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Medtronic, Inc. (NYSE:MDT)

F3Q09 (Qtr End 01/23/09) Earnings Call Transcript

February 17, 2009 8:00 am ET

Executives

Jeff Warren – VP, IR

Bill Hawkins – Chairman and CEO

Gary Ellis – SVP and CFO

Analysts

Mike Weinstein – JP Morgan

Timothy Lee – Piper Jaffray

Tao Levy – Deutsche Bank

Matthew Dodds – Citigroup

Delinnea [ph] – Leerink, Swann

Larry Biegelsen – Wachovia

Ben Andrew – William Blair

David Lewis – Morgan Stanley

Bob Hopkins – Bank of America

Operator

Good morning. My name is Dennis and I will be your conference operator today. At this time, I would like to welcome everyone to the Medtronic third quarter earnings conference call. (Operator instructions) I will now turn the call over to Mr. Jeff Warren, Vice President of Investor Relations. Please go ahead sir.

Jeff Warren

Thank, Dennis. Good morning and welcome to Medtronic’s third quarter conference call and webcast. During the next hour, Bill Hawkins, Medtronic’s Chairman and Chief Executive Officer; and Gary Ellis, Chief Financial Officer, will provide comments on the results of our third quarter, which ended January 23, 2009. After our prepared remarks, we will be happy to take your questions.

A few logistical comments; this call is being web cast via our website www.Medtronic.com. Our press release, earnings statement, balance sheet, cash flow, revenue by business summaries, non-GAAP to GAAP reconciliations, as well as a transcript of the prepared remarks will all be posted on our website. The transcript will remain available on our website until our next earnings call.

Today's commentary should be considered and evaluated in light of the important disclosures and reconciliations contained within our press release as filed with the Securities and Exchange Commission. Please telephone Medtronic Investor Relations or Corporate Communications if you're unable to access the press release or the transcript.

Today’s web cast includes statements regarding Medtronic’s anticipated financial results, market growth, market share, acquisitions, divestitures, product acceptance, and capabilities, new products, cost savings and regulatory approvals, as well as other forward looking statements based on management’s current expectations. It’s important to note that our actual results may differ materially from those anticipated.

Information on factors that could cause actual results to differ materially from these forward looking statements is contained in the Medtronic’s Form 10-K for the year ended April 25, 2008, filed with the Securities and Exchange Commission. We encourage you to review this carefully. All statements are made as of today’s date and we undertake no duty to update the information provided in this call.

And unless we say otherwise, references to quarterly results increasing or decreasing are in comparison to the third quarter of fiscal year 2008. With that, I’m now pleased to turn the call over to Medtronic Chairman and Chief Executive Officer, Bill Hawkins.

Bill Hawkins

Good morning and thank you, Jeff. Q3 was a solid quarter. Revenue of $3.494 billion grew 6% after adjusting for $110 million unfavorable impact of foreign currency. Net earnings in the third quarter were $723 million or $.65 per diluted share.

After adjusting for in-process research and development charges of $72 million, or $0.06 per share, non-GAAP net earnings and diluted earnings per share in the period were $795 million, or $0.71 per diluted share, an increase of 12% and 13%, respectively.

As we all know, these are challenging economic times. Across all industries, the level of uncertainty, volatility, and unpredictability has never been higher. Medtronic’s fundamental business model is relatively resilient to macroeconomic downturns, and while we have minimum exposure to slowdowns and elective procedures, we are not immune to the global economic turmoil affecting nearly everyone.

One of our strengths remains our technologically and therapeutically diverse business model. Our results underscore that we are not overly dependent on any single business, product line, or geography. Our balance sheet is well capitalized with $3.9 billion in cash and investments. We continue to generate significant free cash flow. In fact this quarter, for the first time we had free cash flow of over $1 billion.

Looking ahead, our focus across all our businesses will be on extending our market share leadership, investing for market growth, and leveraging geographic expansion. Also doing the right thing by halting shipments of our Fidelis leads a year and a half ago hurt us. Today, we are back on the offensive. Make no mistake, in each of businesses we are playing to win.

Across all over businesses, competition has never been tougher. At the same time, we're never been more committed to extending our market share leadership by leveraging every tool at our disposal. In our CRDM business, we will lead with market exclusives like OptiVol and Minimal Ventricular Pacing.

In Spinal, we will leverage our innovative spine fusion technologies with unique, navigation, sensor, and biologics capabilities.

In Diabetes, we will differentiate ourselves with our sensor augmented pumping. We will lead by leveraging the unique breath of Medtronic's portfolio to meet the needs of GPOs and IDNs in large hospital systems. We will lead with innovations like INFUSE and MRI-safe products as well as novel therapies using deep brain stimulation. We will lead with best-in-class product quality, customer service, and sales support.

In short, we will lead in the future just as we have in the past. In addition to our commitment to market leadership, we are also moving into new growth markets. Our recent investments in two novel atrial fibrillation technology platforms position Medtronic to ultimately become the undisputed leader in one of the fastest growing and promising markets in med-tech. Our acquisition this month of Ablation Frontiers follows the recent acquisition of CryoCath last quarter, giving us two of the most exciting players in AF.

As one AF thought leader told us recently, there are really only two technologies that physicians are talking about as potential real breakthroughs in AF ablation, and now Medtronic owns them both.

We are combining these two companies with our existing EP Catheter business and our unique remote diagnostics technology called Reveal XT, which was recently launched in the US. This novel subcutaneous diagnostic monitor allows physicians to monitor AF to better manage their patients. With this combination of therapies and diagnostics, we intend to become the market leader in AF disease management by bringing breakthrough therapies that are simple, safe, effective, and offer more predictable procedure times than current treatment methods.

In short, our goal is to democratize AF. Strong growth in the quarter across many of our international markets underscores our commitment and focus on geographic expansion. After adjusting for the unfavorable impact of foreign exchange, revenue in markets outside the US grew 9% over twice as fast as US revenue growth.

China, Central Eastern Europe, Middle East and Africa, and Latin America all had constant currency growth rates in the mid-to-high teens. Business units and product line standouts included ICDs, core spinal, neuromodulation, diabetes, and Surgical Technologies.

Our Weigao joint venture is up and running, marking an important milestone in our overall China strategy. And although we continue to invest in our international infrastructure, earnings in these geographies continue to grow faster than revenues.

Beyond the revenue performance, during the quarter, we again made solid progress on driving meaningful operating leverage. A key component of this overall operating leverage initiative is to reduce cost of goods sold by 25% by fiscal year 2012. We achieved 175 million loss of savings in FY08 and were on pace to deliver an additional $180 million of savings towards this goal in FY09. We are also making good progress on several longer-term SG&A leverage initiatives, which are designed to grow in direct selling and G&A expenses at 50% of revenue growth and direct selling and marketing expenses at 80% of revenue growth.

Looking ahead to the end of the fiscal year and beyond, we are confident that we can continue to generate double-digit growth in our earnings per share.

Before turning the call over to Gary, who will take you through the detailed financial results, I like to draw your attention to several highlights across some of our business units. In CRDM, after adjusting for the impact of foreign currency, growth in the global ICD market appears to have stabilized in the mid-single digits. Looking ahead, our focus will continue to be on protecting and growing profitable market share in an increasingly competitive marketplace by leveraging our market exclusives and recent product launches, which include the Vision 3D, featuring PainFREE strategy shock reduction; minimal ventricular pacing, complete capture management and (inaudible) for which physicians can now be reimbursed.

We attained StarFix left ventricular lead, MRI SureScan Pacing technology in certain US markets, the 4 French left heart lead Attain Ability; and new left heart lead delivery systems, Attain Command; and the Reveal XT subcutaneous diagnostic monitor.

Turning to our Spinal business, overall revenue growth in the quarter was in line with our expectations. We were encouraged to see some stability return to our core spinal business, reflecting positive moment from several new or enhanced products, including the ATLANTIS Translational Plate, CD HORIZON LEGACY PEEK Rods, Hydroxyapatite-coated screws, and our PYRAMID +4 Lumbar Plate. These products are examples of our efforts to revitalize our entire core spinal product pipeline over the next two years. Although much work remains to return this business to market growth, we are beginning to see the impact of the rebuilding.

We are also encouraged to see the results in our biologics franchise stabilize after a challenging second quarter. Although this business continues to be negatively impacted by several external factors, we did not see any further incremental contraction. Overall, we continue to work on a number of fronts to regain momentum in this business.

Coronary vascular growth was fuelled by the commercial launch of five angioplasty products on rapid exchange in the US. Supply constraints during the quarter limited the penetration of RX to just 50% of our account base. However, during the quarter, we saw steadily accelerating revenues and looking ahead, we believe we will be able to leverage increase supply of RX products to increase our market share.

Our Endovascular business posted another quarter of exceptional growth and is closing in on being a $500 million business. Endovascular is currently the fastest growing business segment in the company and one with considerable future potential. Strong business in our Neuromodulation business reflects strength across all major product lines. Looking ahead, we continue to make good progress on advancing several new therapies.

During the quarter, we attained an IDE for a randomized trial evaluating DBS for depression, and we are currently working through IRB approvals and initial patient screening. We were encouraged by the presentation in December of positive clinical data from the SANTE trial, demonstrating that DBS reduced the seizure rate in patients with severe epilepsy, and we are currently working on a PMA submission for this claim.

We continue to prepare for the US approval and launch of InterStim Therapy for the treatment of fecal incontinence, early next fiscal year.

Quarterly performance in our Diabetes business was highlighted by Continuous Glucose Monitoring Systems, which had another quarter of exceptional growth. Particularly in the US, CGM momentum was fuelled by positive results from the recent JDRF trial and the resulting expansion in covered lives. Another highlight in our CGM business was the completion of enrolment in our 495 patient STAR 3 trial, and we expect results early in calendar year 2010.

Looking ahead, we remain confident in our plans to protect and extend our market leadership in diabetes via a series of three new product launches over the next several quarters.

I will now turn the call over to Gary, who will take you through the detailed financial results. And after his comments, I will conclude with some closing remarks. Gary.

Gary Ellis

Thanks, Bill. As mentioned earlier, third quarter revenue of $3.494 billion grew 6% after adjusting for $110 million unfavorable impact of foreign currency. Breaking this out geographically, revenue in the US was $2.176 billion, up 4%. Outside the US, revenue of $1.318 billion increased 9% on a constant currency basis.

As expected, the significant strengthening of the dollar in Q3 versus the first half of FY09 and the prior year had a tremendous impact on revenue. In fact, we saw $175 million swing from the impact of currency translation on revenues between Q2 and Q3. However, as I will discuss in a moment, we were able to offset this impact with our hedging programs.

CRDM revenue of $1.169 billion decreased 1% after adjusting for $38 million unfavorable impact of foreign currency. Worldwide ICD revenue was $694 million, including a $22 million unfavorable impact of foreign currency. As Bill mentioned, after taking into account the impact of currency, our data indicates that the global ICD market grew in the mid-single digits in the quarter.

Furthermore, our analysis suggests the initial implant market in the US continues to be relatively flat. As we have always stated, assessing quarterly market share movements is challenging, and this is especially true this quarter given the difference in selling days among competitors. However, after normalizing for the number of selling days, our analysis indicates our ICD share remained stable from the prior quarter.

Pacing systems revenue of $457 million included $14 million negative impact of currency. After normalizing for selling days during the quarter, our worldwide Pacing business performed roughly in line with the market. Outside the US, the highlight of our Pacing results was the initial positive acceptance of our MRI SureScan Pacing technology.

Spinal revenue of $832 million grew 4% on a constant currency basis. Core spinal revenue of $479 million grew 6% on a constant currency basis, reflecting increasing stability in this business and traction from a series of recent product introductions. Biologics revenue of $205 million grew 1% on a constant currency basis, and as Bill mentioned this business continues to feel the pressure from several external factors. However, relative to the second quarter, we were encouraged by the stability in this business, which gives us confidence that we may have experienced the worst.

Kyphon revenue of $148 million grew 3% on a constant currency basis. As we have said previously, growth in this business is not meeting our expectations. I speak for the whole management team by assuring you, we are continuing to focus on making the changes necessary to get things on track and we remain excited about the growth potential for these products.

On a positive note, synergies with core spine have been higher than we planned, which is helping on the EBIT line.

Cardiovascular revenue of $565 million grew 16% on a constant currency basis. The coronary stent revenue of $186 million grew 25% on a constant currency basis. As Bill described, coronary stent growth was fuelled by the commercial launch of five angioplasty products on rapid exchange in the US. Although we were surprised by the decline in our MX(2) business, demand for Endeavor on RX exceeded our supply. As a result, share bottomed out early in the quarter and then began to increase as our supply situation improved.

Excluding Japan, the Endeavor and Endeavor Resolute market share in markets outside the US remained stable in the high teens to about 20%. The Endeavor launch in Japan is on track for the first half of fiscal 2010.

Endovascular revenue of $99 million grew 49% on a constant currency basis, fuelled by the recently launched Talent Abdominal and Thoracic Stent Grafts in the US. Growth outside the US of 36% was driven by the launch of our next generation Endurant Abdominal Stent Graft.

Neuromodulation revenue of $354 million increased 13% on a constant currency basis. Pain stimulation revenue was $137 million and grew 14% in constant currency, driven by continued strong market growth coupled with momentum from our restored ULTRA spinal cord stimulator, still the thinnest pain stimulator on the market.

These factors were partially offset by a slowing replacement cycle and a competitive product launch.

Movement Disorders revenue of $103 million grew 10% on a constant currency basis fuelled by growth in our Activa DBS therapy for Parkinson’s disease and Essential Tremor, particularly in markets outside the US.

Late in the quarter, JAMA published results from the largest randomized controlled study of DBS for Parkinson's disease. This study adds to the growing body of evidence that demonstrates the superiority of DBS, and we look forward to leveraging this data to expand utilization.

Gastro/Uro revenue of $71 million grew over 20% on a constant currency basis driven by another strong quarter from InterStim.

Diabetes revenue of $327 million grew 12% on a constant currency basis. Diabetes growth was driven by strong sales of durable pump systems and continued strength in our CGM franchise, which is annualizing at almost $100 million in revenue. These areas of strength helped to partially offset several factors that continue to pressure our overall growth, including the negative impact of the macroeconomic environment on new pump penetration, a negative replacement cycle, and intensified competition.

We are encouraged that the economy is not yet led to noticeable attrition in consumables revenue, and we are pleased that patients see sufficient value to stay on pump therapy.

Surgical Technologies revenue of $207 million grew 10% on a constant currency basis. Growth was highlighted by the strong sales of the Fusion Image Guidance Surgery System and the O-Arm Navigation System coupled with strength in our service contracts. We successfully closed the InfluENT Medical acquisition, which further enhances our sleep apnea product offering. It’s important to note that despite the strong growth this quarter, given the elective nature of the underlying procedures and the large capital equipment component of the business, Surgical Technologies has exposure to macroeconomic pressures that we are managing very closely.

Finally, Physio Control revenue of $90 million grew 1% on a constant currency basis. Results reflect the successful resolution of the product availability issue from last quarter. We continue to work with the FDA to return to full shipments.

Turning to the rest of the income statement, the gross margin was 75.7% compared to 74.4% in the third quarter of last year. The prior year comparable period gross margin included a $34 million charge for the fair value adjustment of the acquired inventory of Kyphon that negatively impacted the gross margin by 100 basis points.

Compared to Q2 of FY09 gross margin of 75.3%, foreign exchange had a 40 basis points to 50 basis points unfavorable impact on the Q3 FY09 gross margin but our efforts to reduce product costs continue to pay dividends. Looking ahead, in the fourth quarter we expect our gross margin to be slightly above 76%.

As Bill mentioned, a key component of our overall operating leverage initiative is to reduce cost of goods sold by 25% by fiscal year 2012. Some examples of initiatives that have annual savings in FY09 include, $40 million in savings from the application of Lean Sigma initiatives across CRDM, $15 million in savings from the outsourcing of CRDM wafer fabrications and, $30 million in savings from the work of various commodity teams to better leverage our global purchasing power.

Third quarter R&D spending of $337 million represents 9.6% of revenue compared to $329 million last year. Consistent with the prior three quarters, third quarter results include a reclassification of approximately $11 million of certain legal and patent expenses from R&D to SG&A. Before this reclassification, R&D would have been approximately 10% of revenue. We remain committed to investing in new technologies to drive future growth and going forward, we anticipate R&D spending will approximate 9.5% of revenue, including this ongoing reclassification.

Third quarter SG&A expenditures of $1.257 billion represented 36% of sales, compared to 35.4% of sales in the third quarter last year. Foreign exchange had a 20 basis point negative impact on SG&A. The R&D reclassification, I previously mentioned, increased SG&A expense in the quarter by approximately 30 basis points. Taking into account currency and the reclassification, SG&A would have been 35.5% of sales. We expect SG&A for FY09 will be less than 35% of sales, including the R&D reclassification.

As we have discussed, we have several initiatives underway to further leverage our SG&A cost structure over the remainder of fiscal 2009 and beyond. With the implementation in Asia, SAP is now fully implemented across the enterprise and we can now begin assessing many of our core functional activities to identify opportunities to reduce costs and create operating leverage.

Some examples of initiatives that will contribute to savings include

$20 million in savings over the next five years from outsourcing of logistics in our Diabetes business, $20 million in FY09 savings from optimizing IT procurement across businesses, and $10 million in FY09 savings from the consolidation of data centers.

Looking ahead, we will continue to explore additional savings in many other areas including freight, car fleet spending, sales force automation and contract administration.

Despite our efforts to deliver meaningful operating leverage, I think it’s important to not lose sight of the fact that today Medtronic’s operating margins and productivity far exceeds that of our closest competitors, and we intend to widen the gap further.

Our sales rep productivity, product cost, and revenue per employee are significantly better which allows us to focus spending on innovation. But we know we can do even better and are focused on numerous areas for efficiency to allow us to increase our returns to shareholders and increase our R&D investment.

Turning back to the P&L, net other expense for the quarter was $50 million compared to $119 million in the prior year. The year-over-year decrease primarily is a result of the gains from our hedging programs, which were $31 million during the quarter, compared to $41 million in losses in the comparable period last year. As you know, we hedge our operating results so that during time periods when the dollar is strengthening significantly, lower translated revenues will for the most part be offset by currency hedging gains.

Accordingly, at current FX rates, we anticipate hedging gains over the remainder of the fiscal year somewhere in the range of $45 million to $50 million. Taking this into account, we anticipate net other expense will be in the range of $50 million to $70 million in the fourth quarter.

Net Interest Income for the quarter was $2 million compared to income of $9 million in the prior year period. This change from the prior year reflects an impairment charge on our marketable securities portfolio and lower interest rates, offset by a gain on sale of securities.

As of January 23, 2009, we had approximately $3.9 billion in cash and cash investments and debt of $6.7 billion. We generated in excess of $1 billion in free cash flow this quarter, defined as operating cash flow minus capital expenditures. Looking ahead, we expect our cash to continue to increase. However, lower interest rates will negatively impact our return on this cash.

Let’s now turn to our tax rate. Our effective tax rate in the third quarter was 22.4%. Excluding the tax impact of IPR&D charges, our effective tax rate in the third quarter was 20.8%. This rate includes a $12 million tax benefit related to the finalization of certain fiscal 2008 tax returns, and adjustments to uncertain tax position reserves associated with international and state tax audits. Excluding both this $12 million benefit and the tax impact of IPR&D charges, our third quarter effective tax rate would have been 22.0%. Exclusive of one-time adjustments, we expect our fiscal year tax rate to be in the range of 21.5% to 22.5%.

Third quarter weighted average shares outstanding, on a diluted basis, were 1.120 billion shares. During the third quarter, we repurchased $90 million of our common stock, or approximately 2.6 million shares. As of January 23, 2009, we had remaining capacity to repurchase over 18.8 million shares under our Board authorized stock repurchase plan.

During the quarter, we also paid out over $210 million in dividends bringing our year-to-date dividend payments to over $630 million.

As before, we have attached an income statement, balance sheet and cash flow statement to this quarter's press release, and I direct your attention to these statements for additional financial details.

Let me conclude by commenting on the full 2009 fiscal year guidance. As you know, we limit our guidance to one year at a time and keep this guidance more directional in nature. Based upon our third quarter results, we are tightening our previous revenue and EPS guidance ranges. We currently forecast fiscal 2009 revenue in the range of $14.6 billion to $14.7 billion at today’s foreign exchange rates. The current Wall Street consensus estimate for Q4 revenue of $3.840 billion, which falls at the lower end of this range, appears reasonable at this time. We currently anticipate our fiscal 2009 EPS to fall in the range of $2.91 to $2.95, which includes $0.02 of dilution from the AF acquisitions. As in the past, my comments on guidance do not include any unusual charges or gains that might occur during the fiscal year.

A couple of final housekeeping items before I turn things back over to Bill, who will conclude our prepared remarks. First, I wanted to provide a head’s up that there will be an extra selling week in the first quarter of our fiscal year 2010 for a total of 14 weeks. This anomaly is due to the way our fiscal years are structured with this “catch up week” occurring once every six years.

Secondly, we will be hosting our annual Institutional Investor and Analyst meeting again this year on Tuesday, June 2nd. This year, the meeting will be held at our World Headquarters facility in Minneapolis. Bill.

Bill Hawkins

All right. Before we begin our Q&A session, let me just close by reiterating what I said to begin with in that Q3 was a solid quarter. Our growth reflects both internal challenges and a challenging environment. We continue to balance our focus on driving innovation to fuel growth and on both shaping and executing across the enterprise to generate efficiency and leverage to fund future opportunities.

I’d now like to open things up for Q&A. In the interest of getting to as many questions as possible, we would like to respectfully request that each caller limit themselves to one question with one follow-up. So operator, first question please.

Question-and-Answer Session

Operator

Your first question comes from the line of Mike Weinstein with JP Morgan.

Bill Hawkins

Good morning, Mike.

Gary Ellis

Good morning, Mike.

Mike Weinstein – JP Morgan

Good morning. Can you hear me? Let me start with just one housekeeping item, it is on the other income line, the – could you just give us some more detail on those pluses and minuses that you talked about.

Gary Ellis

Yes, Mike. This is Gary. As I said, other income and expense line for the quarter was the $50 million kind of net number. As you know that includes currency gains and losses, royalty payments, royalty income, amortization intangibles. There are lots of different items in that line item itself. The major fluctuation from the prior year which – when the number was about $119 million was in the foreign exchange contracts. Last year, we had a $41 million loss on our foreign exchange contracts. This year it was about – over $30 million gain and as a result there was a $70 million swing year-on-year just related to the foreign exchange contracts themselves. The rest of the items in there net-net were pretty offset, but that was the major change.

Mike Weinstein – JP Morgan

Okay thanks. Let me just set back for a minute, Bill we went – going back to the conference last month, you talked for the first time about the growth profile of the company suggesting organic growth of 5% to 8% top line and leveraging that to get to 10% or better on the bottom line. Tell me what do you do to deliver on that growth which is on the top line certainly, where you were this quarter organically, and you were at least in the bottom line. To do that longer term, what do you have to do in your view relative to your existing markets and then to do better than that, what would you require relative to your market share. I guess part of what I'm asking is everybody is aware that you have had challenges in some of your bigger markets and defending your market share in CRM and spine, and as well as many other spaces. Can you continue to give up market share and deliver 5% to 8% top line growth or what do you assume for underlying market growth in your key areas?

Gary Ellis

So, it is a combination of things Mike. It is a combination of market, the stability in the markets and growth where we can in market growth, and secondly in being able to defend and grow our market share. If you look at the ICD market, as we have suggested, we look at growth in that sort of mid-single digits. And as I mentioned on this call, we are – you know, we had a set back a year and half ago with Fidelis, but, you know, we're back on the offensive. We feel very good about our product portfolio and we are in a mode of going back and stabilizing and gaining share. So that is one of the assumptions. Secondly on the Spine business, you know, that continues to be a good market. We see still solid growth in that market and around the 10% range. We have lost share to the smaller companies but we see that stabilizing and, you know, our plans over the next couple of years are to get back into growing with the market if not – and getting back into a position, where we can actually regain share in that market.

Then the other thing that has been a bit of a tailwind for us has just been the strength of the neuromodulation business, which we pioneered. If you go back in time via Medtronic, we created the pain stem market, as well as the whole movement disorder market; and we see good growth continuing in that business and we have a very strong product line-up, which we believe will enable us to continue to grow with that market, notwithstanding new competitors coming in.

On the Diabetes business, there too, we are best of market. We think there is still a lot of headroom given the fact that the market is still under penetrated and with our – the excitement that we have around the continuous glucose monitoring combined with the latest pump technology in the patch pump, which will be coming out, we see that being a good tailwind for us going forward.

And then surgical technologies and cardiovascular are good solid markets, you know, for us to being in and then we're investing in new areas. The atrial fibrillation space, we think is going to be one of the more exciting spaces in med-tech and with the two acquisitions we just did combine that with our existing EP business and our Reveal XT, I mean it is already close to $200 million business for us and we see good growth coming out of that market. So that is just again, a recap of some of the things that we see that give us the confidence that we can grow in that mid-single digit range.

Mike Weinstein – JP Morgan

Let me just ask one follow-up, a short one. Can you just spend a minute on Kyphon, and build a strategy for getting that going in the right direction.

Bill Hawkins

Kyphon, very candidly has been a bit of a disappointment for us. In terms of just, some things that have happened since we acquired the business with the – just kind of the slowdown particularly in the lumbar spinal stenosis segment, you know, that was a part of Kyphon; and we've had as I have mentioned in the previous conference calls, they kind of go back to sort of retrain and kind of – and make sure that we are positioning the product appropriately. And we still see that as having a lot of headroom for growth but we are in that kind of a rebuilding phase. On the core BKP business, this quarter we did okay in the US. We hit some speed bumps outside the US, but I again if I look at the overall sort of fundamentals, we feel that there is a lot of headroom for growth and we've got some new products coming out in the first part of fiscal year ‘10. So, you know, we think that we will be able to get the same growing again and we see a lot of downstream, a lot of opportunities to leverage this platform more into the minimally invasive arena.

Mike Weinstein – JP Morgan

Thanks for letting me just jump in.

Bill Hawkins

Okay, thanks, Mike.

Operator

Your next question is from the line of Timothy Lee with Piper Jaffray.

Timothy Lee – Piper Jaffray

Hi, good morning. Thanks for taking the question. Just on the ICD side, today you talked about your market share being flat sequentially. I can’t get there from my math, because I guess there are some better numbers and ideas. Can you just kind of one, just tell us what you expect your share was and I guess, Bill to your point of you know, getting profitable market share in CRM, I mean just given your profitability profile, is it by definition if somebody comes in at their segment operating margin, it is going to be less profitable for you. So, I mean, is that a business that you are walking away from. So if you just kind of give some better sense of that dynamic please?

Gary Ellis

Tim, this is Gary. Let me kind of respond to the first with respect to the market share sequential comment. As I said in my comments, the issue you have is you have to be very, very careful taking a look at what is happening with currency and what happens with basically extra selling days that individuals having to go quarter-to-quarter, even as we look at our quarter-to-quarter comparison there is extra selling days, which do have a significant impact on the result. When we – and in this situation this quarter, one of our competitors had an extra week sales and if you take those into consideration, if you look at the actual selling days that each company had, we come up to – basically our margins for both last quarter and this quarter are right around that 47% to 47.5% area worldwide in ICDs. And so that is why we have said sequentially we are basically flat with where we were in the prior quarter.

Bill Hawkins

And just to quickly respond to the question about profitable market share. You know, we continue to sort of bring forth innovations that give us the opportunity to kind of move the whole market up. We did that with minimal ventricular pacing. We've done that with OptiVol, and we are continuing to innovate and bring forth things like MRI safe systems, which we believe will enable us to generate a modest premium and to be able to gain share, while protecting and if not growing our margins.

Timothy Lee – Piper Jaffray

And then just one last one. I mean just following up on the CRM share position. I mean, is that your other two competitors have been selectively adding to their sales infrastructure and, you know, any thoughts on, you mean, Medtronic kind of reversing its course in terms of reallocating expenses on the CRM side?

Bill Hawkins

Well, first of all we have been reallocating expenses on the CRDM side. If you look at where we are today, I mean, we reduced our worldwide headcount in the overall CRDM business about 20%. So we have been very smart in reallocating resources, but at the same time protecting that competitive field force that we have had and today, I mean when you look at the – our enterprise and you combine our sales force and our clinical specialist, I mean we feel that we are well positioned and well structured to be able to maintain and grow our market share going forward.

Gary Ellis

And just add to Bill’s comment, Tim, I mean we're obviously always focused on what is the right productivity that we need in our organizations. And as I mentioned in my comment, we know that our sales productivity and lot of the productivity within our CRDM business is much higher than what the competition is at. We obviously are doing a good job of leveraging our overall expense structure and managing that, and as Bill said even with MCRD, and we've shifted things out of CRDM, and even within CRDM we have shifted out resources to really focus on what services and what components do the customers and the patients really need versus what maybe have been there historically. So, more clinical specialists et cetera [ph] versus even adding more sales reps. We just think, we're focused on trying to make sure we deliver the basic services that the patients and the customers really need. So, we think we have a good expense profile at this point in time to continue to manage the business.

Timothy Lee – Piper Jaffray

Great, thank you.

Operator

Your next question is from the line of Tao Levy with Deutsche Bank.

Tao Levy – Deutsche Bank

Good morning.

Gary Ellis

Good morning, Tao.

Bill Hawkins

Good morning, Tao.

Tao Levy – Deutsche Bank

And that was a question on the pacemaker side actually. I mean if you look at the last few quarters in the US, you guys have declined and, I know, you commented that your shares stayed stable there. And maybe you could comment just briefly on the market what you're seeing there in – where there any one-offs that have led the last few quarters to be negative growth?

Bill Hawkins

Well, again go back to Gary’s comments, when you look at from this issue of number of days and that plays into this whole equation, but when I go back and look at our product portfolio and with the recent launch of the MRI SureScan technology, some of the capabilities that we have with minimal ventricular pacing, we feel very good that we have a very competitive product line up, and are vigorously defending and growing – protecting our market share and, you know, the market in terms of just overall growth has been pretty much where it has been in that sort of low single digits. So – that is kind of where we are.

Tao Levy – Deutsche Bank

And just briefly, on the acquisition strategy front, you guys have made a couple of acquisitions over the last couple of months. There are some media reports of maybe another one coming. You know, when you look back at Kyphon and the issues that you faced at Kyphon, is there any sort of lessons you have learnt there that you think you can apply to what you might be doing going forward and again relative to the last two, at least that have been publicly announced?

Bill Hawkins

Well, it is interesting. If you go back and look over time at where we have been maybe more successful, in some respects it has been in the smaller kind of tuck-in acquisitions. When I look at what we did with the (inaudible) the endovascular business and how we have been able to grow that. And so, you know, we're looking for the unique sort of innovative proprietary technologies that complement our current sort of distribution footprint that give us the opportunity to grow into attractive markets and the recent acquisitions and (inaudible) fit that very well. I mean, early technology gives us a chance to kind of come in and help to shape it, and to build that market and be able to drive meaningful growth going forward. So, I think – looking back I would say we, you know, we think that we can make a difference in these earlier stage technologies.

Gary Ellis

Just, Tim, excuse me, Tao just to add to Bill’s comments. The other thing that I would say, we have done is we have looked at our integration processes and have really improved and done some steps to try to improve in that area as we go forward. We have dedicated integration teams that we have assigned to these acquisitions now and so, for example, on each of the acquisitions and we just did a kind of follow-up here recently on the Kyphon acquisition on lessons learnt. Well, what didn’t go so well, and we expect to take those lessons learned and apply those into the AF acquisitions Bill just mentioned.

Tao Levy – Deutsche Bank

Okay, great. Thanks.

Operator

Your next question comes from the line of Matthew Dodds with Citigroup.

Matthew Dodds – Citigroup

Great thanks. Just a couple of questions. Bill first for you, back to the ICDs and market share, when you look at the US, you know, US – in the US it does look like you lost shares sequentially. I'm just wondering how much of that you think has to do with this replacement argument where you said you don't think replacements are helping you that much for other companies, and said they are still benefiting. Just comment on that one more time, I know, you commented in the last quarter.

Bill Hawkins

Yes Matt, I think it clearly plays into the equation. If you look at replacements today they are roughly 30% plus of the total revenue to market. So there – it is not unimportant and not insignificant component of the overall sales make up and we are going through a phase right now where – and I think you've heard some of our competitors speak about it at their most recent conference calls, where they are in a cycle where it is going to be a bit of a tailwind for them and for us it is, you know, it's a bit of a headwind. So, you got to sort of factor that into this whole equation and when you look at that and we look at and track very carefully our initial implants and what we are saying is that we think we, you know, we are being able to maintain if not marginally gain share from the initial implants, which will benefit over the long run.

Matthew Dodds – Citigroup

And Bill just a follow up on that with the devices you had to remove in 05, shouldn’t a replacement cycle and have a sort of a second lag effect on you because of that.

Bill Hawkins

Well it did. I mean it, we didn't. It certainly went against us because we basically replaced at no charge a number of those products that would have been in our replacements cycle. So you're right Matt, I mean, that is – that has been another sort of negative drag on us with the reactions and responsible actions we took with Marquee, a few years ago.

Matthew Dodds – Citigroup

I mean those will be, my assumptions those will be coming back though because there are in about a year or two going to be replaced.

Bill Hawkins

Yes it is in our case, since, you know, we have longer battery lives. It is going to be probably 6 to 7 years.

Matthew Dodds – Citigroup

Okay. And then for Gary on the SG&A, you said that FX was an impact.

Gary Ellis

Correct.

Matthew Dodds – Citigroup

I guess, I assume there would be a benefit depending on how you pay people internationally. Just, can you comment on that and then going forward will FX given the current rate turn to a benefit in SG&A or remain negative?

Gary Ellis

Well, the issue you have with on why foreign exchanges are negative is basically the selling part of the equation is pretty comparable and as a percentage of revenue in OUS areas it is similar to the US, and so you don't have much of an impact, but obviously we have more G&A and more marketing dollars that are over in the US and so as a percentage, the reduction you get in the revenue from dollar strengthening is more than you obviously get on the expense side. And so that is why there was a negative, you obviously get a benefit in your selling expenses by translating that the strength in dollar but the problem you have is as a percentage there, it's a lower percentage, and so it actually has a negative impact on the overall SG&A percentage and as I mentioned it is 20 basis points to 30 basis points here kind of in the quarter itself.

At today's FX rates that would continue to be slightly negative for us as we go forward for these next several quarters comparing to the prior years because that would, again the same impact would be there in the subsequent quarters. Now we are seeing, obviously the benefit, however, of some of our other spending reduction leverage plans as we go forward and as we have talked about as you get into Q4, again the problem we have in our Q3, we have fewer selling days. The expenses are basically the same because you're paying everybody on obviously the month or a quarterly basis, but the fact of the matter is you'll have a higher SG&A percentage. We always do in Q3 because we have fewer selling days. That will – as you go to Q4 you have more selling days and actually the SG&A percentage drops just because of the leverage component you get there. And the last comment I would add to the comment here Matt is – even though I mentioned the SG&A percentage it was negative on the SG&A itself, as I mentioned on my bottom line perspective, we basically – the hedging results and the hedging gains that I mentioned we had a net basically zero benefit neutral benefit on the bottom lines. So basically we offset that entire revenue impact from currency on the bottom line.

Matthew Dodds – Citigroup

All right. Thanks Gary. Thanks Bill.

Operator

Your next question comes from the line of Rick Wise with Leerink, Swann.

Delinnea – Leerink, Swann

Hi, good morning everyone. This is Delinnea [ph], I am in for Rick today. Just want to expand a bit more on your CRM comments. First of all, broadly speaking given extended new products offerings from St. Jude and Boston Scientific and more likely to come in the next 12 months, can you expand on Medtronic key new product offerings and highlight whether you think more aggressive pricing is a greater risk now given the narrowing product line differences.

Bill Hawkins

So, we have just launched the new a whole new platform, the vision 3D over the last six months and complementing that we have a whole new family of leads, the Attain StarFix lead, which is getting a lot of very positive traction out there. We just supplemented that with the Attain Command. So, and then broad-based delivery systems in addition to the lead. So we have new delivery systems, we have new leads, we have a whole new platform. We are about to bring forth improved an improved CareLink system. So, we have a pretty fresh new product line that we believe will give us the opportunity to really continue to protect and to gain profitable share. Now, so – so we have a – we feel very good about our product line.

Gary Ellis

And just kind of add to what Bill mentioned, overall as far as pricing, we don't think you will see pricing playing an issue because as get into some of the share discussions here but the reality is all of us are adding value to our products and that should maintain the pricing aspects as we go forward. So, we don't see that being a major component. I think we'll continue to compete on what the therapies we provide and for example, you know, Medtronic products are right now – I think it is worth only one half. Some of the things that Bill mentioned earlier like OptiVol, for example, we're the only one that has that feature and actually doctors are now being able to be reimbursed for monitoring of the OptiVol function. So, we think actually that will be an advantage for us and some of the features we do have in our products going forward and that we are differentiated.

Delinnea – Leerink, Swann

Okay, and then if I could follow up a little bit more specifically, just a few weeks ago one of your competitors at their investor conference having a piece of CRTP devices with our telemetry and remote follow-up capability later this year. Is this something that is in Medtronic’s pipeline and if so when could we see that in the US?

Bill Hawkins

Yes, it is. And I don’t have the specific dates. We can follow up with you on that, but we have obviously, it is – it is essential part of our ICD platform, the wireless telemetry capabilities that we have, and we have the technology that we are building into our pacemakers as well.

Delinnea – Leerink, Swann

Great, thanks so much guys.

Bill Hawkins

Next call.

Operator

Your next question is from the line of Larry Biegelsen with Wachovia.

Larry Biegelsen – Wachovia

Hi, thanks for taking my call. One, excuse me, one housekeeping question. Endeavor sales in the quarter, I don't know if you mentioned that?

Bill Hawkins

Endeavor for worldwide, we reported about $180 million in overall stents and for the Endeavor, we did about $100 and close to $130 million.

Larry Biegelsen – Wachovia

And the US portion?

Bill Hawkins

It was about – around $50 million.

Larry Biegelsen – Wachovia

Thanks. And Gary for the quarter – fiscal 4Q ‘09 what is the FX impact you are expecting now, and I'm sorry I didn't have a chance to do the math but what does that imply for the constant currency growth rate for sales in the quarter. By my math, it looks like about 7% to 13%.

Gary Ellis

7% to 13% revenue growth.

Larry Biegelsen – Wachovia

What is the FX impact for 4Q ‘09 that you're assuming now. It is a little bit lighter in the third quarter than I think the initial guidance. So what is the constant currency growth rate that your guidance assumes right now?

Gary Ellis

Basically, our guidance would say we are that our growth in the fourth quarter would probably be similar to what we had here in Q3. You know, of the 50% we talked about it you know, the last couple – the last quarter here. It will be again at the lower end of that range based on what we see currently at a constant currency level. I mean again foreign exchange right now, we expect would be at today's rates would be a little bit heavier impact in Q4 versus what you saw in Q1. It could be – at today's rates it could be somewhere, you know, $150 million to $200 million on negative FX. So, we'll have to see how that plays out but at today's rate that is what you will see.

Larry Biegelsen – Wachovia

You mean that is a little higher in the fourth quarter versus the third quarter Gary?

Gary Ellis

That is correct.

Larry Biegelsen – Wachovia

Okay.

Gary Ellis

At today's rates.

Larry Biegelsen – Wachovia

Okay. And lastly, in Spine, could you give us an update on Kyphon, Japan, the CAVIAR trial, and when you plan to file the Cervical indication and Prestige LP. Thanks, timing on that.

Bill Hawkins

So on Kyphon Japan, we just submitted our (inaudible), just this quarter and we are looking at early FY11, probably when you factor reimbursement and everything to be on the market. So that is Kyphon. What was the other?

Larry Biegelsen – Wachovia

The CAVIAR study and Prestige LP.

Bill Hawkins

The CAVIAR is moving along. We are – I can’t remember exactly the number that we’ve enrolled, but it is you know, that study is out there, still probably a couple of years, but it is more actively enrolling in CAVIAR, and then on the Prestige LP, I'm not sure I have, we get back to you on that.

Gary Ellis

I don’t have that detail. We will have to get back to you.

Larry Biegelsen – Wachovia

The filing for INFUSE cervical indication, sorry, that is the last one.

Bill Hawkins

The filing for the INFUSE cervical. We have this study under way and so again I don't know the specifics, but we have the amplified study for the posterolateral, okay, and we have ACDF study for – both of those are studies that are sort of – the posterolateral study is done but I think the ACDF study is under way.

Larry Biegelsen – Wachovia

Thank you.

Bill Hawkins

Next question.

Operator

Your next question is from the line of Ben Andrew with William Blair.

Bill Hawkins

Good morning Ben.

Ben Andrew – William Blair

Hi, good morning. Can you talk a little bit about kind of following on the spine topic, back in the construct side, when do you think you will have a more competitive product line. Is that the issue because you did talk about a series of new product launches, where you can get that business growing again back at the market rate. Is that an FY 2010 timeframe?

Bill Hawkins

Yes. We are – we actually have been developing a major new product that will replace our kind of legacy systems that will be starting to come into the market probably the end of next, of this fiscal year okay – next fiscal year of FY10. And it's something we are very exited about. It will completely replace our sort of legacy system, if you will. So that's going to be, if you will, the backbone of our spine offering. And then on top of that, we continue to bring forth the innovations. In these translational plates, we have a new system called the EX-VBR [ph], which is kind of a telescopic cage. We have a, you know, new cervical plates we have. One of the things that we are continuing to do is to lead the way with new material sciences, these Hydroxyapatite-coated screws, and then we are – combine that with just as I mentioned in my remarks the capabilities that we have with biologics and with navigation. We feel like we are going to be in a very strong position as we come into FY10 and going forward.

Gary Ellis

Just to add to Bill’s comment, I want to make it clear that this new product line we're talking about is a whole new platform. I mean the legacy – our existing platform and the legacy platform has been out there probably about 6 to 7 years now and so those will be a brand-new platform that will include instruments, it will include all new products, et cetera. I think there is over 5000, you know, really parts and stuff to this. So it is not one product line. This is a whole new platform on the spinal business that as Bill said we are very excited about that we think will really help accelerate that business.

Ben Andrew – William Blair

Thank you.

Operator

Your next question is from the line of David Lewis with Morgan Stanley.

David Lewis – Morgan Stanley

Good morning.

Bill Hawkins

Good morning, David.

David Lewis – Morgan Stanley

Bill, just a question or CRM, given your comments on profitable growth. If I made a statement that you're essentially staffing the CRM business to minimize share losses opposed to share gains and incremental share gains have to come from new products. Is that kind of an accurate statement or no?

Bill Hawkins

No. I mean we're not staffing to minimize share loss. We are staffing to protect and to grow our business, very clearly. We are playing to win in this market place and it is a combination of products, it is a combination of service, it is a combination of having the right contracts with hospitals. So, on a broad-based way, we have – we are playing to win.

David Lewis – Morgan Stanley

Okay. And then this commentary on the core fusion business, this new platform, are we to assume that this new platform will address nerve sparing type procedures as well. So some navigation or another augmentation to minimally invasive surgery.

Bill Hawkins

That is a little bit separate from the new platform, but that is the direction where we're going. We have proprietary technologies for integrating nerve monitoring into some of our tools to be able to ensure a – safe procedures. So, absolutely that is technology that we have leveraged from our ENT business that we are bringing over to our spine business, and we believe that that again is going to help us to differentiate our technology.

David Lewis – Morgan Stanley

Okay. I'm sorry, Bill, and that will be included in the new platform launch or could be later than these?

Bill Hawkins

It will be later. It is a little bit separate from the new platform launch. The new platform by the way, one of the real elements of that is it is a smaller configuration of components that enable you to do these procedures even more minimally invasive going forward. So again that is the core value of this whole new platform that we are bringing in – and it got the infrastructure, and then on top of that, you know, we will add sensor technology, navigation technologies that will further differentiate these products.

David Lewis – Morgan Stanley

Okay. I mean just two more quick ones. One just staying with spine, on the synergy comment that Gary made, you are seeing higher synergies, is that just from a more rationalized sales channel. Are there other areas of synergies that we are missing here?

Gary Ellis

The primary synergies actually are not in the sales area. As we've talked about in the past, we basically just combine the sales rep organization. So there is really not a lot of synergies that we have experienced there. It is more in the back-office types of activities, you know, the customer service, the finance et cetera. There is some synergy on marketing et cetera we have also achieved. But overall it will come on the R&D side, but the sales side, there has not been as much in the sales side. Looking at sales management, but primarily at the back office has been where the synergies have been at.

David Lewis – Morgan Stanley

Okay. Just last question, I will jump back into queue. Given it is a hard quarter. Given, RX supply constraints, is RX going to be a share stabilizer or potentially as share gainer as we look forward over the next couple of quarters? Thank you.

Gary Ellis

It will be a share gainer. We will leverage the RX platform to incrementally gain share, we believe, quarter-after-quarter.

Bill Hawkins

Okay, why don't we take one more question and wrap up the Q&A here. One more question.

Operator

And today's final question is from the line of Bob Hopkins with Bank of America.

Bob Hopkins – Bank of America

Thanks. Good morning everybody.

Bill Hawkins

Good morning, Bob.

Bob Hopkins – Bank of America

A couple here. Just first on spine, can you give us an update on Amplify and when you expect approval?

Gary Ellis

Well, let me get someone to help me here. Mid FY10, we should have Amplify.

Bob Hopkins – Bank of America

Okay, and then Bill, is the basic message on spine, especially as it relates to biologics in Kyphon, that those businesses have now stabilized, and we have seen the lows from a quarterly revenue perspective or is this quarter just you know, sort of nice stabilization, but we could see some more bumps down before we head back up again.

Bill Hawkins

No. I think it is fair to say that we are seeing both these businesses as stabilized on the biologics side with INFUSE, and then secondly on the Kyphon, yes. So, I think it is fair to say that they are both stable, and we are going to be investing to grow.

Bob Hopkins – Bank of America

Okay. And then Bill, one bigger picture question I wanted to ask you is that obviously the economy seems to be getting worse, but most importantly things are changing very quickly and so I'm wondering if you could talk about what you have seen especially over the just the last month or month and a half in your businesses, you know, such as spine or ICDs or pacemakers. You know, are you noticing in the last month any change out there for your businesses that it could be susceptible to a weaker economy, especially one of this nature. Just want to get your kind of latest thoughts on what you are seeing out there in the hospital marketplace over the course of the last month.

Bill Hawkins

Well, when I talk to a few people who are close that run large healthcare systems and take their pulse on kind of what they are saying and combine that on what I am saying. I do see the whole elective procedure and that comes back to what you define as elective, as being increasingly impacted. And if again you go back to our comments in terms of the businesses that we think are – have more of an elective component. You know, one is the Diabetes. You know, with the patients perhaps not being in a position to afford the co-pay for a pop. Secondly, and the Surgical Technologies business. There are a number of procedures particularly in the ENT space that are arguably elective. Thirdly, I do think the spine, you know, is, you know, could be somewhat vulnerable as patients will maybe endure more pain to put off having a surgical procedure that takes them out of work or put them at risk of their job. And one thing that is one comment that I've heard from talking to hospital CEOs is that their – if you will their whole musculoskeletal sort of business has been down and spine has sort of figured into that a little bit. So, I think the spine, I think Surgical Technology, Diabetes are the areas that are most susceptible to the economic turmoil.

Gary Ellis

Bob just to add to Bill’s comments, I think the other thing I would add is kind of from an overall perspective, obviously these hospitals and countries try to figure out how they balance their budgets, et cetera. We obviously have seen them trying to do some reductions in their own inventory levels, etc. and trying to minimize those levels. So that is an area we are also keeping an eye on. Do they start to lengthen receivables, do they start to do some other things. We haven't seen it yet, but that is the other area of focus where I think you could see the economy having some impact on us as we move ahead.

Bill Hawkins

Okay. I think we will go to wrap it up here. So just again on behalf of the management team thanks for your interest and continued support, and we will talk to you next quarter. Thanks.

Operator

Ladies and gentlemen, this does conclude the Medtronic third-quarter earnings conference call. You may now disconnect.

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Source: Medtronic, Inc. F3Q09 (Qtr End 01/23/09) Earnings Call Transcript
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