Business context and reporting period
Medtronic plc is a global medical-technology company. This unaudited Form 10-Q covers the second quarter and first six months of fiscal 2018, ended October 27, 2017; comparisons are with the corresponding prior-year periods unless noted.
Financial performance
| Metric | Three months | Six months |
|---|---|---|
| Net sales | $7.05 billion, down 4% from $7.35 billion | $14.44 billion, essentially flat versus $14.51 billion |
| Gross margin | 69.9%, versus 68.3% | 69.1%, versus 68.4% |
| Operating profit | $1.90 billion, versus $1.39 billion | $3.29 billion, versus $2.55 billion |
| Net income attributable to Medtronic | $2.02 billion; diluted EPS $1.48 | $3.03 billion; diluted EPS $2.21 |
| Non-GAAP diluted EPS | $1.07, versus $1.12 | $2.19, versus $2.15 |
| Cash from operations / free cash flow | Six months: $1.64 billion / $1.12 billion, compared with $3.02 billion / $2.42 billion |
Reported earnings were affected by significant unusual and tax items, so GAAP EPS growth does not represent underlying operating trends alone. The quarter included a $697 million pretax gain from a business sale and a $404 million tax benefit from certain tax adjustments. Early adoption of intra-entity tax guidance increased net income by $582 million for the quarter and $557 million for the six months, and diluted EPS by $0.43 and $0.41, respectively. The filing’s non-GAAP reconciliation reports diluted EPS of $1.07 for the quarter and $2.19 for the six months.
At October 27, 2017, cash and cash equivalents were $5.53 billion and current investments were $8.00 billion. Total debt was $29.07 billion ($3.13 billion current and $25.94 billion long-term), down from $33.44 billion at April 28, 2017, mainly after debt repayments funded in part by divestiture proceeds. Working capital was $14.67 billion and the current ratio was 2.4. The company reported $700 million of commercial paper outstanding and no borrowings under its $3.5 billion revolving credit facility. Approximately $5 billion of cash and investments held by certain non-U.S. subsidiaries may not be available for general corporate purposes.
Material changes versus prior period
- Net sales were pressured by the July 29, 2017 sale to Cardinal Health of Patient Care, Deep Vein Thrombosis, and Nutritional Insufficiency businesses. Medtronic received $6.1 billion in proceeds and recorded a $697 million pretax gain. The divestiture reduced Minimally Invasive Therapies Group sales, particularly Respiratory, Gastrointestinal & Renal.
- Hurricane Maria disrupted Puerto Rico manufacturing. Management estimated a $55–$65 million adverse sales impact in the quarter and disclosed $34 million of related charges; the filing also cites $17 million of costs to restore operations.
- Sales by segment in the quarter: Cardiac and Vascular $2.77 billion, up 7%; Minimally Invasive Therapies $1.95 billion, down 21%; Restorative Therapies $1.86 billion, up 2%; and Diabetes $462 million, flat. The divestiture was a major driver of the Minimally Invasive Therapies decline.
- Gross margin improved, primarily because the divested businesses had lower margins. Selling, general and administrative expense rose as a share of sales amid transition-service and product-launch costs, while research and development expense was 7.9% of sales versus 7.5%.
- Operating cash flow fell by $1.38 billion year over year. The company cited higher income-tax payments, retirement-plan funding, divestiture expenses, litigation payments, derivative collateral outflows, lower customer collections, and higher inventory spending.
Outlook, commentary, risks and contingencies
Management gave no consolidated numerical sales or earnings guidance in the supplied filing text. It described growth priorities as therapy innovation, globalization, and economic value; emerging-market sales grew 9% in the quarter and 10% for the six months. It expects approximately $850 million of Covidien-related cost synergies through fiscal 2018, with restructuring cash outlays substantially complete by fiscal 2019.
- Diabetes sales were constrained by sensor supply shortages despite strong demand for the MiniMed 670G; management expected expanded sensor manufacturing capacity by the fourth quarter of fiscal 2018.
- Management cited competition, pricing pressure, reimbursement changes, product-approval timing, procedural volumes, currency movements, supply and quality issues, and international-market risks across its businesses.
- Accrued litigation was approximately $1.0 billion. The company cautioned that outcomes and ultimate costs could materially affect earnings, financial position, or cash flows. Certain environmental remediation estimates described in the filing were preliminary and ranged from $25 million to $235 million for potential Penobscot River and Bay options.
- Gross unrecognized tax benefits were $1.8 billion, with $394 million of accrued gross interest and penalties. Ongoing tax audits and disputes, including IRS matters involving income allocation to Puerto Rico, could have a material impact.
- Management stated that the June 2017 IT disruption was not material to revenue or EPS for the six months. Disclosure controls were assessed as effective; ERP deployment to the Minimally Invasive Therapies Group was expected to continue through fiscal 2020.
Most important facts for investors to verify
- Reconcile GAAP earnings and EPS to non-GAAP results, including the divestiture gain and the material tax benefit from accounting adoption and intercompany intellectual-property transactions.
- Assess the ongoing revenue and margin effect of the Cardinal divestiture, transition manufacturing arrangements, and related transition costs.
- Track recovery of Puerto Rico production and resolution of Diabetes sensor constraints, including whether manufacturing capacity targets are met.
- Monitor cash conversion, tax payments, capital returns, and debt reduction against the decline in operating cash flow and free cash flow.
- Review developments in litigation, environmental matters, tax audits, and unrecognized tax benefits, whose outcomes and ultimate costs remain uncertain.