Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations

Overview

The following discussion and analysis contains forward-looking statements within the meaning of the federal securities laws, and should be read in conjunction with the disclosures we make concerning risks and other factors that may affect our business and operating results. See “Note Regarding Forward-Looking Statements” preceding Part I, Item 1 in this Quarterly Report on Form 10-Q.

We are the global leader in patient-focused medical innovations for structural heart disease and critical care monitoring. Driven by a passion to help patients, we partner with the world's leading clinicians and researchers and invest in research and development to transform care for those impacted by structural heart disease or who require hemodynamic monitoring during surgery or in intensive care. We conduct operations worldwide and are managed in the following geographical regions: United States, Europe, Japan, and Rest of World. Our products are categorized into the following areas: Transcatheter Aortic Valve Replacement ("TAVR"), Transcatheter Mitral and Tricuspid Therapies ("TMTT"), Surgical Structural Heart ("Surgical"), and Critical Care.

Financial Highlights and Market Update

The COVID-19 pandemic has adversely impacted, and may further adversely impact, nearly all aspects of our business and markets, including our workforce and the operations of our customers, suppliers, and business partners. Our priority has been to maintain access for patients to our life-saving technologies while providing continuous front-line support to our clinician partners, and protecting the well-being of our employees. Our manufacturing operations have continued to respond to impacts related to COVID-19, and we have been able to supply our technologies around the world. Across the organization, we are proactively managing inventory, assessing alternative logistics options, and closely monitoring the supply of components.

During the first quarter of 2021, COVID-19 stressed the global healthcare system during the winter months. However, we saw strong recovery beginning in the second quarter of 2021 as COVID vaccines became more widely available and patients who had postponed their care were treated.

During the first quarter of 2022, the Omicron variant had a pronounced impact on hospital capacity, resources, and procedure volumes in January 2022, especially in the United States. Outside the United States, we experienced a less pronounced year-over-year impact from the pandemic.

During the second quarter of 2022, our sales were impacted by slower than expected improvement in United States hospital staffing shortages and foreign currency headwinds.

Despite the challenging macroeconomic factors, our net sales for the first six months of 2022 were $2.7 billion, representing an increase of $122.5 million over the first six months of 2021, driven primarily by sales of our TAVR products.

Our gross profit increase in the six months ended June 30, 2022 was driven by our sales growth and the positive impact of our foreign currency hedging program. The decrease in our diluted earnings per share in the six months ended June 30, 2022 was driven by changes in the fair value of our contingent consideration liabilities, which resulted in a $98.1 million after tax gain in the first six months of 2021 compared to a $21.9 million after tax gain in the first six months of 2022, and increased sales and marketing and research and development expenses in 2022, partially offset by the aforementioned gross profit increase.

We continue to closely monitor the impact of COVID-19 on all aspects of our business and geographies, including its impact on our customers, employees, suppliers, vendors, business partners, and distribution channels. The extent to which the COVID-19 global pandemic and measures taken in response thereto impact our business, results of operations, and financial condition will depend on future developments, which are highly uncertain and are difficult to predict. These developments include, but are not limited to, the duration and spread of the outbreak (including new and more contagious variants of COVID-19), its severity, the actions to contain the virus or address its impact, the timing, distribution, public acceptance and efficacy of vaccines and other treatments, and the associated impact on economic and operating conditions. Even after the COVID-19 outbreak has subsided, we may continue to experience materially adverse impacts on our financial condition and results of operations.

Healthcare Environment, Opportunities, and Challenges

The medical technology industry is highly competitive and continues to evolve. Our success is measured both by the development of innovative products and the value we bring to our stakeholders. We are committed to developing new technologies and providing innovative patient care, and we are committed to defending our intellectual property in support of those developments. Despite the challenges of the COVID-19 pandemic, our dedicated field teams have found creative ways to support physicians, our engineers continued to advance innovation, and our colleagues worked diligently to keep our clinical trials on track. In the first six months of 2022, we invested 17.7% of our net sales in research and development.

Results of Operations

Net Sales by Region

(dollars in millions)

			Three Months Ended June 30,																								Six Months Ended June 30,
									Percent Change												Percent Change
			2022						2021						Change						2022						2021						Change
United States			$	800.8					$	795.7					$	5.1					0.6		%				$	1,550.3					$	1,470.4					$	79.9					5.4		%
Europe			302.8						309.8						(7.0)						(2.2)		%				613.9						589.8						24.1						4.1		%
Japan			122.9						131.8						(8.9)						(6.8)		%				258.4						264.1						(5.7)						(2.2)		%
Rest of World			147.4						138.7						8.7						6.1		%				292.5						268.3						24.2						9.0		%
Outside of the United States			573.1						580.3						(7.2)						(1.2)		%				1,164.8						1,122.2						42.6						3.8		%
Total net sales			$	1,373.9					$	1,376.0					$	(2.1)					(0.1)		%				$	2,715.1					$	2,592.6					$	122.5					4.7		%

Net sales outside of the United States include the impact of foreign currency exchange rate fluctuations. The impact of foreign currency exchange rate fluctuations on net sales is not necessarily indicative of the impact on net income due to the corresponding effect of foreign currency exchange rate fluctuations on international manufacturing and operating costs, and our hedging activities.

Net Sales by Product Group

(dollars in millions)

			Three Months Ended June 30,																								Six Months Ended June 30,
									Percent Change												Percent Change
			2022						2021						Change						2022						2021						Change
Transcatheter Aortic Valve Replacement			$	906.9					$	901.5					$	5.4					0.6		%				$	1,788.2					$	1,693.2					$	95.0					5.6		%
Transcatheter Mitral and Tricuspid Therapies			27.9						22.1						5.8						25.6		%				54.9						38.4						16.5						42.6		%
Surgical Structural Heart			228.5						237.4						(8.9)						(3.7)		%				449.3						450.4						(1.1)						(0.2)		%
Critical Care			210.6						215.0						(4.4)						(2.0)		%				422.7						410.6						12.1						3.0		%
Total net sales			$	1,373.9					$	1,376.0					$	(2.1)					(0.1)		%				$	2,715.1					$	2,592.6					$	122.5					4.7		%

Transcatheter Aortic Valve Replacement Sales

Net sales of TAVR products increased for the three and six months ended June 30, 2022 driven by:

• higher sales of the Edwards SAPIEN platform in 2022, primarily the Edwards SAPIEN 3 Ultra valve in the United States and Europe, and the Edwards SAPIEN 3 in Japan;

partially offset by:

• foreign currency exchange rate fluctuations, which decreased net sales outside of the United States by $36.4 million and $52.7 million for the three and six months ended June 30, 2022, respectively, primarily due to the weakening of the Euro and the Japanese yen against the United States dollar.

During the first half of 2022, we continued to advance our EARLY TAVR pivotal trial, studying the treatment of severe aortic stenosis patients before their symptoms develop, and our PROGRESS pivotal trial, studying moderate aortic stenosis patients. During the second quarter of 2022, we began treating patients in our ALLIANCE pivotal trial, studying our next-generation TAVR technology, SAPIEN X4.

Transcatheter Mitral and Tricuspid Therapies Sales

Net sales of TMTT products increased for the three and six months ended June 30, 2022 primarily due to continued adoption of our PASCAL system in Europe.

We remain on track for United States Food and Drug Administration approval and CE Mark Medical Device Regulation approval of PASCAL Precision for patients with degenerative mitral regurgitation by year end. In mitral replacement, we continued to broaden our experience with both of our transcatheter mitral replacement therapies through the ENCIRCLE pivotal trial for SAPIEN M3 and the MISCEND study for EVOQUE Eos. We also continued to make progress in enrolling the TRISCEND II pivotal trial of the EVOQUE system and the CLASP IITR pivotal trial with PASCAL in patients with symptomatic, severe tricuspid regurgitation..

Surgical Structural Heart Sales

Net sales of Surgical products decreased for the three and six months ended June 30, 2022 primarily due to foreign currency exchange rate fluctuations, which decreased net sales outside of the United States by $12.0 million and $17.4 million for the three and six months ended June 30, 2022, respectively, primarily due to the weakening of the Euro and the Japanese yen against the United States dollar. The impact of foreign currency was partially offset by increased sales of the INSPIRIS RESILIA aortic valve, primarily in the United States and Europe, the KONECT aortic valved conduit, primarily in the United States, and the MITRIS RESILIA valve, primarily in the United States and Japan.

In March 2022, we received United States Food and Drug Administration approval for the MITRIS RESILIA valve and initiated the product launch in the United States in April 2022. MITRIS RESILIA is a tissue valve replacement specifically designed for the heart's mitral position and incorporates our advanced RESILIA technology.

Critical Care Sales

Net sales of Critical Care products decreased for the three months ended June 30, 2022 and increased for the six months ended June 30, 2022 primarily due to:

• increased demand for our HemoSphere monitoring platform, pressure monitoring products, and enhanced surgical recovery products, primarily in the United States;

partially offset by:

• foreign currency exchange rate fluctuations, which decreased net sales outside of the United States by $9.6 million and $14.1 million for the three and six months ended June 30, 2022, respectively, primarily due to the weakening of the Euro and the Japanese yen against the United States dollar.

Gross Profit

The increase in gross profit as a percentage of net sales for the three and six months ended June 30, 2022 was driven by a 3.8 percentage point and 3.1 percentage point increase for the three and six months ended June 30, 2022, respectively, from the impact of our foreign currency hedging program, which includes natural hedges and hedge contract gains (primarily the strengthening of the United States dollar against the Japanese yen and the Euro).

Selling, General, and Administrative ("SG&A") Expenses

SG&A expenses increased for the three and six months ended June 30, 2022 primarily due to higher field-based personnel-related costs and a resu'mption of in-person commercial activities, primarily TAVR and TMTT in the United States and Europe. Foreign currency exchange rate fluctuations decreased expenses by $15.5 million and $22.4 million for the three and six months ended June 30, 2022, respectively, due to the weakening of the Euro and the Japanese yen against the United States dollar.

Research and Development ("R&D") Expenses

R&D expenses increased for the three and six months ended June 30, 2022 primarily due to continued investments in our transcatheter innovations, including increased clinical trial activity.

Change in Fair Value of Contingent Consideration Liabilities, net

The change in fair value of contingent consideration liabilities resulted in gains of $20.9 million and $102.6 million for the three and six months ended June 30, 2022 and 2021, respectively. The gains were driven by changes in the projected probability and timing of milestone achievements and the projected timing of cash inflows. For further information, see Note 5 to the "Consolidated Condensed Financial Statements."

Other Income, net

(in millions)

			Three Months Ended June 30,												Six Months Ended June 30,
			2022						2021						2022						2021
Foreign exchange losses (gains), net			$	1.8					$	(2.7)					$	4.3					$	(4.4)
Gain on insurance settlement			(3.8)						—						(3.8)						—
(Gain) loss on investments			(0.8)						(1.4)						0.1						(4.1)
Other			(1.5)						(0.3)						(1.6)						(1.4)
Other income, net			$	(4.3)					$	(4.4)					$	(1.0)					$	(9.9)

The net foreign exchange losses (gains) relate to the foreign currency fluctuations primarily in our global trade and intercompany receivable and payable balances, partially offset by the gains and losses on foreign currency derivative instruments.

The gain on insurance settlement in the three and six months ended June 30, 2022 relates to an insurance recovery for damaged cargo shipments of heart valves.

The (gain) loss on investments primarily represents our net share of gains and losses in investments accounted for under the equity method, and realized gains and losses on investments in equity securities.

Provision for Income Taxes

The provision for income taxes consists of provisions for federal, state, and foreign income taxes. We operate in an international environment with significant operations in various locations outside the United States which have statutory tax rates typically lower than the United States tax rate. Accordingly, the consolidated income tax rate is a composite rate reflecting the earnings in the various locations and the applicable rates.

Our effective income tax rate was 12.5% and 10.3% for the three months ended June 30, 2022 and 2021, respectively, and 13.4% and 11.5% for the six months ended June 30, 2022 and 2021, respectively. The increase in the effective rate between the six months ended June 30, 2022 and 2021 was primarily due to a reduced tax benefit from employee share-based compensation and the estimated impact of U.S. foreign tax credit regulations published by the U.S. Treasury on January 4, 2022 . These regulations limit the amount of foreign taxes that are creditable against U.S. income taxes. In addition, the effective rates for the six months ended June 30, 2022 and 2021 were lower than the federal statutory rate of 21% primarily due to (1) foreign earnings taxed at lower rates, (2) Federal and California research and development credits, and (3) the tax benefit from employee share-based compensation.

In the normal course of business, the Internal Revenue Service (“IRS”) and other taxing authorities are in different stages of examining various years of our tax filings. During these audits we may receive proposed audit adjustments that could be material. Therefore, there is a possibility that an adverse outcome in these audits could have a material effect on our results of operations and financial condition. We strive to resolve open matters with each tax authority at the examination level and could reach agreement with a tax authority at any time. While we have accrued for matters we believe are more likely than not to require settlement, the eventual outcome with a tax authority may result in a tax liability that is more or less than that reflected in the consolidated condensed financial statements. Furthermore, we may later decide to challenge any assessments, if made, and may exercise our right to appeal. The uncertain tax positions are reviewed quarterly and adjusted as events occur that affect potential liabilities for additional taxes, such as lapsing of applicable statutes of limitations, proposed assessments by tax authorities, negotiations between tax authorities, identification of new issues, and issuance of new legislation, regulations, or case law.

We executed an Advance Pricing Agreement ("APA") in 2018 between the United States and Switzerland governments for tax years 2009 through 2020 covering various, but not all, transfer pricing matters. The unagreed transfer pricing matters, namely Surgical Structural Heart and Transcatheter Aortic Valve Replacement (collectively "Surgical/TAVR") intercompany royalty transactions, then reverted to IRS Examination for further consideration as part of the respective years' regular tax audits. In addition, we executed other bilateral APAs as follows: during 2017, an APA between the United States and Japan covering tax years 2015 through 2019; and during 2018, APAs between Japan and Singapore and between Switzerland and Japan covering tax years 2015 through 2019. We have filed to renew all the APAs which cover transactions with Japan for the years 2020 and forward. The execution of some or all these APA renewals depends on many variables outside of our control.

At June 30, 2022, all material state, local, and foreign income tax matters have been concluded for years through 2015. While not material, we continue to address matters in India for years from 2010.

The audits of our United States federal income tax returns through 2014 have been closed. The IRS audit field work for the 2015 through 2017 tax years was substantially completed during the fourth quarter of 2020, except for transfer pricing and related matters. The IRS began its examination of the 2018 through 2020 tax years during the first quarter of 2022.

During 2021, we received a Notice of Proposed Adjustment (“NOPA”) from the IRS for the 2015-2017 tax years relating to transfer pricing involving certain Surgical/TAVR intercompany royalty transactions between our United States and Switzerland subsidiaries. The NOPA proposes an increase to our United States taxable income, which could result in additional tax expense for this period of approximately $180 million and represents a significant change to previously agreed upon transfer pricing methodologies for these types of transactions. We have formally disagreed with the NOPA and submitted a formal protest on the matter during the fourth quarter of 2021. During the second quarter of 2022, we received the IRS's rebuttal to our protest and were notified that the case had been transferred to the IRS Independent Office of Appeals. We continue to evaluate all possible remedies available to us, which could take several years to resolve. No payment of any amount related to the NOPA is required to be made, if at all, until all applicable proceedings have been completed. We believe the amounts previously accrued related to this uncertain tax position are sufficient and, accordingly, have not accrued any additional amount based on the NOPA received.

Certain Surgical/TAVR intercompany royalty transactions covering tax years 2015-2022 that were not resolved under the APA program remain subject to IRS examination, and those transactions and related tax positions remain uncertain as of June 30, 2022. We have considered this information, as well as information regarding the NOPA and rebuttal described above, in our evaluation of our uncertain tax positions. The impact of these unresolved transfer pricing matters, net of any correlative repatriation tax adjustment, may be significant to our consolidated condensed financial statements. Based on the information currently available and numerous possible outcomes, we cannot reasonably estimate what, if any, changes in our existing uncertain tax positions may occur in the next 12 months and, therefore, have continued to record the uncertain tax positions as a long-term liability.

Liquidity and Capital Resources

Our sources of cash liquidity include cash and cash equivalents, short-term investments, cash from operations, and amounts available under credit facilities. We believe that these sources are sufficient to fund the current and long-term requirements of working capital, capital expenditures, and other financial commitments. However, we periodically consider various financing alternatives and may, from time to time, seek to take advantage of favorable interest rate environments or other market conditions.

As of June 30, 2022, cash and cash equivalents and short-term investments held in the United States and outside of the United States were $1,065.6 million and $450.2 million, respectively.

We had a Five-Year Credit Agreement ("the Prior Credit Agreement") which was scheduled to mature on April 28, 2023 and provided up to an aggregate of $750.0 million in borrowings in multiple currencies. As of June 30, 2022, there were no borrowings outstanding under the Prior Credit Agreement and we were in compliance with all covenants. In July 2022, we entered into a new Five-Year Credit Agreement (the "New Credit Agreement") which provides for a $750.0 million multi-currency unsecured revolving credit facility (the "Revolving Facility") and replaced the Prior Credit Agreement. The New Credit Agreement matures on July 15, 2027. We may increase the amount available under the Revolving Facility by up to an additional $250.0 million in the aggregate and extend the maturity date for an additional year, subject to agreement of the lenders. As of July 29, 2022, no amounts were outstanding under the Revolving Facility. For further information, see Note 14 to the "Consolidated Condensed Financial Statements."

In June 2018, we issued $600.0 million of 4.3% fixed-rate unsecured senior notes (the "2018 Notes") due June 15, 2028. As of June 30, 2022, the carrying value of the 2018 Notes was $596.0 million.

From time to time, we repurchase shares of our common stock under share repurchase programs authorized by the Board of Directors. We consider several factors in determining when to execute share repurchases, including, among other things, expected dilution from stock plans, cash capacity, and the market price of our common stock. During the six months ended June 30, 2022, under the Board authorized repurchase program, we repurchased a total of 7.2 million shares at an aggregate cost of $746.4 million. As of June 30, 2022, we had remaining authority to purchase $380.1 million of our common stock. In July 2022, the Board of Directors approved an additional $1.5 billion of repurchases of our common stock under our share repurchase program, effective July 28, 2022. This share repurchase program has no expiration date.

At June 30, 2022, there had been no material changes in our cash requirements from known contractual and other obligations, including commitments for capital expenditures, as disclosed in Item 7, "Management's Discussion and Analysis of Financial Condition and Results of Operations," of our Annual Report on Form 10-K for the year ended December 31, 2021.

Consolidated Cash Flows - For the six months ended June 30, 2022 and 2021:

Net cash flows provided by operating activities of $625.5 million for the six months ended June 30, 2022 decreased $201.1 million over the same period last year primarily due to a higher bonus payout in 2022 associated with 2021 performance, an increase in inventory builds compared to the prior year, and an increase in estimated tax payments.

Net cash provided by investing activities of $359.1 million for the six months ended June 30, 2022 consisted primarily of net proceeds from investments of $558.4 million, partially offset by capital expenditures of $115.8 million.

Net cash used in investing activities of $379.2 million for the six months ended June 30, 2021 consisted primarily of net purchases of investments of $204.8 million and capital expenditures of $175.3 million.

Net cash used in financing activities of $676.2 million for the six months ended June 30, 2022 consisted primarily of purchases of treasury stock of $760.7 million, partially offset by proceeds from stock plans of $86.5 million.

Net cash used in financing activities of $333.3 million for the six months ended June 30, 2021 consisted primarily of purchases of treasury stock of $414.5 million, partially offset by proceeds from stock plans of $85.8 million.

Critical Accounting Policies and Estimates

The consolidated condensed financial statements have been prepared in accordance with accounting principles generally accepted in the United States which require us to make estimates and assumptions that affect the reported amounts of assets and liabilities at the date of the consolidated condensed financial statements and revenues and expenses during the periods reported. Actual results could differ from those estimates. Information with respect to our critical accounting policies and estimates which we believe could have the most significant effect on our reported results and require subjective or complex judgments by management is contained on pages 34-36 in Item 7, "Management's Discussion and Analysis of Financial Condition and Results of Operations," of our Annual Report on Form 10-K for the year ended December 31, 2021. There have been no significant changes from the information discussed therein.