Medtronic plc — Form 10-Q Summary
Business context and reporting period
Quarter ended July 31, 2015, the first quarter of fiscal 2016. Medtronic is a global medical technology company operating across cardiac and vascular, minimally invasive therapies, restorative therapies, and diabetes businesses. Comparisons with the quarter ended July 25, 2014 are significantly affected by the January 26, 2015 Covidien acquisition: the current period includes Covidien results, while the prior period does not. Fiscal 2016 also includes an extra selling week in the first quarter.
Financial results and liquidity
| Metric | Quarter ended July 31, 2015 | Comparable 2014 period |
|---|---|---|
| Net sales | $7.274 billion | $4.273 billion |
| Operating profit | $1.131 billion | $1.088 billion |
| Net income | $820 million | $871 million |
| Diluted earnings per share | $0.57 | $0.87 |
| Cash from operations | $816 million | $310 million |
| Capital expenditures | $224 million | $109 million |
| Free cash flow, as defined by the company | $592 million | $201 million |
- Reported sales rose 70%; management estimates the extra selling week contributed approximately 6 percentage points to first-quarter growth. Foreign currency translation reduced sales by $529 million year over year.
- Reported operating margin was approximately 15.5% versus 25.5%; cost of products sold was 33.8% of sales versus 25.9%. The current period included acquisition-related inventory step-up expense of $226 million and substantially higher acquired-intangible amortization.
- Effective tax rate was 12.8%, compared with 19.6%. Management’s non-GAAP reconciliation reported adjusted net income of $1.462 billion, excluding specified acquisition, inventory step-up, restructuring, and amortization items.
- At July 31, cash and cash equivalents were $2.979 billion and current investments were $15.003 billion. Current assets were $29.147 billion, current liabilities $7.660 billion, working capital $21.487 billion, and the current ratio 3.8.
- Short-term borrowings were $1.850 billion and long-term debt $33.709 billion. The company’s stated net cash position, after cash, cash equivalents, and current investments, was negative $17.577 billion; debt-to-total-capital was 40%.
- Cash from operations improved partly because the prior-year period included a $750 million settlement payment to Edwards. Financing cash outflow was $1.744 billion, including $1.004 billion of long-term debt payments, $538 million of dividends, and $750 million of share repurchases.
Material changes versus the prior period
- The Covidien acquisition added $2.456 billion in reported Minimally Invasive Therapies Group sales and expanded the company’s scale; therefore, consolidated sales growth is not a like-for-like comparison.
- Excluding the new group, reported segment sales increased 14% in Cardiac and Vascular, 13% in Restorative Therapies, and 7% in Diabetes. Management cited the extra selling week as a benefit and foreign exchange as a headwind.
- Net income declined 6%, while diluted EPS fell 34%; diluted weighted-average shares increased to 1,436.4 million from 1,005.2 million following the transaction.
- Net interest expense increased to $191 million from $5 million, primarily reflecting higher borrowings associated with Covidien. Amortization expense increased to $481 million from $87 million, primarily due to acquired intangible assets.
Outlook, risks, and unusual items
- Management expects approximately $850 million of Covidien-related cost synergies through fiscal 2018; restructuring charges are expected to continue during fiscal 2016 and later periods as initiatives are finalized. First-quarter restructuring charges were $67 million.
- Management expects research and development expense to remain 7%–8% of sales in fiscal 2016 and anticipates returning 50% of fiscal 2016 free cash flow to shareholders. These statements are targets and expectations, not a full-year earnings or sales forecast.
- Management said available cash and investments, together with the $3.5 billion revolving credit facility and commercial paper program, should meet foreseeable working-capital needs for at least 12 months. Commercial paper outstanding was $425 million; no amounts were drawn on the credit facility.
- Risks include integration and realization of acquisition synergies; competition, pricing and reimbursement pressure; foreign exchange; product, regulatory and clinical-development risks; and litigation and tax matters. The company reported $787 million of accrued certain litigation charges.
- Significant disclosed matters include ongoing INFUSE and pelvic-mesh claims, patent disputes, environmental proceedings, and tax audits. The company stated that certain potential losses are not presently probable or reasonably estimable. The Penobscot River environmental report cited preliminary remediation estimates of $25 million–$235 million, described as very rough and subject to further study.
- Unrecognized tax benefits were $2.561 billion, with $580 million of accrued gross interest and penalties. Management warned that unresolved tax matters and guarantees inherited with Covidien could have a material adverse effect; outcomes and timing are uncertain.
- Covidien purchase accounting remained preliminary and may be revised, potentially affecting results and financial position. Covidien internal controls were still being documented and tested for inclusion in the fiscal 2016 annual assessment; management concluded disclosure controls were effective.
Important facts for investors to verify
- Assess underlying, comparable sales growth after separating Covidien contributions, the extra selling week, and currency effects.
- Track progress toward the approximately $850 million synergy target, restructuring costs, and integration execution.
- Review debt, interest expense, cash generation, and the extent to which overseas cash is available for U.S. needs; approximately $17.0 billion of cash, cash equivalents, and investments was held by non-U.S. subsidiaries and designated as permanently reinvested.
- Monitor the final Covidien purchase-price allocation, acquired-asset amortization, and any related adjustments.
- Follow litigation, environmental matters, and tax disputes, including whether any outcomes change recorded accruals or require additional payments.