Medtronic plc — FY2015 Form 10-K
Reporting period: Fiscal year ended April 24, 2015 (52 weeks). Although the request refers to 2014 Q4, this filing reports FY2015; its fourth quarter ended April 24, 2015. Medtronic acquired Covidien on January 26, 2015, so FY2015 includes only about one quarter of Covidien results. Comparisons with FY2014 are therefore materially affected by the acquisition.
Business context and reporting period
Medtronic is a global medical-technology company operating in approximately 160 countries. After acquiring Covidien in a cash-and-stock transaction valued at approximately $50 billion, the company reported four groups: Cardiac and Vascular, Minimally Invasive Therapies, Restorative Therapies, and Diabetes. Management’s stated strategies are therapy innovation, globalization, and economic value in healthcare.
Financial results and liquidity
| Metric | FY2015 | FY2014 |
|---|---|---|
| Net sales | $20.261 billion | $17.005 billion |
| Operating profit / margin | $3.766 billion / 18.6% | $3.813 billion / 22.4% |
| Net income | $2.675 billion | $3.065 billion |
| Diluted EPS | $2.41 | $3.02 |
| Operating cash flow | $4.902 billion | $4.959 billion |
| Capital expenditures | $571 million | $396 million |
| Free cash flow (company-defined non-GAAP) | $4.331 billion | $4.563 billion |
FY2015 gross profit was $13.952 billion, or approximately 68.9% of sales, versus approximately 74.5% in FY2014. Lower reported margins reflect, in part, Covidien’s product mix and $623 million of acquisition-related inventory step-up amortization. Foreign-currency translation reduced FY2015 sales by $666 million.
FY2015 sales increased 19%, primarily due to Covidien; legacy group growth was 6% in Cardiac and Vascular, 4% in Restorative Therapies, and 6% in Diabetes. Minimally Invasive Therapies contributed $2.387 billion after the acquisition. On an unaudited pro forma basis, as if Covidien had been acquired at the start of FY2014, sales were $28.369 billion in FY2015 and $27.380 billion in FY2014; pro forma net income was $3.944 billion and $3.280 billion, respectively.
At year-end, cash, cash equivalents, and current investments totaled $19.480 billion; total debt was approximately $36.186 billion, producing a reported net cash position of negative $16.706 billion. Working capital was $21.671 billion and the current ratio was 3.4:1. Long-term debt was $33.752 billion. Debt-to-total-capital was 40%, compared with 38% a year earlier. The company reported no commercial paper outstanding and no borrowings on its $3.5 billion revolving credit facility. It stated that available liquidity was expected to meet foreseeable working-capital needs for at least 12 months.
Cash provided by operating activities was nearly flat year over year. Investing cash use rose to $17.058 billion, primarily reflecting the Covidien acquisition; financing provided $15.949 billion, largely from debt issuance. Dividends declared were $1.22 per share, versus $1.12 in FY2014.
Material changes and unusual items
- Covidien contributed $2.683 billion of sales from the acquisition date through year-end. Its reported operating loss of $423 million included $623 million of inventory step-up amortization, $379 million of acquired-intangible amortization, $218 million of acquisition-related charges, and $142 million of restructuring charges.
- Acquisition-related expenses were $550 million; intangible amortization was $733 million, up from $349 million; and net interest expense increased to $280 million from $108 million, reflecting acquisition financing.
- FY2015 included $237 million of restructuring charges, net, and $42 million of litigation charges, compared with $770 million of litigation charges in FY2014, largely associated with an Edwards patent settlement.
- The effective tax rate was 23.3%, versus 17.3%. A $349 million tax adjustment included a $329 million expected resolution of Kyphon-related IRS issues and a $20 million Covidien-acquisition tax charge.
- Reported quarterly FY2015 sales were $7.304 billion in Q4, compared with $4.566 billion in Q4 FY2014; Q4 FY2015 net income was a loss of $1 million, and diluted EPS rounded to zero. Acquisition accounting and other unusual charges materially affected the quarter.
Outlook, commentary, and risks
- Management expected FY2016 R&D expense to be 7%–8% of sales and approximately $208 million of additional inventory step-up amortization in Q1 FY2016.
- Management expected approximately $850 million of Covidien-related cost synergies through FY2018, with restructuring charges expected during FY2016. The filing cautions that synergies may be delayed or not achieved.
- No consolidated sales, earnings, or EPS guidance is stated in the provided filing text. Management discussed product launches, market acceptance, and growth opportunities, while citing pricing pressure, reimbursement constraints, competition, foreign exchange, and integration execution as factors affecting performance.
- In April 2015, Medtronic entered an FDA consent decree concerning the SynchroMed drug infusion system and Neuromodulation quality system. The decree restricts manufacture and distribution until specified corrections and an acceptable third-party certification are completed; it does not require product retrieval.
- Product-liability and other legal exposures include approximately 800 filed INFUSE lawsuits representing about 1,500 individual claims and an estimated 4,600 unfiled claimants as of June 1, 2015. Accrued certain litigation charges were $879 million at year-end; actual outcomes and additional losses remain uncertain.
- Tax uncertainties include a pending Medtronic transfer-pricing dispute concerning income allocation to Puerto Rico, with a Tax Court ruling expected in FY2017, and Covidien-related tax-sharing exposures. The filing discusses an IRS assessment against former Tyco entities of $914 million plus $154 million penalties, excluding interest; the dispute’s outcome is uncertain.
- The company disclosed approximately $4 million of FY2015 gross revenue and $3 million of net profit from certain Iran sales by a non-U.S. affiliate that were not covered by a general OFAC license at the time. It later obtained required specific licenses and submitted an initial voluntary self-disclosure to OFAC.
- Other principal risks include regulatory approval and product-quality issues, patent litigation, self-insured product-liability exposure, supply interruptions, reimbursement and pricing changes, foreign-exchange and international credit risks, and the possibility of higher taxes or weaker liquidity from substantial acquisition debt.
Important facts for investors to verify
- Separate acquired Covidien revenue and acquisition/accounting effects from underlying comparable growth; the filing’s FY2015 reported growth is not directly comparable with FY2014.
- Track the integration plan, realization and timing of the targeted $850 million in synergies, restructuring charges, and the effect of purchase-accounting amortization on margins and earnings.
- Monitor debt repayment, interest costs, credit ratings, cash availability, and the company’s ability to maintain liquidity while servicing acquisition-related obligations.
- Follow FDA consent-decree milestones for SynchroMed, related operating restrictions, and any resulting effects on product supply or sales.
- Review developments in INFUSE and pelvic-mesh litigation, the Puerto Rico tax dispute, Covidien-related tax-sharing matters, and the OFAC disclosure.
- Confirm subsequent performance against management’s stated FY2016 R&D range and disclosed Q1 inventory amortization, and look for any later consolidated guidance.