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Executives

Jeff Warren - Vice President Investor Relations

William Hawkins - Chairman and Chief Executive Officer

Gary Ellis - Chief Financial Officer

Analysts

Ben Andrew – William Blair

Tao Levy – Deutsche Bank

Bob Hopkins – Bank of America

Raj Denhoy – Thomas Weisel Partners

Larry Biegelsen – Wells Fargo

Timothy Lee - Piper Jaffray

Michael Weinstein - J.P. Morgan

Matthew Dodds - Citigroup

David Lewis - Morgan Stanley

Frederick Wise - Leerink Swann

Medtronic, Inc. (MDT) F1Q10 Earnings Call August 25, 2009 8:00 AM ET

Operator

Good morning. My name is Regina, and I will be your conference operator today. At this time, I would like to welcome everyone to the Medtronic first quarter earnings release conference call. (Operator Instructions). I would now like to turn the call over to Jeff Warren, Vice President of Investor Relations. Mr. Warren, you may begin your conference.

Jeff Warren

Good morning and welcome to Medtronic’s first 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 fiscal year 2010 first quarter which ended July 31, 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 revenue by business summary. You should also note that some of the statements during this call may be considered forward looking statements, and that actual results might differ materially from those projected in the forward-looking statements. Additional information concerning factors that could cause actual results to differ are contained in our 10-K for fiscal year 2009 and we do not undertake to update any forward-looking statement. In addition, the reconciliations of any non-GAAP financial measures are available on the Investor Relations portion of the Medtronic website.

Finally, unless we say otherwise, references to quarterly results increasing or decreasing are in comparison to the first quarter of fiscal year 2009. With that, I am now pleased to turn the call over to Medtronic’s Chairman and Chief Executive Officer, Bill Hawkins.

William A. Hawkins

Good morning, and thank you, Jeff. This morning we reported first quarter revenue of $3.9 billion, which represents a 10% increase over the prior year after adjusting a $145 million unfavorable impact from foreign currency. Non-GAAP earnings and diluted earnings per share for the quarter were $883 million and $0.79 respectively. These results include an $18 million revenue reversal which resulted in a negative $0.01 EPS impact associated with the buyout of our cardiovascular distributor in Japan.

Q1 results reflect the solid progress we’re making on driving our One Medtronic initiatives. The focus of our entire management team continues to be driving solid consistent execution to deliver operating results that meet or exceed our financial commitments to develop innovative products for our pipeline and improve margins through a continued focus on operating leverage.

As highlighted at our analysts’ meeting in June, our goal is to extend our market leadership in large part by increasing our focus on innovation. While I’m pleased with the progress we’re making, this is a journey. Last quarter, we launched a number of new products including the Veo low glucose suspend insulin pump outside the US, the Activa PC and RC generation of deep brain stimulators, and our Endeavor drug-eluting stent in Japan. We’ve had good success integrating our atrial fibrillation and trans-catheter valve acquisitions which are both off to a strong start, exceeding our expectations.

In the coming quarters, we expect to introduce an arsenal of new products with first to market features that will continue to extend our market leading positions. Also this quarter, we continued to make solid progress on driving operating leverage. Our gross profit remained steady as cost-saving initiatives continue to offset modest pricing pressures. SG&A margins showed improvement year over year even as we continue to invest in our salesforce. Since Q1 of FY09, we’ve added over 400 sales representatives globally.

Now, let’s turn to some key highlights within our businesses starting with cardiac rhythm and disease management. The global ICD market grew in the mid single digits on a constant currency basis. We believe the penetration of international markets will continue to drive worldwide growth in the mid single digits. We’re also cautiously optimistically about the benefits of our Reverse study and the recently announced success of MADIT CRT and what they will have on the market.

Our overall CRDM market share this quarter was stable, marking several quarters in a row where we have maintained share. Physicians continue to view Medtronic as the clear technology leader with key differentiating features like OptiVol fluid monitoring, MVP or managed ventricular pacing, and pain-free shock reduction. Our new family of left heart leads and lead delivery systems has clearly made a difference in our heart failure business where we continue to gain momentum, and in pacing, the overall performance was solid as we continued to gain traction with first to market MRI safe pacemakers. In fact, we’re the only company to offer comprehensive remote monitoring coverage for all of our pacemakers.

Furthermore, we continue to make progress towards commercializing first to market products in technologies like the Advisa MRI-safe pacemaker, the Protecta total shock reduction ICD, and our next generation OptiVol. We’re excited about the many innovative products in our pipeline and remain on track to deliver them over the coming 24 months.

In our AF solutions business, we’re making significant progress in becoming the undisputed leader in one of the fastest growing and most promising areas of MedTech. The integration of CryoCath and Ablation Frontiers continues to track very well in Q1 as the integrated salesforce delivered on their target during the first quarter as a combined unit. We also announced the completion of the 12-month followups in the STOP AF clinical trial. This study evaluates our Arctic Front cryoablation catheter system in treating paroxysmal atrial fibrillation. We remain on track to submit the PMA for Arctic Front in the coming months, which keeps on target to gain FDA approval in early FY11.

Similarly, the IDE clinical trial for Ablation Frontiers remains on track which positions us well for reaching the market by the end of the next fiscal year. With our investments in these two technologies and the appropriate clinical evidence, we could become the only company to have labeled indications for all stages of AF. Our intent to enable physicians to treat patients faster, safer, easier, and with more predictable procedure times has never been closer.

Turning to our spinal and biologics, the results this quarter were in line with our expectations as we continue to work towards reinvigorating the business. The overall spinal and biologics market remains robust growing in the 10% range, and biologics remain confident about the business’s performance and continue to drive initiatives to capture the long-term value of this franchise.

For example, we’re increasing our investment in clinical trials to expand indications for BMP. Amplified, our BMP solution for posterolateral fusion, continues to move forwards, and we hope to receive FDA approval later this fiscal year. Additionally, we’re making great progress in expanding our portfolio of alternative bone grafting solutions with products like Progenics Plus, a unique demineralized bone matrix.

In core spine, our team continues to track toward reestablishing our innovation leadership by enhancing the most comprehensive line of products on the market with innovations like the G5 platform and the Vertex cervical fixation system and the next generation balloon kyphoplasty system.

Let me say one thing before continuing on. Medtronic has and will vigorously defend its intellectual property rights in all of our markets including balloon kyphoplasty. We’re very happy to have achieved a number of recent positive legal developments including victories regarding lawsuits with AGA Medical and Globus Medical. We also resolved substantially all intellectual property litigation affecting the design and delivery of our bare metal and drug-eluting stents.

That brings me to our cardiovascular business which delivered strong growth driven by continued momentum in our coronary franchise, exceptional growth in our endovascular business, and a seamless integration of our CoreValve acquisition. With sales of greater than $700 million after adjusting for a revenue reversal associated with the distributor buyout in Japan, Medtronic cardiovascular division is one of the largest and fastest growing businesses in the cardiovascular space. In coronary, international stent revenue grew in the double digits on a constant currency basis with momentum coming from the launch of Endeavor in Japan, where physicians were quick to embrace Endeavor’s deliverability and unique safety profile. We estimate that our worldwide market share for all coronary stents is now above 20%.

Our endovascular business continues to deliver exceptional growth and is well on its way towards becoming a $500 million business. The integration of CoreValve continues to progress extremely well as the business delivered strong results in Q1. The transcatheter valve market is now annualizing at roughly $200 million, and we continue to command half of the market. The breadth and capacity of our global cardiovascular infrastructure has greatly enhanced CoreValve’s ability to meet the growing demand for its products by accelerating the development and scalability of the CoreValve operations. In fact, our Santa Ana valve manufacturing facility in California played a critical role in CoreValve’s impressive performance this quarter.

I’d also like to highlight that during the quarter, our Melody transcatheter pulmonic valve became the first transcatheter valve to go before an FDA panel and gain recommendation for a humanitarian device exemption approval. We’re very proud of this accomplished and hope to launch this product in the second half of this fiscal year.

Moving to neuromodulation, results this quarter were driven by our deep brain stimulation therapy for Parkinson’s disease and our InterStim therapy for incontinence, both of which grew faster than 20% on a constant currency basis. Both of these markets continue to perform extremely well as we work closely with physicians to develop the infrastructure for continued growth through patient education and referral channel development. The pain stim market continues to grow at a healthy rate as well. While our franchise experienced some market share pressure as competitors dramatically invested to expand their sales organization, we’re confident actions we have underway will enable us to recapture our position in future quarters. Additionally, I believe our product portfolio and pipeline is the strongest in the industry and will help us to extend our leadership position over the long haul.

In diabetes, the business delivered solid double digit results on a constant currency basis despite the economic headwinds. These results also reflect the team’s work in successfully managing the Quick-Set field action. We reached over 158,000 patients with replacement products within the first few days of the recall. Additionally, the continued success of continuous glucose monitoring and solid insulin pump sales in this economic environment further validated the value of our market leading technology. This quarter, we also extended our lead as the only company with a proprietary CGM sensor augmented pump on the market by launching the Veo insulin pump in the UK and Ireland. Veo is a significant step forward as the first semi-closed loop product which features a low glucose suspend function that automatically shuts down insulin delivery when a patient’s glucose levels are trending dangerously low, and we’re planning to launch it most international markets later this quarter.

In the US, we’re also very excited about our pipeline and remain on target with plans to launch our Rebel insulin pump later this quarter and our patch and next generation durable pumps in fiscal 2011. These innovations will extend the most complete and comprehensive line of sensor augmented therapy options available on the market.

And lastly, our surgical technology business continues to deliver solid growth. As we mentioned, we’ve kept a close watch on this business given its larger proportion of elective procedure and capital equipment revenue. We were particularly encouraged during the quarter to see a rebound in the capital equipment portions of this business and remain optimistic as we look at the remainder of the year.

Looking at our business from a geographical perspective, our international operations delivered very solid double digit growth in the quarter on a constant currency basis. Our market outside the US remains significantly underpenetrated, and we expect international revenues to be pace our growth going forward. As such, we remain steadfast in our commitment and focus on geographic expansion. As I mentioned earlier, we were very excited to see the initial traction of Endeavor in Japan and the success of our AF and transcatheter valve products in the international markets.

Additional international highlights include the continued penetration of our Endurant AAA stent graft, strong demand for our OR navigation system which we launched in Japan during the first quarter.

Overall, I’m pleased with the solid first quarter results and the progress this represents toward fulfilling our full year commitments. I remain confident in our FY10 commitments and the strides we’re taking on our pipeline to ensure sustained growth in FY11 and beyond. We remain resolute on our objectives of the 5-8% revenue and double digit earnings per share growth for the foreseeable future.

Finally, before I turn the call over to Gary, I’d just like to briefly address some of the key macro issues confronting our industry. The debate on healthcare reform in the US continues, and we remain very active in the ongoing discussions. I’m spending an increasing amount of my time meeting with key legislators and thought leaders to help shape a solution that continues to allow for appropriate investment and innovation while providing patients with access to therapies when they require them, and despite the wide range of options being discussed, I firmly believe that no matter what direction reform takes, the medical technology industry will be part of the solution to the challenges our country and other economies are facing with rising costs of healthcare.

Medtronic will continue to take the leadership role in enabling better healthcare. We’ve led the way with outcome-based medicine and are leading the way with enabling technologies and unique diagnostic tools to reduce unnecessary visits to clinics or hospitals. Our therapies are designed to help restore people to health and to enable them to return to a more productive level in society. On the subjection of preemption, we continue to believe that the FDA is the appropriate governing body for determining device safety and effectiveness, and we’re opposed to any legislation that would undermine the FDA’s authority.

Lastly, let me briefly address the recent media coverage surrounding our physician relationships and collaboration with industry. Appropriate physician collaboration is vital for medical device innovation. The well-accepted concept of from bedside to bench to bedside recognizes that the people best suited to innovate and evaluate the most useful and revolutionary products are the physicians who use these products every day. That said, it is clear that there is much work to be done in this area. Medtronic as the industry leader has played a strong and ongoing part in working to create new standards for financial transparency and conflict of interest disclosure, and we will continue to do so. In February of this year, we announced our voluntary decision to disclose all payments to US doctors beginning in 2010.

In the end, we strongly support our physicians and are amazed on a daily basis by their innovation, passion, and unique insight into patient solutions. With the aging of the population, the changing demographics, and the growing burden of chronic disease, there is a great opportunity for Medtronic and our physician partners to make an impact. No one is better positioned than Medtronic to lead the industry in developing the standards that ensure industry and physician collaboration continues to bring innovative life-saving medical technology to market.

I’ll now turn the call over to Gary who will take you through the financial results, and after this comments, I’ll conclude with some closing remarks.

Gary Ellis

As mentioned earlier, first quarter revenue of $3.933 billion grew 10% after adjusting for a $145 million unfavorable impact of foreign currency. Breaking this out geographically, revenue in the US was $2.391 billion, up 6%, while sales outside the US were $1.542 billion increasing 16% on a constant currency basis. As expected, the significant strengthening of the dollar in Q1 versus the year ago period created a large foreign exchange headwind. However, as I’ll discuss in a moment, unlike many companies, we were able to offset much of the bottomline impact through our hedging program.

After adjusting for restructuring, certain litigation charges, and the non-cash charge to interest expense due to the change in accounting rules governing convertible debt, first quarter earnings and diluted earnings per share on a non-GAAP basis were $883 million and $0.79, respectively. GAAP earnings and diluted earnings per share were $445 million and $0.40, respectively.

The first quarter of fiscal 2010 was impacted by a number of items that we have reconciled for our non-GAAP results. First, as initially described in the first quarter, related to the initiative to realign and delayer the organization started in the fourth quarter of 2009. Second, we recorded $444 in certain litigation charges for the settlement of all outstanding intellectual property litigation with Abbot Laboratories. Lastly, $43 million of non-cash interest expense was recorded in the first quarter in accordance with our adoption of the new convertible debt accounting rules.

In addition, there are several unusual items that impacted our first quarter earnings results. First, a $16 million charge related to the supplier related Quick-Set field action in our diabetes business which Bill talked about, which translates into $0.01 negative impact on our earnings per share. We are currently in discussions with our supplier and are working with them to recovery substantially all costs associated with this field action.

Second, as Bill mentioned, we reversed $18 million in revenue related to the buyout of our cardiovascular distributor in Japan, which serviced 40% of all accounts in the country. Our cardiovascular business will now be completely direct. The transaction negatively impacted earnings per share by $0.01 in Q1 but is expected to be recovered in the back half of FY10.

Third, our first quarter resulted included an extra week due to our 52- to 53-week fiscal year which had a favorable impact on our results. The exact benefit of the extra week is difficult to estimate. However, based on our analysis, we calculated it added approximately 500 basis points to growth in the first quarter which would translate into 100 to 150 basis points of revenue growth in the full year.

Moving on to a more detailed analysis of our businesses, CRDM revenue of $1.337 billion increased 7% on a constant currency basis. Worldwide ICD revenue of $775 million grew 5% on a constant currency basis. The US ICD market grew in the low to mid single digits, and the global ICD market grew in the id single digits after taking into account the impact of currency.

Pacing revenue of $536 million grew 7% on a constant currency basis. Spinal and biologics revenue of $915 million grew 8% on a constant currency basis. The core spinal revenue of $696 million grew 11% on a constant currency basis reflecting continued stability in this business and the growth from a series of recent product introductions.

Kyphon grew modestly in the first quarter driven mainly by the BKP procedural growth. International core spine revenue growth of 24% on a constant currency basis reflects solid performance across all geographies. It was also aided somewhat by the revenue reversal recorded last year related to our distributor buyout resulting form the initiation of our joint venture with Weigao.

Biologics revenue of $219 million was flat compared to the prior year on a constant currency basis. Although this business continues to feel pressure from several external factors, we were encouraged by the continued stability in the US and double digit growth outside the US on a constant currency basis. It should also be noted that Q1 was the last quarter of difficult comparables for the biologics business as the physician health notification that impacted sales was published in July 2008.

Cardiovascular revenue of $689 million grew 15% on a constant currency basis. Excluding the impact of our distributor buyout, cardiovascular revenue would have been 18%. Coronary revenue of $353 million increased 8% constant currency, reflecting the strength of our Endeavor launch in Japan which contributed over $30 million in revenue this quarter as physicians rapidly initiated product evaluations. Looking ahead, we would expect our share levels in Japan to remain stable for the remainder of the calendar year as the frequency of cath lab evaluations begins to normalize. Our worldwide coronary stent share is now estimated at over 20%.

Endovascular revenue of $118 million grew 41% on a constant currency basis. US growth of over 44% 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 nearly 40% was driven by the ongoing success our next generation Endurant abdominal stent graft. We continue to advance evidence-based medicine in this growing market by launching three post-market clinical trials last quarter.

Neuromodulation revenue of $373 million increased 11% on a constant currency basis driven by the continued strength in deep brain stimulation and Gastro/Uro. Revenue in our BDS business grew in the mid 20% range in constant currency. The launch of our next generation DBS system, Activa PC and RC, contributed to the ongoing momentum in that business.

Gastro/Uro revenue grew well above the 20% level on a constant currency basis driven by another strong quarter from InterStim. Our pain stim and infusion pump businesses grew in the low single digits. Diabetes revenue of $295 million grew 15% on a constant currency basis driven by the continued strength in our CGM franchise which is annualizing at almost $120 million. We were also encouraged to see that despite a challenging economic environment and increased competition, insulin pump systems still achieved double digit growth on a constant currency basis.

Surgical technologies revenue of $227 million grew 16% constant currency. Growth was driven by international revenue which increased 23% on a constant currency basis. This was driven by strong O-Arm sales as our teams focused on international markets including Western Europe and launched the system in Japan. The market for the O-Arm remains well underpenetrated both domestically and internationally. We also saw strong sales in fusion image guide and surgery systems, nerve monitoring products, power disposables, and in our service business. I think it’s also important to note that given the elective nature of some 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 $97 million increased 7% on a constant currency basis. Results were driven by the growth of our recently launched LifePak 15 monitor defibrillator. We continue to be focused on all remaining FDA related questions, so that we can return to full shipping to all customers.

Turning to the rest of the income statement, the gross profit margin was 76% after excluding the previously discussed $16 million charge for the infusion set recall and the $7 million of restructuring charges recorded in cost of goods sold. Gross margin in the first quarter of last year was 76.9%. Foreign exchange had a 90 basis points negative impact on gross margin this quarter. 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.

First quarter R&D spending of $370 million represents approximately 9.4% of revenue, compared to $324 million or 8.7% of revenue in the first quarter of 2009. We remain committed to investing in new technologies to drive future growth.

First quarter SG&A expenditures of $1.368 billion represented 34.8% of sales, compared to 35.6% of sales in the first quarter last year. SG&A expense benefited from our ongoing SG&A initiatives to leverage our facilities and IT expenses. Additionally, our realignment and restructuring efforts from both fiscal year 2008 and 2009 provided some tailwind in reducing the expenditures.

Net other expense for the quarter was $96 million compared to $151 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 $67 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 $66 million which includes $43 million of non-cash interest expense related to the new convertible debt accounting rules. As of July 31, 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. As reported, our effective tax rate was 20.7%. Excluding the tax impact of the restructuring and certain litigation charges and a $7 million foreign R&D credit, our non-GAAP normal tax rate in the first quarter was 21%. We expect our fiscal year 2010 tax rate exclusive of one-time adjustments to be in the range of 21-22%.

Fourth quarter weighted average shares outstanding, on a diluted basis, were 1.115 billion shares. During the first year, we repurchased $344 million of our common stock. As of July 31, 2009, we had remaining capacity to repurchase approximately 67 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 an update on 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 and continue to see movement in the first quarter. It remains difficult to predict exchange rates; therefore, we continue to provide revenue growth guidance on a constant currency basis.

We believe that constant currency revenue growth of 5% to 8% provided on our fourth quarter call remains reasonable for the remainder of fiscal 2010 as we continue to execute on our product pipeline and monitor the economy and healthcare reform. 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 yesterday for the remainder of the year, then our revenue for the full year would be positively impacted by $75-100 million as the impact from currency turns positive and offsets the headwinds we experienced during the first quarter and the $30 to $40 million of negative impact expected in the second quarter. This compares to the negative $220 to $240 million estimate provided in our Q4 conference call for the full year.

Turning to guidance on the bottom line, we were encouraged by the solid performance in Q1, but want to remind everyone that Q2 historically tends to be the most difficult quarter for us to predict. As a result, we believe it is still reasonable to model earnings per share in the range of $3.10 to $3.20 excluding the impact of the non-cash charge to interest expense due to the change in accounting rules governing convertible debt, as previously commented on during our Q4 conference call. This guidance represents earnings per share growth of 8% to 12% after adjusting for approximately $0.06 to $0.07 of dilution from our AF and transcatheter valve acquisitions.

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.

I’ll now turn things back over to Bill who will conclude our prepared remarks.

Bill Hawkins

Before we begin our Q&A session, first let me close by reiterating what I said to begin that Q1 was a solid quarter. As I look across the company, I’m pleased with the progress being made in aligning the organization towards One Medtronic. These changes are having a positive impact on driving innovating, 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 are both shaping and executing across the enterprise to generate efficiency and leverage to fund future opportunities. Looking forward, we’re focused on delivering on our commitments for the remainder of the year and preparing for the future.

I’d now like to open things up for Q&A, and in the interest of getting to as many questions as possible, we would really respectfully request each caller limits themselves to one question with one followup.

Question-and-Answer Session

Operator

The first question comes from the line of Ben Andrew with William Blair.

Ben Andrew – William Blair

I just wanted to follow up on the operating margin discussion. There are a few one-time items in there this quarter, but you did mention some modest pricing pressure Gary. Is that changing versus what you had seen or is this across the businesses? Maybe just talk a little bit further about that.

Gary Ellis

Ben, actually the pricing pressure that we are seeing has been pretty consistent with what we have seen over the last year or two. I don’t think it’s dramatically changed, and it is across probably all businesses that we are seeing. Some of that is hospitals trying to get through this economic downturn that they have been experiencing, but I don’t think it was anything unusual here in the first quarter versus what we have seen really over the last year or two.

Ben Andrew – William Blair

Focusing on spine briefly, you talked about the better performance there, and obviously there were some developments on the Minimed side on the clinical front in the quarter. Can you talk about the trajectory of sales in that business in particular coming away from that data and what you might expect for the next several quarters?

William Hawkins

Let me make sure I’m clear. Was it spine or diabetes?

Ben Andrew – William Blair

I meant Kyphon.

William Hawkins

The Kyphon, in terms of a business, it has been consistent in the last couple of quarters in terms of the growth, and we continue to think there’s a lot of head room for this therapy, and we just launched a new out of fluoro-field delivery system called the MATRx which we are encouraged by, and we’ve got a lot of products in the pipeline, so this is a business that we’re investing in, and we think there are good opportunities for sustainable growth.

Ben Andrew – William Blair

You expect an impact from Kyphon from the developments on the clinical side? Have you seen a new change in the trajectory of business?

William Hawkins

There have been a couple of studies obviously. The one that’s getting a lot of press with the New England Journal of Medicine which, to remind people, that was a vertebroplasty versus kyphoplasty. In the FREE study where we had looked at kyphoplasty versus optimal medical therapy, had a very good outcome, and we should have the 2-year data on that by the end of the calendar year, so we’re continuing to be very bullish on the role that kyphoplasty will play.

Operator

The next question comes from the line of Tao Levy with Deutsche Bank.

Tao Levy – Deutsche Bank

Again on the pricing front, what type of visibility do you have heading into any given quarter as to how pricing is going to develop, given that you probably have some long-term contracts out there?

William Hawkins

We track pricing very carefully across all of our businesses, and obviously we can’t predict the future other than just looking at what’s happened in the recent past. We look at quarter to quarter changes, and we’re negotiating contracts all the time, and we try to anticipate if there’s going to be any inflection because of the direction that contracts are going, but as Gary said we say the pricing is pretty stable actually in terms of what we’ve built into our models with a modest price decrease, and when I say modest, that’s in the low signal digits.

Tao Levy – Deutsche Bank

On the Arctic Front product, are you still maintaining the timeline for submission? Did that hit the primary endpoint, and when will we see the data?

Bill Hawkins

We don’t know the data yet. The clinical study is done, and the data should be tabulated as we speak, and I’m not quite sure when we are going to show it publicly. Jeff can get back to you on that, but we are on track for submitting to the FDA and remain on track for the whole PMA.

Operator

The next question comes from the line of Bob Hopkins with Bank of America.

Bob Hopkins – Bank of America

First, I appreciate you giving us your estimation of the impact of the extra week on the entire business of that 500 basis points, but just digging on level deeper, was it roughly the same impact across all business or are there any anomalies that are worth pointing out in any of the key businesses where it was less or more than that 500 basis points?

Gary Ellis

As you said the 500 basis point impact, our estimate is for the total company as far as what we’ve evaluated, it will vary by business. It goes back to which businesses might be more procedural in nature and which are consignment sales. For example, businesses like Physio/Control or some of those other ones where you might have maybe more bulk purchases, some even in our cardiovascular businesses or in CRDM in some cases where is there bulk purchases that obviously isn’t impacted necessarily by the extra week, and so as a result, it will vary by business as far as the impact, so we haven’t gotten down to the details of that. The 500 basis points for the total company is kind of our best guess at this. It is very difficult to estimate it because it is impacted by procedures, but clearly it’s also impacted by how they are buying and what their inventory level that they might be maintaining.

Bob Hopkins – Bank of America

The second question is on SG&A over the course of the year and how the restructuring will impact that SG&A level because obviously to meet your targets, it’ll need to come down from here throughout the course of the year, so could you just talk about the restructuring that you’re speaking of on the last quarter in terms of the net adds versus the offsets from the restructuring, and how that plays out throughout the course of the year? You mentioned you have 400 adds year over year. How many more adds are we talking about, and then what about the roughly 1300 layoffs or early retirements that you talked about? Just talk about the cadence of that throughout the year.

Gary Ellis

As we indicated in our fourth quarter call, we have approximately 1500 positions that we are going to be eliminating and we are going to include it in this restructuring charge we just talked about. About the third of those really were already eliminated as we went through Q1. Majority of the rest of them will be completed here early in Q2, and you’ll see the full impact of that as we go through Q2 and the remainder of the year. As we have indicated, eliminating those positions obviously will help us in achieving our SG&A percentage, but it also allows us to make the investments that we still feel are more important to drive the company’s growth, and as we indicated in our comments, we have added 400 positions over the last year. I’m not going to get into predicting how many we’re going to be adding as we go forward, but you can assume that we will continue to be adding sales positions as the company continues to grow around the world, especially internationally where as we’ve talked about our growth rate has been very high, and we’re very pleased to see the double digit growth there internationally this year, so we’ll continue to make investments where we see the opportunities for growth, but we’ll also continue to realign the organization as we have done here in this restructuring charge in Q4/Q1 and really the effect rolling into Q2 going forward. We understand that we’ll have to bring down the SG&A percentage as we’ve talked about. It’s not just the restructuring efforts that will bring down our percentage; it is leverage and the rest of the infrastructure, and there are many other initiatives we have underway to make sure we can achieve our objectives on improving the overall operating margins for the organization.

Bob Hopkins – Bank of America

You’re still comfortable with the 80 to 100 basis points in SG&A year over year?

Gary Ellis

Yes. That’s what we indicated at the beginning of the year, and we feel comfortable about that, but I want to highlight to everyone our focus is on achieving the operating margin improvement that we’ve talked about. We’re going to get that both in gross margin and SG&A percentages, but the 80 to 100 basis points is what we communicated at the beginning of the year. We feel good about that, but I want to make sure everyone understands, we’re trying to leverage the entire P&L as we go forward, and so if I can get opportunities in gross margin will do that, and so we’re trying to make sure that the bottom line is the piece that we’re actually leveraging.

Operator

Our next question comes from Timothy Lee - Piper Jaffray.

Timothy Lee - Piper Jaffray

Bill, I think in your prepared comments you had mentioned the potential impact from HCRT and Reverse; can you give us a sense of what your thoughts are on that front and you get filed for indication for Reverse; is the indication really necessary to really drive the growth on that front?

William A. Hawkins

If we look at what made HCRT and Reverse will do, I mean, they had evidence for cardiac indication for mildly symptomatic heart failure patients, and I think both studies are good for the industry. There is worldwide 22 million heart failure patients, in the US are 5 million; so if Reverse is like HCRT, is aimed at expanding the benefits for less symptomatic heart failure patients. So, we think this is going to be a positive, and we think that Boston will more than likely file for the extended indication and that will benefit everybody.

Timothy Lee - Piper Jaffray

Would you care to quantify the magnitude of how positive it could be?

William A. Hawkins

No, I can’t; I mean, that’s hard to estimate.

Timothy Lee - Piper Jaffray

One real quick one on the neuro side; you had mentioned that the pain business is under some competitive pressures. What turns that around and how quickly does that turn around?

William A. Hawkins

As I mentioned, we have a very rich pipeline in the pain stim business with Restore Sensor and the recently launched RC and TC. So, a lot of it is going to be technology. We’re adding to the sales force selectively here as well. So, I think the combination of focus, and sure we have the right coverage, the continued focus on innovation, the combination is going to enable us to continue to drive growth in that business.

Operator

Our next question comes from Michael Weinstein - J.P. Morgan.

Michael Weinstein - J.P. Morgan

Gary, you elected not to raise guidance for the full year. Is that just because it is the first quarter out of the box and you want to see how the year progresses? You did have a relatively good quarter; you beat where the street was at, your tax rates coming in a little bit lower, but you didn’t raise; maybe just want to comment on it?

Gary L. Ellis

Mike, that’s a good way to look at it. Obviously, as you said and as we have indicated in our comments, we think we had a very solid Q1 and did beat expectations. As I also indicated in my comments, however, Q2 tends to be a very difficult quarter for us to predict just because of the summer months, especially international, etc. So, as a result, we’re just saying this is one quarter, but let it continue to go through the year; obviously, it’s a good start and that’s what we want to see, but we’re not at this point in time going to be raising guidance until we see how it’s continuing to deliver these very strong results.

Michael Weinstein - J.P. Morgan

Two operational questions for Bill; I am interested in tracking how the pacemaker launches are doing outside the US for the MRI compatible systems. Have you started to launch that yet, and if so, do you have any feedback or is that really off still in front of you?

William A. Hawkins

We’ve had some very good results in certain segments of the marketplace. The real opportunity for us is on the Advisa MRI pacemaker, and that we haven’t launched as of yet. So, we continue to be very optimistic about the overall opportunity for our differentiated products in that segment.

Michael Weinstein - J.P. Morgan

The Advisa line, that’s upcoming this quarter, right, or is that changed?

William A. Hawkins

Advisa is coming this quarter in Europe and EnRhythm MRI at the end of the fiscal year in the US.

Michael Weinstein - J.P. Morgan

Obviously, Advisa is the more important product.

William A. Hawkins

Correct.

Michael Weinstein - J.P. Morgan

The other operational question I want to ask; you had some issues at your plant where you manufacture SynchroMed that also had some impact, I believe, on your diabetes business. I just wanted to check to see whether that would have been an impact on the timeline for the products you have upcoming in diabetes; you do have some important products coming out in the next 12 months.

William A. Hawkins

No Mike, it’s not going to have any impact.

Operator

Our next question comes from Matthew Dodds - Citigroup.

Matthew Dodds - Citigroup

The core spine, Bill; it looks like when you back out Kyphon and you back out the 500 basis points roughly from the extra week, it looks like the core business grew mid single digits; I know you said it did strengthen a little bit, but you really haven’t rolled out the core new systems in lumbar and cervical yet; so I am wondering what do you think is driving the big picture, already the mid single digit rate, is it share or is it market strengthening?

William A. Hawkins

Well, the market has been pretty robust. The procedures, we think, are up a little bit; mix has been favorable for us; pricing, as we already talked about, there has been a modest impact on pricing, but I think really what’s driving it is the procedure growth, and for us outside the US, we have seen very strong growth, roughly greater than 20% growth outside the US.

Matthew Dodds - Citigroup

When do you really see a lot of the launch for the new lumbar and cervical, I guess, the G5 or Celera and then also in cervical, when do you have at least in critical math, the rollout?

William A. Hawkins

That’ll be in early FY’11.

Matthew Dodds - Citigroup

Just one quick followup on the pacing side; it looks like, even if you back out the extra selling week, you gained share in that market for the first time in a while; how is that one changing differently from ICDs where it doesn’t look like the share gains have really come back yet; is there something different going on there versus ICDs?

William A. Hawkins

Matt, it’s always hard to look at one quarter. You really have to look at a trend line and we feel very good about the competitiveness of our brady product line as we do with our ICD product line. Yes, we feel good about what we did this quarter, but it represents, we think, the strength that we have in the marketplace, and we think we’re moving in the right direction with ICDs.

Matthew Dodds - Citigroup

On pacing, there’s been no re-focus on pacing or no major products to highlight in this quarter.

William A. Hawkins

Well, the MRI, and to be candid we had some reasonably good comps from last year, which helped us.

Operator

Our next question comes from David Lewis - Morgan Stanley.

David Lewis - Morgan Stanley

Gary, just want to clarify commentary; you talked about, you’re going to take margins where you see the opportunities whether it be SG&A or gross margin; I think, historically I guess our view is that you found that gross margin opportunities going forward, we’re going to be less robust than middle of the income statement opportunities; is there some change that has happened in the last three to six months or that was just more of a broader statement?

Gary L. Ellis

It was just more of a broader statement; I mean, if you look at it, and what I am trying to get to is, last year obviously, we had an improvement of 110 basis points in our operating margins and a lot of that obviously came through the gross margin. As you indicated, going forward, we think there is more probably more opportunity for us in SG&A versus gross margin, but it was just a broader statement to say that we’re focused on leveraging both the product cost and the SG&A category, and that there is no one focus for us that is going to drive that operating margin improvement. We have several different levers that we’re trying to pull to make sure that we can deliver the operating leverage improvement that we’ve talked about.

David Lewis - Morgan Stanley

Bill, you mentioned core valve; when you talked about the $200 million market, at 50%, I am assuming you mean on a revenue basis, not on a per-unit basis?

William A. Hawkins

That’s right.

David Lewis - Morgan Stanley

Okay, and then, the clinical catalysts, either a TCT or an updated timeline for the idea process of core valve; can you provide that?

William A. Hawkins

We’re on track for the middle of next year and things are going well.

David Lewis - Morgan Stanley

Lastly Bill, you talked about selling and construction, where you’re investing across the reps that you mentioned. Versus your revenue base, is there any area where you’re invested on outsize basis versus where your revenue would imply?

William A. Hawkins

No, I can’t think off the top of my head if there is any place that it would be for more competitive reasons than for market reasons.

Gary L. Ellis

I would say, just to add to Bill’s comment, as I mentioned in my comments, a lot of it has obviously been international where we’ve seen a lot of the growth; most of it has been in markets whether it’s, to some extent diabetes or neuro, for example, where the markets are still growing very very strong, or international, that’s where we’re making the investments to basically match with what those markets are reflecting with; the procedural growth and the need for additional coverage.

David Lewis - Morgan Stanley

In terms of your strategy for the global stent franchise, you’ve seen some stabilization here in the last couple of quarters; in terms of how you’re investing with either R&D dollars or sales and marketing infrastructure, is the strategy for the broader stent franchise to grow market share or to sustain market share, and are you investing accordingly depending on what the outcome there is?

William A. Hawkins

We’re investing in technology to grow market share. Resolute, which is doing very well outside the US, we’re investing that here in the US, we’re well on track to completing the IDE clinical study here in the US and on track for a launch in a couple of years in the US, and we believe that the combination of Resolute and Endeavor is going to give us the strongest, if you will, technology platform that will enable us to grow market share.

Operator

Our next question comes from Frederick Wise - Leerink Swann.

Frederick Wise - Leerink Swann

Let me start with something you said Bill. You talked about Medtronic’s international business, some words effective pacing future growth. I’ll adjust for the extra week, but international ex-currency grew three times the domestic business; is this the pattern we should expect to see going forward, and maybe, you could give us a little more color on how sustainable that strong double-digit growth is for international relative to marketing your products or as we discussed and as you said, before the sales.

William A. Hawkins

Rick, we’ve said pretty consistently that we think that the international markets will pace the growth of the company. We, in the past I think have said that 2% to 3% points faster than what we see in the US. So, this is a particularly good quarter for us as we had 16% growth on a constant currency basis versus 6% here in the US, but going forward, it is an area that we think represents big opportunity; markets are largely under-penetrated. There are some strategic markets like China, we’re investing more now in India, we think there is some real upside in Latin America, in Brazil. So, I would say, going forward, yes, we think there are good opportunities to have OUS grow much faster than the US.

Gary L. Ellis

The other thing I would add to Bill’s comment, Rick, is that outside the US obviously is where these new products; on the AF side, transcatheter valves, etc., where we’re seeing those new products come into the marketplace obviously first, and so you’re seeing those actually help to accelerate the growth rate, and obviously that gives us lot of comfort even as we go into the US markets when those products at the US market will even help accelerate here in the US. So, the new products also, in addition to the fact that the market themselves have more opportunity.

William A. Hawkins

Endeavor in Japan this quarter was very helpful. So, you had Endeavor Japan, the transcatheter valves, the atrial fibrillation products; that was all very helpful to our growth outside the US.

Frederick Wise - Leerink Swann

Just a couple of quick followups; biologic revenue, I think, if I saw it correctly, were flat; just give us some perspective on when you think that graph would start to grow and would be dependant on trial outcomes, and lastly, Bill, if you could just give us some perspective on the billion-dollar cost reduction program by 2012; where are we now, are we halfway through and what’s left to be done?

William A. Hawkins

First on the biologics; as I mentioned in my remarks, we’re investing heavily to expand the indications for BMP, the biggest near-term is the Amplify, which is a posterolateral indication which we’re on track for beginning of FY’11. We have several indications to prove right now, one for trauma and two for the oromaxillofacial which we’ve seen very good growth coming out of that sector, it’s a small part of our business now, but we think it has potential to be a $250 million to $500 million market. Beyond that, there are other areas that we are expanding indications; we’re investing to expand indications with BMP. So, this is the category that we think has long-term very solid growth fundamentals.

Gary L. Ellis

Rick, just to answer your question on the cost savings objective on the product cost or reducing the product cost by a billion dollars by FY’12 that we played out; we’re about halfway through that process at this point in time. We’re close to, as we indicated, through the first two fiscal years, we would have saved over almost $400 million, and we clearly have seen savings here as we’ve even entered just fiscal year ’10. So, we’re probably halfway through the process. The real things that are going to continue to really start to have an impact and help us achieve that objective as we go forward is just some of these new products coming into the marketplace because we’ve put in this design for manufacturing a few years ago, and that is starting to have an impact now as some of these new products get rolled off, that you’re getting products that have fewer piece parts, basically lower cycle times through production, etc. So that will start to have an impact on the overall product cost in addition to our ongoing programs on reducing supplier cost and consolidating manufacturing, so we are about halfway through the process, it is tracking right in line with what we would expect, and we still see that billion dollars by FY12.

Operator

The next question comes from the line of Raj Denhoy with Thomas Weisel Partners.

Raj Denhoy – Thomas Weisel Partners

I wonder if I could followup a little bit on the biologics question. I guess as Rick mentioned, it was flat in the quarter, but if you back out the extra selling, it was actually down 5%. With continued scrutiny on that business, is it really wise to expect that to do much until next year or should we expect that to continue to slide here over the balance of the year?

Gary Ellis

Let me add a little bit to what Bill mentioned earlier. First of all, as far as the extra week, this is one of the businesses that you can’t necessarily do the exact calculation like we talked about. The other thing I would remind everyone is we’re comparing against Q1 last year right before the physician notification came into effect, and so if you look at the sequential amounts and where we are at, this is tracking relatively consistently where we have been for the last 2 or 3 quarters as far as the absolute revenues even with the extra days in there from that perspective, so it’s down because we’re comparing it to the toughest period we had last year as far as where that revenue is at. As Bill mentioned going forward, we’ll have easier comps, but more importantly, as we start to see some of these new indications start to take impact, we do see the growth potential.

Raj Denhoy – Thomas Weisel Partners

Within spine as well, for Kyphon you gave the number for constant currency growth there, but could you give a little bit of clarity on how St. Francis is doing within that business?

Bill Hawkins

It’s consistent what we have said in the past. This is an area that we are continuing to invest, to build, to really develop that market. We continue to believe that lumbar spinal stenosis is a large unmet clinical need, and we had to go back and do some things to really to help to build the market here.

Raj Denhoy – Thomas Weisel Partners

In the diabetes franchise, any updates on the timing of the patch pump coming to market?

Bill Hawkins

We’re on track for the beginning of FY11, so moving along very well.

Operator

The next question comes from the line of Larry Biegelsen with Wells Fargo.

Larry Biegelsen – Wells Fargo

For the ICD market, we have positive data from three studies this year—Reverse 24 months, MADIT 2 at 8 years, and MADIT CRT and then potentially a fourth study next year, and replacement growth should continue to be strong through 2010 because initial implants were strong through 2005, and as you know there were a number of explants in early of ’05 that need to start being replaced in 2010. Given these factors, what do you see as you look over the 12 to 18 months? In other words, would you be disappointed if didn’t accelerate from this quarter’s mid single digit growth?

Bill Hawkins

The market is recovering a little bit from where it was if you look back the last couple of years, it was in that very low single digit. In fact, for a couple of quarters, it was actually negative, and now, I think we are seeing some of what you’ve already articulated in that there is mid to high single digit growth.

Gary Ellis

Obviously as we have indicated, we have been watching this market for the last two or three years. As Bill said in his comments, we’re cautiously optimistic about what some of these studies can mean for us, but we’re going to wait and see the actual results before we get too excited about what they could mean to the overall growth in the market place.

Larry Biegelsen – Wells Fargo

Then on valves, just to clarify, the $200 million market that it is annualizing at, the transcatheter valves, is that excluding the distributor margin, and then would you be willing to give us the implant numbers this quarter? For example, your implant numbers for CoreValve in Europe, and then lastly any color on the uptake through this quarter, has it continued to be strong, the implant volume?

Bill Hawkins

I’ll start with the last. Yes, the uptake and the demand is very strong, and in fact as I mentioned had it not been for the difficulties we had in our Santa Ana operation, we wouldn’t have gotten to numbers where we got to, and I can tell you there is even more demand than what we are able to supply, so that’s the good news. In terms of the dollar volume, in the terms of the distributor aspect, we’re looking towards being direct in most of the markets we’re in, so it’s really not much of an impact on the distributor, and then we are not going to get into the unit implant numbers going forward.

Bill Hawkins

On behalf of the entire management team, thanks for your interest and continued support. As you can see, we feel good about the quarter. It was a strong quarter, and as Gary indicated, Q2 is always a challenging quarter for us, but we’re doing the things that we think are going to enable us to deliver on the commitment we have for the fiscal year. Thank you and we’ll talk to you next quarter.

Operator

This concludes today’s conference. Thank you for participating.

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Source: Medtronic, Inc. F1Q10 (Qtr End 07/31/09) Earnings Call Transcript
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