Medtronic plc — Form 10-Q Summary
Reporting period: Second quarter and first six months of fiscal 2017, ended October 28, 2016. Comparative periods ended October 30, 2015. All amounts are U.S. dollars; financial statement figures are in millions unless noted.
Financial performance
| Metric | Q2 FY2017 | Q2 FY2016 | Six months FY2017 | Six months FY2016 |
|---|---|---|---|---|
| Net sales | $7,345 | $7,058 | $14,511 | $14,332 |
| Operating profit | $1,385 | $1,300 | $2,552 | $2,431 |
| Net income attributable to Medtronic | $1,115 | $520 | $2,044 | $1,340 |
| Diluted EPS | $0.80 | $0.36 | $1.46 | $0.94 |
| Operating margin | 18.9% | 18.4% | 17.6% | 17.0% |
Sales increased 4% in Q2 and 1% for the six-month period. The six-month comparison was affected by an extra selling week in the prior-year first quarter, which management estimated reduced the current-period comparison by about $450 million. Currency translation benefited sales by $50 million in Q2 and $43 million for the six months. Q2 gross margin was 68.3%, versus 69.1%; the decline principally reflected a $38 million HeartWare inventory fair-value step-up charge. Six-month gross margin was 68.4%, versus 67.6%, partly because the prior-year period included a $226 million Covidien inventory step-up charge.
The sharp increase in GAAP earnings largely reflects the prior-year $442 million tax charge related to an internal reorganization, as well as a much lower current-period effective tax rate. Effective tax rates were 8.3% in Q2 and 7.3% for the six months, compared with 52.0% and 33.8%. Adjusted non-GAAP nominal rates were 14.7% and 15.2%, respectively, versus 16.5% and 17.3% in the comparable periods. Non-GAAP diluted EPS was $1.12 for Q2 and $2.15 for the six months; these measures exclude specified items and are not GAAP results.
Segments and material changes
- Cardiac and Vascular: Sales rose 4% in Q2 and 1% year to date. HeartWare contributed following its August acquisition; growth in AF solutions, diagnostics, and vascular products was partly offset by implantable-device market declines and competitive pressure in coronary and structural heart.
- Minimally Invasive Therapies: Sales rose 5% in Q2 and 2% year to date. Surgical products and the return of the Puritan Bennett 980 ventilator to market supported results; competition, product reprocessing, and tender timing were offsets.
- Restorative Therapies: Sales rose 3% in Q2 and 1% year to date. Brain and specialty therapies grew, while pain therapies declined; year-to-date spine sales also fell.
- Diabetes: Sales rose 3% in Q2 and 2% year to date, supported by international markets. U.S. sales faced a gap between earlier-than-expected FDA approval and the anticipated MiniMed 670G launch.
- Geographically, Q2 sales rose 1% in the U.S., 8% in non-U.S. developed markets, and 8% in emerging markets. Six-month U.S. sales declined 1%, while developed and emerging markets each grew 4%.
Cash flow, debt, and liquidity
- Six-month operating cash flow was $3.022 billion, up from $2.095 billion. Capital spending was $598 million, producing reported free cash flow of $2.424 billion, versus $1.649 billion.
- Cash and cash equivalents were $2.954 billion at period-end; cash, equivalents, and current investments totaled $11.257 billion. Working capital was $12.925 billion, and the current ratio was 2.4, down from 3.3 at fiscal year-end.
- Total current and long-term debt was $32.377 billion, versus $31.102 billion at April 29, 2016. Net debt was $21.120 billion, up from $18.468 billion; debt-to-total capitalization increased to 39% from 37%. Current debt obligations rose to $3.367 billion, including $1.1 billion of commercial paper.
- Management stated that liquidity, the $3.5 billion revolving credit facility, and commercial paper program were expected to cover foreseeable working-capital needs for at least 12 months. Approximately $6 billion of cash and investments held by certain non-U.S. subsidiaries may not be available for general corporate purposes. The company reported compliance with debt covenants.
- Financing cash outflow included $2.794 billion of share repurchases and $1.192 billion of dividends. The company repurchased 32.7 million shares during the six months and had about 39.1 million shares remaining under its authorization.
Outlook, risks, and unusual items
- No consolidated revenue or earnings guidance is stated in the supplied filing text. Management expected approximately $850 million of Covidien-related cost synergies through fiscal 2018; restructuring charges were expected to continue as plans were finalized.
- Management discussed expected product launches and adoption, including the MiniMed 670G in late fiscal 2017, and anticipated U.S. market releases for certain cardiovascular products. These are forward-looking expectations, not guarantees.
- Notable Q2 and year-to-date items included restructuring charges of $47 million and $151 million, acquisition-related expense of $28 million and $80 million, and $500 million and $987 million of intangible amortization. Six-month litigation charges were $82 million; none were recorded in Q2. HeartWare and Smith & Nephew’s gynecology business were acquired for approximately $1.1 billion and $350 million, respectively.
- Accrued certain litigation charges were approximately $1.0 billion. The company warned that actual outcomes and payments could differ materially from estimates. Matters include INFUSE product claims, pelvic mesh litigation, governmental inquiries, and environmental proceedings; the filing says some potential losses are not currently probable or reasonably estimable.
- Gross unrecognized tax benefits decreased to $1.9 billion; accrued interest and penalties were $274 million. Tax audits and disputes remain, including matters involving Puerto Rico income allocation. The six-month effective tax rate and earnings may not represent ongoing results.
- Other risks include competition and pricing pressure, reimbursement and regulatory changes, product quality or recall issues, integration and restructuring execution, currency movements, and impairment or liquidity risks in investments. The filing reports a voluntary recall of certain neurovascular product lines during Q2 and notes ongoing FDA consent-decree obligations for the SynchroMed system and neuromodulation quality system.
Key facts for investors to verify
- How much of earnings growth reflects operating performance versus the unusually low effective tax rate and prior-year tax charge; review GAAP and non-GAAP reconciliations.
- Underlying sales growth after considering the prior-year extra selling week, currency effects, acquisitions, and individual product-market trends.
- Debt maturities, commercial-paper usage, accessible cash, and the rise in net debt and current obligations.
- Progress toward Covidien cost synergies and the costs, integration results, and commercial contribution of HeartWare and other acquisitions.
- Developments in the approximately $1.0 billion litigation accrual, tax exposures and audits, product recalls, and regulatory obligations.
- Whether anticipated product approvals, launches, and market acceptance occur on the stated timelines.