Medtronic plc — Form 10-Q summary
Business context and reporting period
Quarter ended October 30, 2015 (second quarter of fiscal 2016); financial statements are unaudited. Medtronic completed its approximately $50 billion acquisition of Covidien on January 26, 2015. Covidien’s results are included from the acquisition date, making year-over-year consolidated revenue comparisons substantially acquisition-driven. Fiscal 2016 includes an extra selling week in the first quarter.
Key financial metrics
| Metric | Three months ended Oct. 30, 2015 | Comparable 2014 period | Six months ended Oct. 30, 2015 | Comparable 2014 period |
|---|---|---|---|---|
| Net sales | $7.058B | $4.366B | $14.332B | $8.639B |
| Operating profit | $1.300B | $1.030B | $2.431B | $2.118B |
| Net income | $520M | $828M | $1.340B | $1.699B |
| Diluted EPS | $0.36 | $0.83 | $0.94 | $1.70 |
| Operating margin | 18.4% | 23.6% | 17.0% | 24.5% |
| Gross margin | 69.1% | 73.8% | 67.6% | 74.0% |
Six-month operating cash flow was $2.095B, capital expenditures $446M, and management-defined free cash flow $1.649B. Cash and cash equivalents were $2.378B at quarter-end; current investments were $14.851B. Total debt was $35.848B, yielding a reported net cash position of negative $18.619B (debt less cash and current investments). Working capital was $20.597B and the current ratio 3.5:1. Shareholders’ equity was $52.269B.
Material changes versus prior periods
- Second-quarter sales increased 62% and six-month sales 66%, principally because Covidien was included in 2015 results; foreign currency translation reduced sales by $452M and $980M, respectively. The first-half comparison also benefited from an additional selling week.
- Legacy segment growth was positive in Cardiac and Vascular (9% quarterly; 11% first half), Restorative Therapies (7%; 10%), and Diabetes (5%; 6%). Minimally Invasive Therapies contributed $2.356B of quarterly sales; it had no comparable prior-year segment.
- Quarterly net income declined 37% and diluted EPS declined 57%; first-half net income declined 21% and diluted EPS declined 45%. The quarter included a $442M tax charge related primarily to an internal reorganization of legacy Covidien businesses. Weighted-average diluted shares rose to 1.429B from 993M for the quarter, reflecting the post-acquisition share base.
- Cost of products sold rose to 30.9% of sales in the quarter from 26.2%, reflecting Covidien’s cost structure; first-half cost of sales also included a $226M Covidien inventory fair-value step-up charge. Intangible amortization increased to $483M for the quarter and $964M for the first half, largely due to Covidien.
- Operating cash flow improved from $1.223B to $2.095B for the first half, partly because the prior-year period included a $750M Edwards settlement payment. Investing cash outflow was $2.074B and financing cash outflow $2.525B. Cash declined $2.465B from fiscal year-end.
Outlook, commentary, risks and unusual items
- Management expects fiscal 2016 R&D expense to remain 7%–8% of sales and anticipates returning 50% of fiscal 2016 free cash flow to shareholders. The company expects approximately $850M of Covidien-related cost synergies through fiscal 2018; restructuring charges are expected to continue as initiatives are finalized.
- Reported quarterly effective tax rate was 52.0% (33.8% for the first half), versus 19.0% and 19.3% a year earlier. The non-GAAP nominal rate was 16.5% for the quarter and 17.3% for the first half; these adjusted measures exclude specified items and should not be treated as GAAP results. The reorganization made approximately $9.3B of cash, cash equivalents and investments available for general corporate purposes, although management noted some overseas-held funds may remain unavailable.
- Quarterly charges included $73M restructuring, $26M litigation and $49M acquisition-related items. A $45M loss followed termination of interest-rate swaps for a debt issuance no longer expected after the internal reorganization. The Covidien purchase accounting remained preliminary and could change materially.
- Management cited competition, pricing and reimbursement pressure, currency movements, integration and synergy execution, regulatory and product-approval uncertainty, and clinical or commercial adoption risks. Product-liability, intellectual-property, environmental and tax matters may have material effects; outcomes and potential losses are uncertain. Accrued litigation charges were $777M. The filing also describes substantial tax exposures, including unrecognized tax benefits of $2.602B plus accrued interest and penalties of $588M.
- Liquidity: management believed available resources and the $3.5B revolving credit facility/commercial-paper program would meet foreseeable working-capital needs for at least 12 months. Commercial paper outstanding was $1.307B; the credit facility had no borrowings, and the company reported compliance with its covenants. Disclosure controls were deemed effective; Covidien’s internal controls were still being documented and tested for inclusion in the fiscal 2016 assessment.
Important facts for investors to verify
- Separate acquisition-related revenue growth from underlying organic and constant-currency performance, including the effects of the extra selling week.
- Assess the recurring earnings and cash-flow impact of the $442M tax charge, purchase-accounting amortization, inventory step-up and integration/restructuring costs.
- Track Covidien integration, realization of the $850M synergy target, and final purchase-accounting valuations.
- Review debt maturities, cash availability by jurisdiction, and the negative net cash position alongside dividends and share repurchases.
- Monitor the status and potential financial exposure of product litigation, environmental remediation, tax audits and guarantees.