.21: £1.00 at closing on August 19, 2019), whereby BTG shareholders received 840 pence in cash for each BTG share. The transaction price of $4.023 billion included $404 million of cash and cash equivalents acquired. We implemented the BTG Acquisition by way of a court-sanctioned scheme of arrangement under Part 26 of the United Kingdom Companies Act 2006, as amended.

After closing the BTG Acquisition, we terminated the £150 million BTG revolving credit facility, which contained an option to increase the facility by £150 million and was scheduled to expire in November 2020. The termination was effective on August 27, 2019, and there were no amounts outstanding at the time of close of the BTG Acquisition.

Purchase Price Allocation

We accounted for the BTG Acquisition as a business combination, and in accordance with FASB ASC Topic 805, Business Combinations (FASB ASC Topic 805), we recorded the assets acquired and liabilities assumed at their respective fair values as of the acquisition date. The preliminary BTG Acquisition purchase price was comprised of the amounts presented below, which represent the preliminary determination of the fair value of identifiable assets acquired and liabilities assumed from the BTG Acquisition. The final determination of the fair value of certain assets and liabilities will be completed within the measurement period as required by FASB ASC Topic 805. As of September 30, 2019, the valuation studies necessary to determine the fair market value of the assets acquired and liabilities assumed are preliminary, including the projection of the underlying cash flows used to determine the fair value of the identified tangible, intangible and financial assets and liabilities. Given the size and breadth of the BTG Acquisition, we anticipate that the purchase price allocation will take longer than prior acquisitions and potentially up to the one year allowed under FASB ASC Topic 805 to adequately analyze all the factors used in establishing the fair value of assets acquired and liabilities assumed as of the acquisition date, including, but not limited to, intangible assets, inventories, financial assets, real and personal property, leases, certain assumed liabilities, including reserves and deferred revenues, tax-related items, and the related tax and foreign currency effects of any changes made.

Any potential adjustments made could be material in relation to the preliminary values presented below:

(in millions)
Payment for acquisition, net of cash acquired	$	3,619

The following summarizes the BTG Acquisition preliminary purchase price allocation as of September 30, 2019:

(in millions)
Goodwill	$	1,549
Trade accounts receivable, net	107
Inventories	205
Other current assets	259
Other intangible assets, net	1,869
Other long-term assets	604
Accrued expenses and other current liabilities	(305		)
Other long-term liabilities	(289		)
Deferred tax liability	(380		)
	$	3,619

As a result of the BTG Acquisition, we recognized goodwill of $1.549 billion, which is attributable to the synergies expected to arise from the BTG Acquisition and revenue and cash flow projections associated with future technologies. The goodwill is not deductible for tax purposes. As of September 30, 2019, given the preliminary nature of the purchase price allocation, we have not yet allocated goodwill to the relevant reporting units.

We acquired certain intellectual property and related licensing arrangements, principally relating to Zytiga™, as part of the BTG Acquisition that provides the contractual right to receive future royalty payments. The licensing arrangements were accounted for as financial assets as part of acquisition accounting and were recognized at fair value based upon a discounted cash flow approach considering the probability-weighted expected future cash flows to be generated by the royalty stream. Additionally, as part of the intellectual property related to the licensing arrangements that we acquired we also have the contractual obligation to remit a portion of the cash flows received to the inventors associated with the intellectual property. As such, as part of acquisition accounting we have recorded a financial liability related to the future cash flows we are required to remit to the inventors when we collect the royalty payments. The amount recognized for the financial asset was $633 million in aggregate, comprised of $200 million included in Other current assets and $432 million included in Other long-term assets. The amount recognized for the financial liability was $395 million, comprised of $153 million included in Accrued expenses and other current liabilities and $241 million included in Other long-term liabilities.

We allocated a portion of the BTG Acquisition preliminary purchase price to specific intangible asset categories as follows:

	Amount Assigned (in millions)		Amortization Period (in years)			Risk-Adjusted Discount Rates used in Purchase Price Allocation
Amortizable intangible assets:
Technology-related	$	1,794	10	-	17	10	%	-	12%
Other intangible assets	75		2	-	11	11%
	$	1,869

As a result of the BTG Acquisition, we assumed a benefit obligation related to a defined benefit pension plan sponsored by BTG for eligible United Kingdom (U.K.) employees (U.K. Plan). The U.K. Plan was closed to new entrants as of June 1, 2004. Prior to the acquisition close date of August 19, 2019, the Trustees of the U.K. Plan executed buy-in arrangements (Buy-in Contracts), under which the benefit obligation of the pension plan is not transferred to the insurers, and we remain responsible for paying pension benefits. Effectively, the Buy-in Contracts are intended to provide payments designed to equal all future designated contractual benefit payments to covered participants. We do not anticipate any additional material contributions or payments to the U.K. Plan or the insurer.

The following assumptions were used to measure the fair value of the benefit obligation and associated plan assets:

	Discount Rate	Expected Return on Plan Assets	Rate of Compensation Increase
U.K. Plan	0.4%	0.4%	3.4%

As of the measurement date of August 19, 2019, the funded status recognized in our unaudited condensed consolidated balance sheets was as follows:

(in millions)
Fair value of plan assets	$	213
Benefit obligation	(216		)
Funded status	$	(3	)

BTG Pro Forma Financial Information (unaudited)

BTG contributed $71 million to our Net sales and immaterial amounts to our Net income (loss) for the period from August 19, 2019 through September 30, 2019.

The unaudited estimated pro forma results presented below include the effects of the BTG Acquisition as if it was consummated on January 1, 2018. In the third quarter and first nine months of 2019, we incurred nonrecurring charges that we attributed to the BTG Acquisition, which are presented in our unaudited condensed consolidated statements of operations for these periods. These nonrecurring charges that are attributable to the BTG Acquisition include immaterial amounts of acquisition-related costs, stock-based compensation expenses as a result of the change in control and retention bonuses and severance payments, adjusted for the related tax effects. We have reflected these nonrecurring charges as adjustments to the pro forma earnings presented below for the third quarter and first nine months of 2019 and 2018.

Additionally, these pro forma amounts have been calculated after applying our accounting policies and adjusting the results of BTG to reflect the additional costs associated with fair value adjustments relating to inventories, property, plant, and equipment, and intangible assets as if the BTG Acquisition had occurred on January 1, 2018, with the consequential tax effects. Additionally, the pro forma amounts have been adjusted to reflect the amortization of deferred financing costs and interest expense associated with additional financing entered into as part of the BTG Acquisition. The pro forma results exclude BTG’s historical licensing revenue and related cost of sales, as these arrangements are accounted for as part of the BTG Acquisition as a financial asset and liability and are not accounted for within the scope of FASB ASC Topic 606, Revenue from Contracts with Customers.

The supplemental pro forma information presented below is for informational purposes only and should be read in conjunction with our historical financial statements. The pro forma results do not include any anticipated synergies or other expected benefits of the BTG Acquisition. Accordingly, the unaudited estimated pro forma financial information below is not necessarily indicative of what the actual results of operations of the combined companies would have been had the BTG Acquisition occurred as of January 1, 2018, nor are they indicative of future results of operations. We believe that the pro forma assumptions and adjustments are reasonable and appropriate under the circumstances and are factually supported based on information currently available.

	Three Months Ended September 30,				Nine Months Ended September 30,
(in millions, except per share data)	2019		2018		2019		2018
Net sales	$	2,795	$	2,561	$	8,237	$	7,740
Net income (loss)	152		332		599		950
Net income (loss) per common share — basic	$	0.11	$	0.24	$	0.43	$	0.69
Net income (loss) per common share — assuming dilution	$	0.11	$	0.24	$	0.42	$	0.68

Transaction with Varian Medical Systems, Inc.

On August 21, 2019, we completed the sale of our drug-eluting and bland embolic microsphere portfolio to Varian Medical Systems, Inc. (Varian) in connection with the BTG Acquisition. The transaction price consisted of an upfront cash payment of $90 million, a portion of which is allocated to the fair value of the services to be rendered under the Transition Services Agreement and Transition Manufacturing Agreement entered into with Varian as part of this transaction. Additionally, we transferred certain contingent consideration arrangements arising from our initial acquisition of the portfolio to Varian and agreed to indemnify Varian for any payments ultimately arising under the terms of the contingent consideration arrangement. Accordingly, as part of the disposal, we recorded a liability of $16 million to recognize the fair value of this guarantee based on our potential obligation resulting from the indemnifications. The maximum amount payable under this guarantee is $200 million in accordance with FASB ASC Topic 460, Guarantees, which is consistent with the contingent consideration arrangement executed with our initial acquisition of the portfolio in accordance with FASB ASC Topic 805.

Vertiflex, Inc.

On June 11, 2019, we announced the closing of our acquisition of Vertiflex, Inc. (Vertiflex), a privately-held company which has developed and commercialized the Superion™ Indirect Decompression System, a minimally-invasive device used to improve physical function and reduce pain in patients with lumbar spinal stenosis (LSS). The transaction price consisted of an upfront cash payment of $465 million and contingent payments that are based on a percentage of Vertiflex sales growth in the first three years following the acquisition close. We estimate the sales-based contingent payments to be in a range of zero to $100 million; however, the payments are uncapped over the three year term. Vertiflex is part of our Neuromodulation business.

Millipede, Inc.

On January 29, 2019, we announced the closing of our acquisition of Millipede, Inc. (Millipede), a privately-held company that has developed the IRIS Transcatheter Annuloplasty Ring System for the treatment of severe mitral regurgitation. We have been an investor in Millipede since the first quarter of 2018 as part of an investment and acquisition option agreement, whereby we purchased a portion of the outstanding shares of Millipede, along with newly issued shares of the company, for an upfront cash payment of $90 million. We held an interest of approximately 20 percent immediately prior to the acquisition date. In the fourth quarter of 2018, upon the recent successful completion of a first-in-human clinical study, we exercised our option to acquire the remaining shares of Millipede. We remeasured the fair value of our previously-held investment based on the implied enterprise value and allocation of purchase price consideration according to priority of equity interests. The transaction price for the remaining stake consisted of an upfront cash payment of $325 million and up to an additional $125 million payment upon achievement of a commercial milestone. Millipede is part of our Interventional Cardiology business.

Purchase Price Allocation

We accounted for our 2019 acquisitions of Vertiflex and Millipede as business combinations, and in accordance with FASB ASC Topic 805, we recorded the assets acquired and liabilities assumed at their respective fair values as of the acquisition dates. The preliminary purchase prices of our acquisitions of Vertiflex and Millipede, presented in aggregate, were comprised of the following components:

(in millions)
Payments for acquisitions, net of cash acquired	$	763
Fair value of contingent consideration	127
Fair value of prior interests	102
	$	992

The preliminary purchase price allocations of our acquisitions of Vertiflex and Millipede, presented in aggregate, were comprised of the following components as of September 30, 2019:

(in millions)
Goodwill	$	575
Amortizable intangible assets	220
Indefinite-lived intangible assets	240
Other assets acquired	24
Liabilities assumed	(12		)
Net deferred tax liabilities	(56		)
	$	992

We allocated a portion of the preliminary purchase prices of our acquisitions of Vertiflex and Millipede, presented in aggregate, to the specific intangible asset categories as follows:

	Amount Assigned (in millions)		Amortization Period (in years)	Risk-Adjusted Discount Rates used in Purchase Price Allocation
Amortizable intangible assets:
Technology-related	$	210	12	15%
Other intangible assets	10		12	15%
Indefinite-lived intangible assets:
In-process research and development (IPR&D)	240		N/A	19%
	$	461

2018 Acquisitions

We recorded immaterial purchase price adjustments to the preliminary purchase price allocations of previous acquisitions during the measurement period in the first nine months of 2019.

Claret Medical, Inc.

On August 2, 2018, we announced the closing of our acquisition of Claret Medical, Inc. (Claret), a privately-held company that has developed and commercialized the Sentinel™ Cerebral Embolic Protection System. The device is used to protect the brain during certain interventional procedures, predominately in patients undergoing transcatheter aortic valve replacement (TAVR). The transaction price consisted of an upfront cash payment of $220 million and an additional $50 million payment for reaching a reimbursement-based milestone that was achieved in the third quarter of 2018. Claret is part of our Interventional Cardiology business.

Cryterion Medical, Inc.

On July 5, 2018, we announced the closing of our acquisition of Cryterion Medical, Inc. (Cryterion), a privately-held company developing a single-shot cryoablation platform for the treatment of atrial fibrillation. We have been an investor in Cryterion since 2016 and held an interest of approximately 35 percent immediately prior to the acquisition date. The transaction price to acquire the remaining stake consisted of an upfront cash payment of $202 million. Cryterion is part of our Electrophysiology business.

NxThera, Inc.

On April 30, 2018, we announced the closing of our acquisition of NxThera, Inc. (NxThera), a privately-held company that developed the Rezūm™ System, a minimally invasive therapy in a growing category of treatment options for patients with benign prostatic hyperplasia (BPH). We held a minority interest immediately prior to the acquisition date. The transaction price to acquire the remaining stake consisted of an upfront cash payment of approximately $240 million and up to approximately $85 million in payments contingent upon commercial milestones over the four years following the date of acquisition. NxThera is part of our Urology and Pelvic Health business.

nVision Medical Corporation

On April 16, 2018, we announced the closing of our acquisition of nVision Medical Corporation (nVision), a privately-held company focused on women’s health. nVision developed the first and only device cleared by the U.S. Food and Drug Administration (FDA) to collect cells from the fallopian tubes, offering a potential platform for earlier diagnosis of ovarian cancer. The transaction price consisted of an upfront cash payment of $150 million and up to an additional $125 million in payments contingent upon clinical and commercial milestones over the four years following the date of acquisition. nVision is part of our Urology and Pelvic Health business.

In addition, we completed other individually immaterial acquisitions in the first nine months of 2018 for total consideration of $158 million in cash at closing plus aggregate contingent consideration of up to $62 million.

We recorded gains of $142 million in the third quarter of 2018 and $182 million in the first nine months of 2018 within Other, net on our unaudited condensed consolidated statements of operations based on the difference between the book values and the fair values of our previously-held investments immediately prior to the acquisition dates. The aggregate fair value of our previously-held investments immediately prior to the acquisition dates was $251 million. We remeasured the fair value of each previously-held investment based on the implied enterprise value and allocation of purchase price consideration according to priority of equity interests.

Purchase Price Allocation

We accounted for our 2018 acquisitions as business combinations, and in accordance with FASB ASC Topic 805, we recorded the assets acquired and liabilities assumed at their respective fair values as of the acquisition dates. The components of the aggregate purchase prices are as follows for our 2018 acquisitions as of September 30, 2019:

(in millions)
Payments for acquisitions, net of cash acquired	$	969
Fair value of contingent consideration	190
Fair value of prior interests	251
	$	1,410

The following summarizes the aggregate purchase price allocations for our 2018 acquisitions as of September 30, 2019:

(in millions)
Goodwill	$	618
Amortizable intangible assets	707
Indefinite-lived intangible assets	213
Other assets acquired	19
Liabilities assumed	(14		)
Net deferred tax liabilities	(134		)
	$	1,410

We allocated a portion of the aggregate purchase prices to specific intangible asset categories as follows for our 2018 acquisitions as of September 30, 2019:

	Amount Assigned (in millions)		Amortization Period (in years)			Risk-Adjusted Discount Rates used in Purchase Price Allocation
Amortizable intangible assets:
Technology-related	$	697	10	-	14	17	%	-	23%
Other intangible assets	10		6	-	13	13	%	-	15%
Indefinite-lived intangible assets:
IPR&D	213		N/A			15%
	$	920

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

Goodwill was primarily established due to synergies expected to be gained from leveraging our existing operations as well as revenue and cash flow projections associated with future technologies and has been allocated to our reportable segments based on the relative expected benefit. Based on preliminary estimates updated for applicable regulatory changes, the goodwill recorded relating to our 2019 and 2018 acquisitions is not deductible for tax purposes.

Contingent Consideration

Changes in the fair value of our contingent consideration liability were as follows:

(in millions)
Balance as of December 31, 2018	$	347
Amount recorded related to current year acquisitions	127
Contingent consideration arrangements transferred to Varian	(16		)
Contingent consideration expense (benefit)	(9		)
Contingent consideration payments	(68		)
Balance as of September 30, 2019	$	380

As of September 30, 2019, the maximum amount of future contingent consideration (undiscounted) that we could be required to pay was $747 million, which includes our estimate of maximum contingent payments of $100 million associated with the Vertiflex acquisition described above. The maximum decreased $126 million compared to the amount as of December 31, 2018 primarily due to the contingent consideration arrangement which is now accounted for as a guarantee in connection with our transaction with Varian as discussed in the BTG section above.

The recurring Level 3 fair value measurements of our contingent consideration liability include the following significant unobservable inputs:

Contingent Consideration Liability	Fair Value as of September 30, 2019	Valuation Technique	Unobservable Input	Range				Weighted Average (1)
R&D, Regulatory and Commercialization-based Milestones	$220 million	Discounted Cash Flow	Discount Rate	2	%	-	3%	3%
			Probability of Payment	50	%	-	90%	84%
			Projected Year of Payment	2019		-	2027	2020
Revenue-based Payments	$160 million	Discounted Cash Flow	Discount Rate	11	%	-	15%	13%
			Probability of Payment	60	%	-	100%	99%
			Projected Year of Payment	2019		-	2026	2021

(1) Unobservable inputs were weighted by the relative fair value of the contingent consideration liability. For projected year of payment, the amount represents the median of the inputs and is not a weighted average.

Projected contingent payment amounts related to some of our research and development (R&D), commercialization-based and revenue-based milestones are discounted back to the current period using a discounted cash flow model. Significant increases or decreases in projected revenues, probabilities of payment, discount rates or the time until payment is made would have resulted in a significantly lower or higher fair value measurement as of September 30, 2019.

Strategic Investments

The aggregate carrying amount of our strategic investments was comprised of the following:

	As of
(in millions)	September 30, 2019		December 31, 2018
Equity method investments	$	270	$	303
Measurement alternative investments (1)	173		94
Notes receivable	23		26
	$	468	$	424

(1) Measurement alternative investments are privately-held equity securities without readily determinable fair values that are measured at cost minus impairment, if any, plus or minus changes resulting from observable price changes in orderly transactions for the identical or a similar investment of the same issuer.

These investments are classified as Other long-term assets within our accompanying unaudited condensed consolidated balance sheets, in accordance with U.S. GAAP and our accounting policies.

As of September 30, 2019, the cost of our aggregated equity method investments exceeded our share of the underlying equity in net assets by $308 million, which represents amortizable intangible assets, IPR&D, goodwill and deferred tax liabilities.