Business context and reporting period
Medtronic plc, a global medical technology company, filed this unaudited Form 10-Q for the three months ended July 28, 2017, the first quarter of fiscal 2018. Comparisons are with the three months ended July 29, 2016 unless noted.
Financial performance and liquidity
| Metric | Q1 FY2018 | Prior period | Change |
|---|---|---|---|
| Net sales | $7.390 billion | $7.166 billion | +3% |
| Operating profit | $1.389 billion | $1.167 billion | +19% |
| Net income attributable to Medtronic | $1.016 billion | $929 million | +9% |
| Diluted EPS, GAAP | $0.74 | $0.66 | +12% |
| Gross margin | 68.2% | 68.4% | Down 0.2 percentage points |
| Operating margin | 18.8% | 16.3% | Up 2.5 percentage points |
| Operating cash flow | $737 million | $1.550 billion | Down $813 million |
| Free cash flow (non-GAAP) | $459 million | $1.220 billion | Down $761 million |
Non-GAAP diluted EPS was $1.12 versus $1.03, up 9%; the filing reconciles this measure to GAAP and excludes specified charges and tax items. Sales growth included $92 million from acquisitions, while currency reduced sales by $33 million. By segment, Cardiac and Vascular grew 5%, Minimally Invasive Therapies 3%, Restorative Therapies 2%, and Diabetes declined 1%. Emerging-market sales rose 11%; U.S. sales rose 1%.
Cash, cash equivalents and current investments totaled $13.1 billion at July 28. Working capital was $9.3 billion and the current ratio was 1.6:1. Total debt was $34.0 billion, including $8.1 billion current and $26.0 billion long-term, up from $33.4 billion at April 28. The company had $1.5 billion of commercial paper outstanding and no borrowings on its $3.5 billion revolving credit facility. Management said available liquidity and credit capacity should meet foreseeable operating needs for at least 12 months; approximately $6 billion held by certain non-U.S. subsidiaries might not be available for general corporate purposes.
Material changes versus the prior period
- Revenue and operating profit increased; all segments except Diabetes grew. Management attributed earnings growth to operating-margin expansion, cost savings and international growth. The gross-margin rate edged down, partly due to currency.
- Operating cash flow and free cash flow fell substantially. Drivers included higher tax payments, litigation payments, derivative-collateral outflows, lower customer collections and delayed billing and collections related to the SAP disruption.
- The effective tax rate increased to 15.6% from 6.0%. The prior-year quarter included significant tax adjustments; the current quarter included $60 million of charges primarily related to restructuring steps ahead of the divestiture.
- Share repurchases were $1.233 billion versus $1.763 billion; dividends paid were $625 million versus $599 million. The declared dividend was $0.46 per share versus $0.43.
Outlook, commentary, risks and unusual items
- The filing gives no consolidated full-year revenue or EPS guidance. Management stated that the June 2017 SAP system disruption had some effect on quarterly performance but was not material to quarterly or full-year fiscal 2018 revenue or EPS. The system was restored.
- Management continued to target approximately $850 million in Covidien-related cost synergies through fiscal 2018. Restructuring cash outlays were expected to be substantially complete by fiscal 2019.
- Diabetes sales faced U.S. sensor supply constraints. Management expected new sensor manufacturing lines to be ready for commercial production by Q4 FY2018, and said constraints would delay accelerated MiniMed 670G growth until then.
- On July 29, 2017, after quarter-end, Medtronic sold Patient Care, Deep Vein Thrombosis and Nutritional Insufficiency businesses to Cardinal Health for $6.1 billion; estimated after-tax proceeds were $5.6–$5.8 billion. On August 3, it used $3.0 billion of proceeds to repay a term loan. The company was still assessing the financial statement impact of a subsequent tax ruling related to the proceeds and intercompany transactions.
- Accrued certain litigation charges were approximately $1.0 billion. The company warned actual outcomes could differ materially and adversely affect earnings, financial position or cash flows. Gross unrecognized tax benefits were $1.8 billion, with $384 million of accrued interest and penalties.
- Other risks include competitive and pricing pressure, reimbursement and regulatory challenges, product adoption, supply and quality issues, currency volatility, tax disputes, litigation and potential investment illiquidity. A 10% uniform dollar move was estimated to change derivative fair value by about $924 million, generally offset by underlying exposures; a 10-basis-point interest-rate move was estimated to change the fair value of interest-sensitive instruments by $67 million.
Important facts for investors to verify
- Whether reported growth and margin expansion persist after separating acquisition contributions, currency effects and non-GAAP adjustments.
- Whether operating cash flow and collections recover, and how the SAP disruption and related billing delays affect subsequent quarters.
- Whether sensor supply capacity meets demand and the expected timing of growth from the MiniMed 670G.
- How the Cardinal divestiture, $3.0 billion loan repayment, transition agreements and tax ruling affect future sales, debt, taxes and cash flow.
- Developments in significant litigation and tax matters, including potential changes to the approximately $1.0 billion litigation accrual and $1.8 billion unrecognized tax benefits.
- Debt maturities, share repurchases and liquidity available outside non-U.S. subsidiaries.