Medtronic plc — Form 10-Q summary
Reporting period: Fiscal third quarter ended January 29, 2016, with nine-month results for the period then ended. Although the request labels this “2015 Q3,” the filing covers Medtronic’s fiscal 2016 third quarter. The comparison is substantially affected by Covidien’s acquisition on January 26, 2015; the prior-year quarter included only three days of Covidien results.
Financial performance
| Metric | Three months ended Jan. 29, 2016 | Prior-year quarter | Nine months ended Jan. 29, 2016 | Prior-year nine months |
|---|---|---|---|---|
| Net sales | $6.934 billion | $4.318 billion | $21.266 billion | $12.957 billion |
| Operating profit | $1.355 billion | $1.275 billion | $3.786 billion | $3.393 billion |
| Net income | $1.095 billion | $977 million | $2.435 billion | $2.676 billion |
| Diluted EPS | $0.77 | $0.98 | $1.70 | $2.68 |
| Operating margin | 19.5% | 29.5% | 17.8% | 26.2% |
| Net margin | 15.8% | 22.6% | 11.4% | 20.7% |
Quarterly sales rose 61%; nine-month sales rose 64%, largely reflecting the Covidien acquisition. Foreign-exchange translation reduced sales by $344 million for the quarter and $1.323 billion for the nine months. The nine-month period also included an extra selling week. Quarterly net income increased 12%, but diluted EPS declined 21%; nine-month net income fell 9% and diluted EPS fell 37%. Comparisons reflect the acquisition, higher debt and amortization, and a much larger weighted-average share count.
For the quarter, cost of products sold was 30.9% of sales versus 26.1% a year earlier; R&D was 7.9% versus 8.6%, and SG&A was 33.4% versus 34.4%. Covidien’s higher product costs and acquisition-related intangible amortization affected reported margins. Nine-month GAAP results also included a $226 million Covidien inventory fair-value step-up charge and $1.448 billion of intangible amortization.
Quarterly segment sales were Cardiac and Vascular $2.410 billion (up 8%), Minimally Invasive Therapies $2.291 billion (newly reported following the acquisition), Restorative Therapies $1.759 billion (up 7%), and Diabetes $474 million (up 6%). Within Restorative Therapies, Spine and Neuromodulation sales each declined 5% for the quarter.
Cash flow, liquidity and debt
- Nine-month operating cash flow was $3.892 billion, up from $2.990 billion. Capital expenditures were $693 million; company-defined free cash flow was $3.199 billion, versus $2.674 billion.
- Investing activities used $2.328 billion; financing activities used $3.677 billion. Cash and cash equivalents declined $2.122 billion to $2.721 billion.
- Cash, cash equivalents and current investments totaled $17.286 billion. Short-term borrowings were $2.153 billion and long-term debt $33.681 billion; the company’s stated net cash position was negative $18.548 billion. Debt-to-total-capital was 41%.
- Working capital was $19.428 billion and the current ratio was 3.4:1. The company reported $1.293 billion of commercial paper outstanding and no borrowings under its $3.5 billion revolving facility. It said about $6 billion of cash and investments held by certain U.S.-controlled non-U.S. subsidiaries might not be available for general corporate purposes.
- Nine-month dividends paid were $1.608 billion and share repurchases were $2.170 billion. Cash dividends declared were $0.38 per share for the quarter.
Outlook, commentary and notable risks
- Management expected R&D expense to remain 7%–8% of sales in fiscal 2016, anticipated approximately $850 million in Covidien-related cost synergies through fiscal 2018, and expected to return 50% of fiscal 2016 free cash flow to shareholders.
- Management said restructuring charges would continue through fiscal 2017 and later as synergy plans are finalized. Nine-month restructuring charges were $159 million, net, on the income statement; the filing separately reports $208 million of gross charges for the cost-synergies initiative before reserve reversals.
- Management cited competition, pricing pressure, reimbursement changes, foreign exchange, procedural volumes, product acceptance and regulatory approvals as factors that could affect results. It also noted ongoing integration of Covidien and expected higher future net interest expense as share repurchases reduce investment income.
- Legal and regulatory exposures include product-liability, patent, shareholder, environmental and government-investigation matters. Accrued certain litigation charges were $1.062 billion. The company had reached settlement agreements for approximately 3,900 of about 6,000 asserted or intended INFUSE claims, and approximately 4,200 of about 15,800 pelvic-mesh claims.
- Gross unrecognized tax benefits were $2.647 billion, with $607 million of accrued gross interest and penalties. A tentative resolution of Tyco-related intercompany-debt tax disputes could require total payment by participating companies of $475 million–$525 million, subject to stated conditions; Medtronic’s stated share is 42% under the sharing formula.
- Other unusual items included a $417 million nine-month tax adjustment, primarily related to an internal reorganization of legacy Covidien businesses, partly offset by tax benefits. A $25 million tax benefit was recorded in the quarter. Quarterly effective tax rate was 7.1%; nine-month rate was 24.0%.
Investor facts to verify
- Assess organic and constant-currency growth separately from Covidien acquisition effects and the extra selling week.
- Track integration progress, realization and costs of the targeted $850 million synergies, and the trajectory of restructuring charges.
- Review debt service, accessible liquidity, cash held overseas, and the planned balance among dividends, repurchases and debt reduction.
- Monitor litigation claims and reserves, tax audits and uncertain tax positions, including the contingent Tyco-related settlement.
- Evaluate whether new products and challenged areas—particularly Spine, Neuromodulation, pricing-sensitive markets and reimbursement-dependent therapies—meet management’s expectations.