Medtronic, Inc. F4Q09 (Qtr End 04/24/09) Earnings Call Transcript

| About: Medtronic plc (MDT)

Medtronic, Inc. (NYSE:MDT)

F4Q09 Earnings Call

May 19, 2009 8:00 am ET


Jeff Warren - Vice President Investor Relations

Bill Hawkins - Chairman and Chief Executive Officer

Gary Ellis - Chief Financial Officer


Larry Biegelson – Wachovia

Rick Wise - Leerink, Swann

Bob Hopkins – Bank of America – Merrill Lynch

Matthew Dodds – Citigroup

Mike Weinstein – JP Morgan

Kristen Stewart – Credit Suisse

Ben Andrew – William Blair

Davis Lewis – Morgan Stanley


(Operator Instructions) Welcome everyone to the Medtronic Fourth Quarter Fiscal Year End Conference Call. I would now like to turn the call over to Mr. Jeff Warren, Vice President of Investor Relations.

Jeff Warren

Welcome to Medtronic’s Fourth Quarter Conference Call and Webcast. During the next hour, Bill Hawkins, Medtronic Chairman and Chief Executive Officer, and Gary Ellis, Chief Financial Officer will provide comments on the results of our fourth quarter and fiscal year 2009, which ended April 24, 2009. After our prepared remarks, we will be happy to take your questions.

A few logistical comments; earlier this morning we issued a press release containing our financial statements and a revenue by business summary. You should also note that some of the statements made during this call may be considered forward looking statements, and that actual results might differ materially from those projected in the forward looking statement.

In addition, the 10-K for the fiscal year 2008 identifies certain factors that could cause the company’s actual results to differ materially from those projected in any forwarded looking statements made during this call. The company does not undertake to update any forward looking statements as a result of new information or future events or developments. The 10-K is available through the company or via the Medtronic website.

During the call non-GAAP financial measures may be used to provide information pertinent to ongoing business performance. These measures are addressed in a non-GAAP to GAAP reconciliation that were included in today’s press release and are also available on the Investor Relations portion of the Medtronic website, and unless we say otherwise, reference to quarterly results increasing or decreasing are in comparison to the fourth quarter of Fiscal Year 2008.

With that, I am now pleased to turn the call over to Medtronic Chairman and Chief Executive Officer, Bill Hawkins.

Bill Hawkins

Q4 was a solid quarter with revenue of $3.8 billion, growing 5% after adjusting for a $211 million unfavorable impact of foreign currency. Total year revenue of $14.6 billion, grew 9% after adjusting for a $100 million unfavorable impact of foreign currency. Fourth quarter earnings and diluted earnings per share on a non-GAAP basis were $916 million and $0.82 respectively. Total year earnings and diluted earnings per share on a non-GAAP basis were $3.3 billion and $2.92, growing 10% and 12% respectively.

Despite a challenging economic environment, our fourth quarter and annual results reflect the underlying resilience and strength of Medtronic’s diversified portfolio of businesses that focus on many of the most prevalent chronic diseases across a range of increasingly important global markets. While we continue to closely monitor any potential impact from the ongoing economic turbulence, I remain confident in our ability to deliver sustainable, market leading performance.

Looking ahead, we intend to extend our market leadership by increasing our focus on innovation. Over the next year, we expect to introduce many new products. We will also continue our efforts on relentless execution. We intend to extend our market leadership by strategically investing in faster growing markets like Endovascular, Diabetes, Atrial Fibrillation, Transcatheter Valves, Neuromodulation and Spine. And we expect to extend our leadership by leveraging our global footprint.

Today we are well positioned in the most attractive chronic disease markets with leading technology. We exited fiscal 2009 stronger than we began.

In our CRDM business, growth in the global ICD market appears to have stabilized in the mid single digits on a constant currency basis and appears to be showing positive signs in the US. And although we have clearly felt the impact from Fidelis over the last 18 months, we are now back on the offensive having stabilized our share position and strengthened our overall product line.

Last week, I attended the Heart Rhythm Society meeting in Boston and was encouraged by Medtronic’s arsenal of market exclusives, recent product launches, and very importantly, the buzz around our newly formed AF Solutions business. Our sales force and customers were visibly energized. Among the new product highlights were our new left heart leads and lead delivery systems.

Our recently announced Attain Ability is the smallest and only 4-French left-heart lead on the market. Additionally, Medtronic market exclusives like Optivol, MVP or Minimal Ventricular Pacing and Pain Free shock reduction are truly differentiating technologies that drive physician preference and benefit patients. We also continue to be the leader with first to market products. We are the first and only company to bring an MRI safe pacemaker to market, and the first and only company to embed lead integrity software into our defibrillation systems.

In Atrial Fibrillation, we are poised to be the undisputed leader in one of the fastest growing and most promising areas of med tech. Our AF Solutions business, formed around our recent acquisitions of Ablation Frontiers and CryoCath, possesses two of the most compelling technology platforms in this space.

The integration of these two businesses is going well as we develop a new sales channel in Europe and we remain on track to file the PMA for Arctic Front this summer and the PMA for the AFI catheters later this fiscal year. Physicians are clearly excited about having access to these breakthrough technologies, which aim to enable them to treat patients faster, safer, easier, and with more predictable procedure times.

In Spinal and Biologics, the results this quarter were in line with our expectations. We were encouraged to see continued stability in our core spine business, reflecting positive momentum from several new or enhanced products including translational and lumbar plates, PEEK Rods and other minimally invasive products.

It’s important to note that our extensive line of PEEK products is now annualizing at nearly $300 million and our recently approved PEEK PREVAIL spacer should only add to this momentum. These products are examples of our efforts to revitalize our entire core spinal product pipeline over the next two years.

Although we have much work to do, we still have the most comprehensive line of innovative products in the market, including unique minimally invasive solutions, dynamic stabilization products, navigation and imaging technologies, and exclusive biologic solutions. No one can compete with the breadth of our portfolio.

In our CardioVascular business, solid growth was driven by continued momentum in our Coronary franchise along with exceptional growth in our Endovascular business. In Coronary, worldwide stent revenue grew 15% sequentially with momentum coming from increased adoption of Resolute outside the US, the availability of RX in the US, and positive Endeavor clinical data at ACC in March.

Later today at PCR, new Endeavor-II five year data will confirm the durability of Endeavor’s long term clinical efficacy and challenges the current conventional wisdom on long term efficacy. With Endeavor’s recent approval in Japan, it is now approved in all global markets and we expect momentum to continue as we launch Endeavor into the $500 million plus Japanese drug eluting stent market. In Endovascular, we are making great strides with exceptional company leading growth. This business is well on its way to being a $500 million business.

In the transcatheter valve market, with our recently announced acquisitions of Ventor and CoreValve, we have two of the best platforms to drive toward market leadership. This is clearly an exciting opportunity and is already a market that is taking off in Europe. Based on the excitement that I heard from physicians while at ACC, it should be an even more compelling opportunity here in the United States. These tuck in acquisitions are consistent with our strategy to pursue opportunities that have natural synergies with our existing growth platforms and leverage our global footprint.

In Neuromodulation, both our Activa Deep Brain Stimulation products for Parkinson’s Disease along with our Gastro Uro business grew in the mid to high teens on a constant currency basis, with InterStim growing 20% or better for the thirteenth consecutive quarter. This quarter’s results also reflect some near term pressures that we’ve seen in our Pain Stimulation business. We believe these pressures are both temporary and addressable in nature.

We are also increasing our competitive focus to address some initial trialing excitement surrounding the launch of a competitive product. Looking ahead, Rick Kuntz and his team are highly focused on advancing our technological and competitive leadership in pain stimulation with new offerings to gain share and broaden the market, as well pioneering many other compelling opportunities in Neuroscience, including the use of Deep Brain Stimulation for the treatment of epilepsy and psychiatric disorders.

Today, we have both best in class products and the field sales and support staff necessary to drive our continued leadership in this attractive market, and we will continue to expand the field staff commensurate with market growth in the broad field of Neuromodulation.

In Diabetes, strong double digit performance on a constant currency basis this quarter was driven by the continued success of Continuous Glucose Monitoring and solid insulin pump sales. We continue to have success as the only company with a proprietary Continuous Glucose Monitor Sensor Augmented Pump on the market. At this point, we have a three year lead on the competition. We are also the only company with the iPro, a unique professional CGM tool, and with our Diabetes CareLink therapy management software, we offer the most integrated diabetes data management system on the market.

We continue to execute on our significant new product pipeline, including making strong progress in blazing the trail to a closed loop system so stay tuned for an update on this program at our upcoming Investor Meeting on June 2nd.

As another sign of our increasing business development efforts, later today we will announce details of a strategic marketing collaboration with Eli Lilly, which combines our delivery and glucose sensing leadership with the insulin expertise of Lilly, a recognized leader in diabetes treatment, research, and education.

In Surgical Technologies, this business delivered another quarter of solid growth, reflecting steady performance, particularly given the elective nature of certain ENT procedures and the capital equipment component of the Navigation business.

Turning to our international operations, solid constant currency growth in the quarter underscores our commitment and focus on geographic expansion. After adjusting for the unfavorable impact of foreign exchange, revenues in markets outside the US grew 9%. China, Central/Eastern Europe, Middle East/Africa and Latin America all had constant currency growth rates in the high teens or better.

International product line standouts included Core Spinal, CardioVascular, Diabetes, Gastro/Uro, and Surgical Technologies, which all saw double digit constant currency growth. It’s also important to note that we continue to invest in our international infrastructure.

Reflecting on fiscal 2009, we delivered on our financial commitments despite the unforeseeable shifts in the economic climate. We strengthened our core businesses and made solid progress advancing our pipelines by increasing our focus and discipline on driving innovation and improving R&D productivity across the company.

Fiscal 2009 was a successful year that included:

Delivering double digit constant currency growth in five out of seven businesses

Delivering International constant currency growth of 10% with greater than 20% growth in China, Central and Eastern Europe, Latin America, and the Middle East and Africa

Launching over 20 major new products

Reducing manufacturing costs by nearly $200 million, which when combined with last year has us over 40% towards our goal of a billion dollars savings by FY12

Increasing productivity, with EBIT per employee growing nearly 10%

Generating nearly $3.4 billion in free cash flow, with nearly 50% of it being returned to shareholders via dividends and share repurchases

Delivering non-GAAP operating income growth of 12% versus sales growth of 8%

Making strategic investments, establishing leadership positions in the compelling growth areas of Atrial Fibrillation and Transcatheter Valves

Bottom line, despite currency and other factors significantly impacting our revenue, we delivered on our original FY09 EPS guidance, excluding the impact from the acquisitions.

As I look across the company, I’m pleased with the progress being made in aligning the organization toward one Medtronic. These changes are having a positive impact on driving innovation, achieving operational excellence, and ultimately, unlocking many of the strategic synergies that are innately part of the company, including areas such as clinical expertise and core technology research and development.

Finally, before I turn the call over to Gary, I want to say a few words about the outlook for FY10 and how we see the debate on healthcare reform impacting our business going forward. I firmly believe that our industry will be part of the solution to the challenges our country and other economies are facing with rising healthcare costs.

Medtronic has and will take a leadership position in enabling more efficient and effective healthcare. We have led the way with outcomes based medicine and are leading the way with enabling technologies like CareLink and diagnostics to reduce unnecessary visits to the clinic or hospital. Our therapies are designed to help restore people to health and to enable them to return to a more productive level in society. We are active in the ongoing healthcare reform discussions in Washington, and we are encouraging others in our industry to participate as well.

Regarding US tax reform, we believe the current discussions that are considering removing tax deferral on foreign income would alter the global competitive landscape and would be harmful to US companies. We oppose this. On the subject of preemption, we continue to believe that the FDA is the appropriate governing body for determining device safety and effectiveness, and we are opposed to any legislation that would undermine the FDA’s authority.

Finally, on a positive note, as I travel the world I see first hand the need and the opportunity for all that we do. With the aging of the population, the changing demographics and the growing burden of chronic disease, Medtronic is well positioned to prosper for years to come.

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

Gary Ellis

As mentioned earlier, fourth quarter revenue of $3.829 billion grew 5% after adjusting for a $211 million unfavorable impact of foreign currency. Breaking this out geographically, revenue in the US was $2.376 billion up 2%. Outside the US, revenue of $1.453 billion increased 9% on a constant currency basis. As expected, the significant strengthening of the dollar in Q4 versus the first half of FY09 and the prior year had a tremendous impact on revenue.

Foreign currency translation reduced Q4 revenue by over $200 million versus the prior year. However, as I’ll discuss in a moment, unlike many companies, we were able to offset much of the bottom line impact through our hedging programs.

After adjusting for restructuring, certain litigation, IPR&D, and special charges, and discrete tax adjustments, fourth quarter earnings and diluted earnings per share on a non-GAAP basis were $916 million and $0.82, respectively. GAAP earnings and diluted earnings per share were $250 million and $0.22, respectively.

After adjusting for the same types of charges I just mentioned, fiscal year 2009 earnings and diluted earnings per share on a non-GAAP basis were $3.283 billion and $2.92, an increase of 10% and 12% respectively. GAAP earnings for the fiscal year were $2.291 billion or $2.04 per diluted share. FY09 non-GAAP operating income also grew 12% on 8% revenue growth, which reflects our on-going focus on delivering operating leverage.

As noted, the fourth quarter of fiscal year 2009 was impacted by a number of items; first, we recorded $132 million in income tax benefit related to the reversal of various tax reserves related to tax positions settled with the IRS, numerous state taxing authorities, and assessments received from various foreign tax authorities. These reserves were provided for in prior years and are no longer necessary.

Second, consistent with our ongoing commitment to the improving the health of people and communities throughout the world, we recorded a $100 million special charge related to a charitable contribution made to The Medtronic Foundation.

Third, we recorded $27 million in restructuring charges related to new initiative to realign and delayer the organization started in the fourth quarter partially offset by the reversal of certain reserves remaining from prior periods. These new initiatives resulted in charges in the fourth quarter of fiscal 2009 and further charges are expected to be incurred in the first quarter of fiscal 2010. These initiatives will ultimately result in the elimination of approximately 1,500 to 1,800 positions through early retirement benefits and voluntary and involuntary severance packages.

Fourth, we recorded $270 million in certain litigation charges for the settlement of royalty disputes with Johnson & Johnson which related to Medtronic’s licensed use of certain patents relating to coronary angioplasty stent design and balloon material.

Fifth, we recorded $530 million in IPR&D primarily related to the acquisitions of Ablation Frontiers, Ventor, and CoreValve.

With the exception of the tax benefit, all of these items are disclosed individually on the face of the income statement and all are reconciled in the tables accompanying the earnings release.

Switching to the businesses, CRDM revenue of $1.3 billion increased 1% after adjusting for an $83 million unfavorable impact of foreign currency. Worldwide ICD revenue was $780 million including a $42 million unfavorable impact of foreign currency. As Bill mentioned, the US ICD market grew about 5% and the global ICD market grew 8% after taking into account the impact of currency.

Our analysis also suggests the initial implant market in the US actually grew modestly, and although we continue to face a replacement headwind, our overall share in the US and worldwide remained stable over the past three quarters. Pacing systems revenue of $494 million included a $36 million negative impact of foreign currency.

Spinal revenue of $881 million grew 4% on a constant currency basis. Core Spinal revenue of $512 million grew 5% on a constant currency basis reflecting increasing stability in this business and traction from a series of recent product introductions. Biologics revenue of $215 million declined 1% on a constant currency basis. Although this business continues to feel the pressure from several external factors, we were encouraged by the continued stability of this business in the US. We were also pleased by the double digit growth outside the US on a constant currency basis.

Kyphon revenue of $154 million grew 6% on a constant currency basis. We continue to focus on making the changes necessary to get revenue growth back to double digits and to realize the underlying potential of this business. We were encouraged to see Balloon Kyphoplasty sales in US continue to improve. For the first time, we did over 20,000 BKP cases in the US in the fourth quarter.

CardioVascular revenue of $644 million grew 8% on a constant currency basis. Coronary stent revenue of $213 million declined 8% on a constant currency, reflecting the tough year over year comparisons for Endeavor in the US. However, on a sequential basis, our share in the US did improve modestly as we continued to transition customers to our RX delivery system. In markets outside the US, excluding Japan, Endeavor and Endeavor Resolute market share remained stable at around 20%.

Endovascular revenue of $117 million grew 67% on a constant currency basis. US growth of over 70% was fueled by the continued success of our Talent Abdominal and Thoracic Stent Grafts in the US. Equally impressive constant currency growth outside the US of over 60% was driven by the ongoing success our next generation Endurant abdominal stent graft. We continued to advance evidence based medicine in this growing market by launching three post market clinical trials in the quarter.

Neuromodulation revenue of $389 million increased 7% on a constant currency basis driven by continued strength in Activa and Gastro/Uro. Revenue in our Pain business grew 2% on a constant currency basis. Movement Disorders grew 9% on a constant currency basis fueled by growth in our Activa DBS therapy for Parkinson’s disease and Essential Tremor, which grew 18%. The Activa product line continues to benefit from momentum created late last quarter when JAMA published results from the largest randomized, controlled study of DBS for Parkinson’s disease.

Gastro/Uro revenue of $81 million grew 16% on a constant currency basis driven by another strong quarter from InterStim, which grew over 20% on constant currency basis. Diabetes revenue of $296 million grew 14% on a constant currency basis, driven by the continued strength in our CGM franchise, which is annualizing at $100 million in revenue.

We were also encouraged to see that despite a challenging economic environment and increased competition, insulin pump sales still achieved double digit growth on a constant currency basis. These results reflect the strength, breadth, and depth of our global Diabetes organization.

Surgical Technologies revenue of $235 million grew 8% on a constant currency basis. Growth was highlighted by the strong sales of the StealthStation S7 with Synergy Cranial and EM Fusion coupled with strength in service contracts. I think it’s important to note that given the elective nature of the underlying procedures and the large capital equipment component of the business, Surgical Technologies performed well in this environment.

Finally, Physio-Control revenue of $84 million declined 7% on a constant currency basis. Results reflect the impact of the economy and delayed customer purchases in advance of the LifePak 15, which we received approval for in late March and are now in the process of launching.

Turning to the rest of the income statement, the gross profit margin was 75.7% compared to 75.5% in the fourth quarter of last year and in line with expectations. Foreign exchange had a 60 basis point negative impact on gross margins offset by our ongoing initiatives to improve manufacturing efficiencies and reduce product costs. We continue to see the benefits of the broad portfolio of initiatives we have underway to reduce our cost of goods sold by $1 billion by fiscal year 2012.

Fourth quarter R&D spending of $368 million represents approximately 9.6% of revenue. Consistent with the prior three quarters, fourth quarter results include a reclassification of approximately $12 million of certain legal and patent expenses from R&D to SG&A. Before this reclassification, R&D would have been approximately 9.9% of revenue with a growth rate of 9% versus the prior year. We remain committed to investing in new technologies to drive future growth.

Fourth quarter SG&A expenditures of $1.313 billion represented 34.3% of sales, compared to 33.6% of sales in the fourth quarter last year. During Q4 we intentionally increased our investment by over $20 million in selling and distribution efforts, especially in Spine, to reinvigorate sales growth and focus on maintaining and gaining share. Across the company, we continue to invest in our sales force and added over 400 sales reps globally in FY09.

After annualizing for the impact of Kyphon in FY08, the previously announced R&D reclassification, and the negative impact of FX, we saw a 50 basis point improvement in SG&A in FY09. We will continue to invest in customer facing reps in FY10 with over 500 planned additions globally. Despite the investment in distribution planned for FY10, we are driving for an additional 80 to 100 basis point improvement in SG&A as a percent of sales during the year.

Net Other Expense for the quarter was $53 million compared to $188 million in the prior year. The year over year decrease primarily is a result of the gains from our hedging programs which were $50 million during the quarter, compared to $90 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.

Net Interest Expense for the quarter was $13 million compared to expense of $5 million in the prior year period. This change from the prior year reflects lower interest rates on investments and higher interest expense from our $1.25 billion debt issuance in the quarter. As of April 24, 2009, we had approximately $3.9 billion in cash and cash investments. 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. The fourth quarter provision for income tax reflects an income amount of $24 million. This amount includes the $132 million benefit for the reversal of various tax reserves as well as the tax impact of restructuring, certain litigation, IPR&D, and special charges. Excluding these one time items, our effective tax rate in the fourth quarter was 20.5%. This rate includes a $17 million tax benefit related to the finalization of certain fiscal 2008 state tax returns and a state tax law changes. Exclusive of one time adjustments, our fourth quarter and fiscal year tax rate was 22%.

Fourth quarter weighted average shares outstanding, on a diluted basis, were 1.119 billion shares. During the fiscal year, we repurchased $759 million of our common stock. As of April 24, 2009, we had remaining capacity to repurchase approximately 18 million shares under our Board authorized stock repurchase plan.

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 providing our 2010 fiscal year guidance. As you know, we limit our guidance to one year at a time and try to keep it more directional in nature. In fiscal 2009 we saw significant fluctuations in currency exchange rates. Given the ongoing turmoil in the global economy and the resulting impact on monetary policies around the world, it will continue to be very difficult to predict exchange rates.

Therefore, we are providing revenue growth guidance on a constant currency basis. As we look at our markets over the foreseeable future, we believe that constant currency revenue growth of 5% to 8% remains reasonable and is consistent with our expectations for fiscal 2010. While we are not trying to predict the impact of currency movements, to give you a sense of the FX impact if exchange rates were to remain similar to last week for the remainder of the year, then our revenue growth rate would be negatively impacted by approximately 1% to 2% or roughly $220-240 million.

It is also worth pointing out that we would expect most of the negative FX impact to occur in the first half of the year turning positive in the back half of the year.

Turning to guidance on the bottom line, this is where the benefits of our ongoing hedging strategy are clearly more visible in the current environment. As you know, our hedging strategy is designed to help us more effectively manage our international operations as well to minimize the impact from fluctuating exchange rates on earnings. This means that over the past couple of years while other companies were enjoying the bottom line impact of a currency tailwind, we were not.

Conversely, as the dollar has strengthened our hedging strategy will effectively minimize much of the bottom line impact that many other companies are feeling from the currency headwinds of today’s environment. Having said that, based on expected constant currency revenue growth of 5% to 8%, we believe it is reasonable to model EPS in the range of $3.10 to $3.20, which reflects EPS growth of 8% to 12% after adjusting for approximately $0.06 to $0.07 of dilution from our AF and Transcatheter Value acquisitions.

This guidance also reflects the following major assumptions:

Gross margins would remain in the range of 75.5% - 76%

R&D spending in the range of 9.5% to 10%

As I mentioned earlier, improvement in the SG&A expenses ratio of 80 to 100 basis points

Net Other Expense of $350 to $400 million for the year

Effective Tax Rate in the range of 21.5% to 22.5%

Also, we’ve mentioned before, we have an extra selling week in fiscal 2010, which will occur in the first quarter, which means Q1 will have a total of 14 weeks. As you know, this anomaly is due to the way our fiscal years are structured with this catch up week occurring once every six years.

As in the past, my comments on guidance do not include any unusual charges or gains that might occur during the fiscal year nor do they include the impact of the new accounting method for recognizing non-cash interest expense on convertible debt. Another important housekeeping item before I turn things back over to Bill who will conclude our prepared remarks.

We will be hosting our Annual Institutional Investor and Analyst meeting again this year on Tuesday, June 2nd. This year’s meeting will be held at our World Headquarters facility in Minneapolis. In addition to hearing from our Business Unit leaders in the morning session, this year’s meeting will feature our Medtronic University format, which offers a unique opportunity for attendees to choose from twelve different classroom like sessions ranging from deeper dives into transcatheter valves and AF to sessions on Healthcare Policy, International operations, as well areas such as Innovation and Ventures. Looking over all the sessions, we will be offering some compelling choices for those of you who are able to join us here in Minneapolis.

Bill Hawkins

Before we begin our Q&A session, let me close by reiterating what I said to begin with, Q4 was a solid quarter. As I look across the company, I’m pleased with the progress being made in aligning the organization toward one Medtronic. These changes are having a positive impact on driving innovation, achieving operational excellence, and ultimately, unlocking many of the strategic synergies that are innately part of the company. 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.

Question-and-Answer Session


(Operator Instructions) Your first question comes from Larry Biegelson – Wachovia

Larry Biegelson – Wachovia

I’m trying to understand your fiscal 2010 revenue growth guidance of 5% to 8%. The extra selling week gives you about 2% and CoreValve roughly 50 bps. How are you accounting for that in the 5% to 8% constant currency revenue growth in 2010?

Gary Ellis

The 5% to 8% growth we’re talking about constant currency growth we gave in the guidance would include those. From the standpoint of the extra week, you can’t just do a mathematical calculation on that because obviously we do have an extra week but there are some of our business are more bulk purchases, not procedure related, it’s not a straight percentage calculation. That would obviously be a benefit for us, we agree with that. You’re right, the acquisitions give us some additional revenues go forward. All that was contemplated in that 5% to 8% guidance we gave.

Larry Biegelson – Wachovia

On the CoreValve US IDE could you give us an update on that please?

Bill Hawkins

We expect to submit the IDE mid calendar year ’10, so next year.

Larry Biegelson – Wachovia

Is there a chance that you’ll need a US feasibility study?

Bill Hawkins

I don’t know. We can get back to you on that. Our current thinking and the discussions we have with the FDA would suggest that we’re on track for a mid calendar year ’10 initiation of the IDE.


Your next question comes from Rick Wise - Leerink, Swann

Rick Wise - Leerink, Swann

Starting with gross margins, if I remember correctly you all were talking about gross margins and guidance that might have been better then 76%. Obviously you got very close at 75.7%. Was this greater challenge from currency, were the savings less then you thought? Related to that, was the pricing environment or mix more challenging then you expected?

Gary Ellis

The biggest impact was currency, as you indicated we had indicated last quarter that again we’ve been in the 75.5% to 76.5% range but we thought we’d culture to 76%. As you said, 75.7% is off slightly. The revenue impact on currency for example ended up being about $25 to $30 million more then we expected and which has an impact obviously on the margin.

Rick Wise - Leerink, Swann

On Spine, you said you still have much work to do. Maybe you could share your thoughts, a little more expansive way, on what the work is. Maybe highlight in your mind what the most important new products are that be accelerated or revitalized or help you regain share over the next one, two years as you discussed.

Bill Hawkins

A year ago I put Steve La Neve down in the Spine business and he over the last year has been working to kind of build his team. We just appointed someone to head up operations and R&D, a terrific guy that came from another business across Medtronic. We’re getting the team solidified. We are very clear on the priorities, one of which is to really focus on the pipeline, it is to make sure we get the right cross selling initiatives going on between the Kyphon organization and between the core spine organization, a lot of work on making sure we got the right priorities around clinical studies to drive the biologic side of the business as well as some of the core spine parts of the business.

There are a number of things that we’re doing that are going to strengthen the business for the long line. In terms of the pipeline, there are a lot of things in the pipeline. The biggest of which as we talked about in the past is the G5 and you’ll hear more about that at the analyst day. It’s really a whole new posterior screw system that we think will have a competitive advantage in the marketplace. We continue to be optimistic about some of our PEEK materials as I shared with you we’re annualizing now on the $300 million. We’re launching the new PEEK PREVAIL.

We have the new direct lateral system that will be very competitive in the marketplace. There are a lot of products that we think will drive growth going forward.


Your next question comes from Bob Hopkins – Bank of America – Merrill Lynch

Bob Hopkins – Bank of America – Merrill Lynch

I was wondering if you could talk about the fiscal 2010 guidance a little bit more. Can you give us a rough sense as it relates to the core ICD market and the core spine market, what kind of market growth rate assumptions you’re using for your 2010 assumptions?

Bill Hawkins

For the ICD market as we indicated we’re encouraged by what we’re seeing in the US in terms of a bit of a stabilization and modest low single digit growth here in the US coupled with the high single digit growth outside the US. That is where we get the mid single digit growth for the overall ICD market. That’s a positive.

On the spine business there too, spine the overall market continues to grow in the high single digit range which are low double digits. That’s a good market. The other thing I meant to mention on the ICD at the HRS meeting this last week which I attended there was some very important data that was released on the Madit-II which I think will be very helpful to the overall ICD market and we’re all obviously waiting for the Madit-II CRT data. There are some good things that are happening which we think will stabilize the ICD market and we continue to see good opportunities in the spine market.

Bob Hopkins – Bank of America – Merrill Lynch

Your forecast basically similar rates of growth as to we’re seeing right now for both markets?

Bill Hawkins


Bob Hopkins – Bank of America – Merrill Lynch

A question on the quarter, obviously good in line quarter overall, the two areas that looked a little weak to me relative to expectations were your pacemaker number and your NeuroStim number and you highlighted that a little bit in the prepared remarks. I was wondering if you could give a little more color on both those two businesses and what happened in the quarter and what your expectations are going forward.

Bill Hawkins

Starting with the bray market, worldwide the bray market grew in the low single digits around 1.5% on a constant currency basis, the US bray market was somewhat flat, maybe down a little bit. Overall our position held in there. We’ve maintained now a 50% plus market share for many, many, many years. We feel very good about our position.

We’re excited obviously about the MRI sure scan technology that we launched outside the US and we’ll be bringing the Advisa MRI system in the second quarter of FY10 outside the US and clearly excited about what we’re going to do here in the US with that. We feel good about our position with our product platform in a market that has been somewhat in that low single digits for some time now.

On the pain side as I indicated it’s kind of a tale of two cities. You look at certain parts of our neurosciences business with the strength that we’re seeing in the movement disorders as well as the InterStim offset a little bit by what happened this quarter in the pain stim business principally in the US as we saw a competitor bring forth a new product that we have got people’s attention to at least trail it.

You’re going to hear from Rick at the analyst meeting in June, he’s going to take you through our pipeline which gives me a lot of confidence in our ability to really drive a market leading performance in that business.


Your next question comes from Matthew Dodds – Citigroup

Matthew Dodds – Citigroup

Let me follow up on Bob’s question on the pacers. Not just this quarter but the last four quarters your US pacer growth has been below the market, you have been losing share. Can you say on a more broad based view, what specifically is going on there? Is it competitive, one of the two competitors that have been causing that since it’s more of a trend then one quarter?

On the accounting for the convertible, are you saying it’s going to be removed from the numbers so we should not put it in our forecast, and also back it out of the ’09 results?

Bill Hawkins

On the pacing side, yes you look back over the past two or three quarters and we have had underperformed the market modestly. You’ve got to look a this over the long run. As I mentioned, when I think about the opportunity that we have with the sure scan MRI technology I feel very good that we’re going to be able to bounce back, although its not a big bounce because we didn’t fall that far back. We’ve got to just be careful quarter to quarter stuff here. Overall we’re well positioned with the breadth of our product line in the pacing side.

Gary Ellis

As you indicated, our guidance that we provided did not include the impact of the convertible accounting, which as we’ve disclosed both in our Q before would be about $0.10 impact on earnings per share. As you indicated, you have to restate the prior year’s also to reflect that. Our guidance, we decided to give guidance without that in there. That is what we’ve seen basically being done by many companies currently at this point. They are excluding that in their overall guidance.

As we go forward, adopt the statement, the standard we’ll have to determine how we actually adjust things going forward. Right now to keep things apples to apples we gave guidance without that accounting in there. As we go forward we’ll have to adjust to determine whether we actually continue to provide guidance without it or we ultimately end up including it.

What we’ve seen from other companies who are in the same situation having to adopt this accounting standard, most of them are providing guidance currently without this statement, assuming adoption of the statement.

Matthew Dodds – Citigroup

There’s no form coming out any time soon that would show the ’09 quarterly breakdown of what that would be?

Gary Ellis

We will have to obviously when we do the first quarter results we’ll have to provide that because we’ll be restating the prior years. Prior to the first quarter results I don’t think you’ll see anything, no.


Your next question comes from Mike Weinstein – JP Morgan

Mike Weinstein – JP Morgan

At this point you haven’t decided whether you’re going to include the convert accounting in your reported results or not, or your adjusted results?

Gary Ellis

It will be. We’ll obviously have to adopt the convertible accounting and we’ll adopt that in our first quarter of FY10. We’ll have to restate the prior years. That’s what the accounting rules require. What we’ve done by just saying our guidance right now we’re not including that impact in there. What we’ll do as we go through the year I don’t know yet. Our current assumption is that we will continue to provide guidance without that assumption in there because that’s what we’ve seen other companies doing. We’ll have to determine as we go forward.

As far as adopting it, yes we will be adopting it. There will be the impact on the GAAP results as the result of adopting that accounting, reducing the earnings per share by about $0.10 as I mentioned earlier.

Mike Weinstein – JP Morgan

I’m sure you realize that there’s a variation on the street that some analysts, ourselves included, have adopted and others haven’t at this point.

Gary Ellis

That’s exactly right. That’s one of the reasons we tried to determine what were people assuming, what they’re not assuming as you indicated there’s differences. What we tried to do is make it very clear we’re giving this guidance without it in there and then for instance how they want to go about looking at that.

Mike Weinstein – JP Morgan

Could you comment on Kappa segment dear doctor letter from yesterday? Are you surprised or at all disappointed that you didn’t get to your 33% SG&A target off the year? You did set a pretty aggressive goal for FY10, 80 to 100 basis points. Maybe just talk about your conviction for FY10 versus what you got in 2009.

Bill Hawkins

On the Kappa segment we did send a letter to doctors yesterday in regards to really an older line of pacemakers that go back to 1997, there were 1.7 million of these implanted. We determined that there was a very small subset of those; I think 37,000 roughly most of which by the way were outside the US, but a subset here in the US as well. When you get out past a number of years there was a very, very small risk of a wire lifting off of a bond and it could have rendered the pacer, the battery to deplete. We did send a note to doctors.

The thing that we did comment was that for pacer dependent patients that’s the only case where you would recommend perhaps exchanging out the device. If you look at that population it was like 10% of the 37,000 were affected. If you look at the ones that were affected in the US you really get down to a population of less than 1,000 patients. We called about 50 doctors on Sunday and the people were very comfortable with how we were handling this. We’ve been encouraged that this has been well received by the market, at least how we handled it.

Gary Ellis

I had higher expectations that we would get to a lower percentage on SG&A as a percentage of revenue in the fourth quarter. As we went through the fourth quarter there was clearly a need to make some investment to, as I mentioned in my comments, to drive selling and distribution. We made a conscious decision to increase investments over what I had originally had expected as we started off the quarter. We didn’t quite achieve what I was hoping for overall in the quarter itself.

I was very pleased what we accomplished in the year. As I mentioned earlier, we did achieve a 12% operating income growth on the 8% revenue growth so we clearly did achieve the operating leverage we were looking for during the year. I am very convinced that going forward on the 80 to 100 basis point improvement in FY10 on SG&A we know where that’s coming from. Also in the announcement today we’re talking about the restructuring that we’re doing here within the organization, the de-layering. We are taking costs out.

All the initiatives that we have started over the last year we’re seeing several significant benefits. I am very convinced that we can continue to make the investments necessary to drive the business going forward, at the same time achieving that 80 to 100 basis point improvement on the SG&A going forward. Overall we had to make some decisions here in the fourth quarter that results in us not getting to what I had expected earlier but overall I’m very, very happy with our overall leverage into next year, for this current year and as we go forward.


Your next question comes from Kristen Stewart – Credit Suisse

Kristen Stewart – Credit Suisse

Can you go back and give us a little bit more details on the restructuring? I know earlier you had said that you were going to be taking out upwards of 1,800 individuals. To what degree would you expect to see things in terms of dollar amounts in 2010?

Gary Ellis

In my comments I indicated 1,500 to 1,800 positions, several of which obviously are both early retirement and voluntary. There are involuntary clearly included in that number also. We do expect that number of positions to be eliminated. We are adding obviously as we also talked about. Going forward we’re going to be, as I made in my comments, we’re adding over 500 sales people next year and also making investments in the R&D area.

The amount you take out helps us make sure we can make the investments necessary to continue driving the business. I don’t have the exact dollar amount of what the savings we would expect related to taking out those existing positions. I think it’s important to highlight even if did have what that number is, that amount comes out so we can make investments in the rest of the organization. It provides us the opportunity to continue to make investment necessary to drive the business but achieve the leverage I mentioned earlier.

I don’t know what the exact dollar amount is on an annual basis. Obviously with that number of positions it’s large. It provides us the opportunity to do both aspects of what we’re doing as a company.

Kristen Stewart – Credit Suisse

Would you expect to see any additional restructuring charges as we look out to fiscal 2010 specifically more on like the manufacturing side? I don’t know if there are any opportunities for plant consolidation and things like that.

Gary Ellis

What I indicated in my comments is related to the 1,500 to 1,800 positions we’re talking about at this point in time. That will also include a charge in Q1 based on the way the accounting rules go you can’t book everything in Q4. I don’t know what’s the magnitude of that number is but assume maybe it’s somewhere around what we had this quarter but I’ll have to wait and see as we work through that. There will be a charge in Q1 related to wrapping up with 1,500 to 1,800 employees.

Going forward, no there’s no additional expectation from our perspective as far as what we are expecting to do. On the other hand I will say we’ll continue to evaluate the company and evaluate where our organization is at. If there are opportunities to leverage manufacturing leverage, R&D leverage, our sales structure, leverage our OG&A infrastructure. There’s clearly going to be areas that we’re going to continue to focus on.

A company of our size with 40,000 employees you will always have areas for opportunities like that. I don’t want to say that there is not going to be anything going forward. This is the effort that we were to have at this point. We think this is adequate to get us going through FY10. We’ll continue to look at opportunities as we move through FY10 into FY11.

Kristen Stewart – Credit Suisse

With respect to acquisitions, you’ve clearly done a couple here over the last couple quarters. How should we think about what lies ahead? Would you expect there’d be fewer deals in 2010? Just continue tuck in in nature or would you consider doing things a little bigger to further broaden the footprint.

Bill Hawkins

We’re busy integrating the AF as well as the Transcatheter Valves which are going very well, by the way. At this juncture we don’t have any big things planned. We’ll always be optimistic if there are small tuck ins that we can leverage our global footprint or we get synergies in our current platforms. Right now its heads down, focus on execution and its driving sustainable growth.


Your next question comes from Ben Andrew – William Blair

Ben Andrew – William Blair

I wanted to follow up on the spine industry space and try to understand how you’re changing the structure of the sales force there, if you are, to try to drive a reacceleration of Kyphon and then what sort of assumptions you’ve got baked in for the non-implant business within spine for 2010.

Bill Hawkins

On the spine business we have really multiple sales arms, one the core spine business, two we have a focus group on biologics, and three we have the original Kyphon organization. They all come under one integrated sales management structure and we’re continuing to make improvements on how we leverage the breadth of our total footprint to be able to maximize sales for the overall spine business. It’s moving in the right direction. I feel good about what’s going on there.

The comment about growth in the other non-spine, core spine business, you heard that this quarter we had made good progress on Kyphon, in fact we saw about 11% sequentially grow in terms of procedures in the Kyphon BKB business. Part of that was a result of the favorable free study. We’re excited about that. We’re on track to get into Japan I think the early part of FY11 so that’s still a market opportunity for us.

On the biologics side we’re investing heavily here beyond just the BMP fuse. We are continuing to round out the portfolio of BBM products and other products which will complement our overall biologics component.

Ben Andrew – William Blair

Does your guidance for fiscal ’10 then assume that the overall spine business is growing mid single digits, high single digits, low double?

Bill Hawkins

Overall for the spine it’s in the mid single digits.

Gary Ellis

Our assumption is basically we continue what we’ve been over the last several quarters.

Ben Andrew – William Blair

Maybe a turn in fiscal ’11 then?

Gary Ellis

Yes. As we would end up FY10 a lot of the new products that they have coming out are really towards the end of FY10. As we get into FY11 is when we really expect some of the initiatives that we have underway in the spine business along with the new products really start to have an impact on the revenue growth in spine from what they have currently.


Your last question comes from Davis Lewis – Morgan Stanley

Davis Lewis – Morgan Stanley

Thinking about the growth trends in constant currency over the last several years fall in the 5% to 8% range from something that was closer to double digits, and Gary’s commentary on R&D spending for next year still sort of in this 9% to 10% range. Do we have the appropriate level for R&D spending now that we consider a new adjusted top line growth rate for Medtronic?

Bill Hawkins

We do. Innovation has been, is, and will be the lifeblood of this industry. Our growth is predicated on investing to sustain our existing businesses. Medtronic today is close to a $15 billion business. We have a portfolio of leading technologies. It’s important for us to maintain that business. At the same time to make sure that we’re allocating resources to invest in new areas. You’ll hear about some of those on June 2nd whether in the HEPC area and some of the things that we’re doing post op and a number of other areas. Absolutely, the investment we’re making in R&D will enable us to drive sustainable, profitable growth.

Davis Lewis – Morgan Stanley

Can you quantify the impact of the last three acquisitions on the 2010 number? Can we think about $100 to $150 million of absolute revenue, is that close?

Gary Ellis

Yes, I think that’s probably reasonable to assume overall. I think if you looked at both the AF acquisitions with Core Value I think that’s probably a reasonable range to be in. Obviously almost all that revenue is outside the US as you would know. Yes, that’s probably reasonable range.

Davis Lewis – Morgan Stanley

You talked a lot about SG&A leverage and your commitments to Fiscal ’10. Specifically could you talk about the gross margin in ’10 and specifically what is benefiting that GM and what you think is detracting from that GM heading into next year?

Gary Ellis

Clearly the thing improving the gross margin, as we said the gross margin for next year we would assume to be 75.5% to 76% range at today’s FX rate as I mentioned earlier. FX is clearly still having a negative impact. That’s one of the items that are there. As we go forward, we would expect continue to see the savings from our reductions in product costs as I mentioned. That would be a benefit that would actually start to have some benefit that would drive up the gross margin as we go forward.

The key variable, the big unknown is ASP impact. As we’ve talked about the assumption that we have here on the 75.5% to 76% basically assumes that the product cost improvements that achieved during the current year which should be in excess of $200 million would basically, additional $200 million, those are basically eaten up by ASP declines across all the businesses. If that doesn’t happen as we’ve talked about before, you could see the gross margin inching up a little bit from what I even gave out as guidance. The ASP impact we’ll have to determine as we go through the year.

The assumption on that, by the way, would say that ASP declines accelerate from what they have been historically. We’ll just have to wait and see how that plays out.

Bill Hawkins

Its time to wrap it up. On behalf of the entire management team I want to thank you for your interest and continued support. I hope to see many of you on June 2nd. Thank you very much.


This concludes today’s conference call. You may now disconnect.

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