Medtronic plc — Fiscal 2017 First-Quarter 10-Q
Reporting period: Three months ended July 29, 2016; comparative quarter ended July 31, 2015. Figures are unaudited and in U.S. dollars unless noted. Medtronic is a global medical technology company operating through Cardiac and Vascular, Minimally Invasive Therapies, Restorative Therapies, and Diabetes groups.
Financial performance
| Metric | Q1 FY2017 | Q1 FY2016 | Change / context |
|---|---|---|---|
| Net sales | $7.166 billion | $7.274 billion | Down 1%; prior-year quarter included an additional selling week, estimated to have added about $450 million to sales |
| Operating profit | $1.167 billion | $1.131 billion | Up 3%; operating margin 16.3%, versus 15.5% |
| Net income | $929 million | $820 million | Up 13%; benefited from a lower tax provision |
| Diluted EPS | $0.66 | $0.57 | Up 16% |
| GAAP effective tax rate | 6.0% | 12.8% | FY2017 rate included a $31 million net tax benefit from specific tax adjustments |
| Non-GAAP net income / diluted EPS | $1.444 billion / $1.03 | $1.462 billion / $1.02 | Adjusted net income down about 1%; non-GAAP figures exclude specified items and are not GAAP measures |
| Operating cash flow | $1.550 billion | $816 million | Increase largely reflected lower cash taxes paid and higher income before noncash charges |
| Free cash flow | $1.220 billion | $592 million | Company-defined non-GAAP measure: operating cash flow less capital expenditures |
| Cash dividends declared per ordinary share | $0.43 | $0.38 | Up from prior-year quarter |
Cost of products sold was 31.6% of sales, compared with 33.8%, principally because the prior-year quarter included a $226 million Covidien inventory fair-value step-up charge. R&D was $556 million and SG&A was $2.428 billion. FY2017 included $94 million of restructuring charges, $82 million of certain litigation charges, $52 million of acquisition-related costs, and $487 million of intangible amortization.
Segments and material changes
- Cardiac and Vascular sales were $2.518 billion, down 2%; Cardiac Rhythm and Heart Failure and Coronary and Structural Heart each declined 3%, while Aortic and Peripheral Vascular grew 3%.
- Minimally Invasive Therapies sales were $2.424 billion, down 1%; Surgical Solutions was flat and Patient Monitoring and Recovery declined 3%.
- Restorative Therapies sales were $1.772 billion, down 2%; Brain Therapies grew 5% and Specialty Therapies 3%, offset by declines in Spine (6%) and Pain Therapies (9%).
- Diabetes sales were $452 million, up 2%, supported by international growth.
- Management attributed the reported sales decline primarily to the prior-year extra selling week; currency translation reduced sales by about $7 million. U.S. sales were down 3%, non-U.S. developed-market sales up 2%, and emerging-market sales approximately flat.
- Operating cash flow rose substantially, but the company said the comparison benefited from $521 million less cash paid for income taxes than in the prior-year quarter. Share repurchases increased to $1.763 billion from $750 million.
Financial position and liquidity
- At July 29, 2016, cash and cash equivalents were $3.060 billion and current investments were $9.750 billion. Current assets were $23.498 billion and current liabilities $7.896 billion; working capital was $15.602 billion and the current ratio 3.0.
- Current and long-term debt totaled $32.071 billion, versus $31.102 billion at April 29, 2016. The company reported a net cash position, as defined in the filing, of negative $19.261 billion; debt-to-total-capital was 39%, up from 37%.
- Commercial paper outstanding was $975 million; there were no borrowings under the $3.5 billion revolving credit facility. Management said available liquidity and the facility were expected to meet foreseeable working-capital needs for at least 12 months, while noting approximately $5 billion of cash and investments at certain non-U.S. subsidiaries might not be generally available for corporate purposes.
- Total assets were $98.601 billion, including $41.309 billion of goodwill and $26.437 billion of net intangible assets. Shareholders’ equity was $50.824 billion.
Outlook, management commentary, and notable items
- No consolidated revenue or earnings guidance was provided in the supplied filing text. Management identified competitive and pricing pressure, reimbursement and procedure-volume changes, product approvals, foreign exchange, and product acceptance as factors that could affect results.
- Medtronic continued its Covidien integration cost-synergy program, targeting approximately $850 million of synergies through fiscal 2018. It recorded $111 million of related restructuring charges in the quarter, partly offset by a $7 million reversal of prior accruals.
- After quarter-end, Medtronic acquired Smith & Nephew’s gynecology business for approximately $350 million on August 5, 2016, and HeartWare International for approximately $1.1 billion on August 23, 2016.
- Tax matters materially affected reported earnings: the quarter included a $431 million benefit from resolution of Tyco intercompany-debt issues, partly offset by a $371 million charge for expected IRS resolutions involving certain acquisitions and Puerto Rico income allocations, plus a $29 million charge related to an intercompany minority-interest redemption. The company reported $1.9 billion of gross unrecognized tax benefits and $261 million of accrued gross interest and penalties.
- Accrued certain litigation charges were approximately $1.1 billion at quarter-end, and the company recorded an additional $82 million expense for probable and estimable damages. The filing describes product-liability, pelvic-mesh, environmental, shareholder, intellectual-property, government-investigation, and tax matters; outcomes and potential costs may differ materially from estimates.
- The company had $279 million of gross unrealized losses on available-for-sale debt securities and noted that some investments, including auction-rate securities, had reduced liquidity. It cautioned that worsening market conditions could lead to future impairment charges.
- Disclosure controls were deemed effective. Deployment of an SAP ERP platform in the Minimally Invasive Therapies Group materially changed that group’s internal financial-reporting controls; implementation was expected to continue through fiscal 2018.
Important facts for investors to verify
- How much of sales performance reflects underlying demand after adjusting for the prior-year extra selling week, currency effects, and product mix.
- Whether the unusually low GAAP tax rate and reported EPS are repeatable; compare GAAP results with the company’s non-GAAP reconciliation and review the remaining tax disputes and unrecognized tax benefits.
- The timing and cash impact of litigation settlements, particularly INFUSE and pelvic-mesh claims, and whether the $1.1 billion litigation accrual is adequate.
- Whether operating cash flow and free cash flow remain strong after the unusually favorable year-over-year cash-tax comparison, while funding dividends, buybacks, acquisitions, and debt obligations.
- Progress toward the $850 million Covidien synergy target, and the integration, financing, and performance implications of the post-quarter acquisitions.
- Investment liquidity and impairment exposure, as well as any material changes in debt, ratings, or access to cash held by non-U.S. subsidiaries.