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Executives

Jeff Warren - IR

Bill Hawkins - Chairman and CEO

Gary Ellis - CFO

Analysts

Bob Hopkins - Bank of America/Merrill Lynch

Mike Weinstein - JPMorgan

Bruce Nudell - UBS

Matthew Dodds - Citigroup

Kristen Stewart - Credit Suisse

David Lewis - Morgan Stanley

Larry Biegelsen - Wells Fargo

David Roman - Goldman Sachs

Rick Wise - Leerink Swann

Tao Levy - Deutsche Bank

Medtronic Inc. (MDT) F2Q10 (Qtr End 10/30/09) Earnings Call November 24, 2009 8:00 AM ET

Operator

Good morning. My name is Rachel and I will be your conference operator today. At this time, I would like to welcome everyone to the Quarter Two Earnings Release Conference Call. All lines have been placed on mute to prevent any background noise. After the speakers' remarks, there will be a question-and-answer session. (Operator Instructions)

Thank you. I would now like to introduce Mr. Jeff Warren. Please begin.

Jeff Warren

Good morning and welcome to Medtronic's second 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 fiscal year 2010 second quarter, which ended October 30, 2009. After our prepared remarks, we'll be happy to take your questions.

A few logistical comments. Earlier this morning, we issued a press release containing our financial statements and our 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.

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 second quarter of fiscal year 2009 and all growth rates are given on a constant currency basis.

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

Bill Hawkins

Good morning and thank you, Jeff. This morning, we reported second quarter revenue of $3.8 billion, which represents an 8% increase over the prior year after adjusting for a $60 million unfavorable impact from foreign currency. Non-GAAP earnings and diluted earnings per share for the quarter were $850 million and $0.77 respectively.

Q2 was another solid quarter, reflecting once again the underlying resilience of our businesses and the strength of our globally diversified portfolio. While we have felt an impact from the macroeconomic environment, our initiatives over the past couple of years to resolve outstanding IP litigation, reduce product costs and reallocate resources towards faster growing markets and geographies are clearly making a difference.

As we continue to drop our one Medtronic strategy, we remain committed to our stated financial objectives of delivering 5% to 8% constant currency revenue growth and double-digit earnings per share growth.

We will continue to extend our market leadership through a relentless focus on customer valued innovation, which is the foundation of our success. If I look across the company and our pipeline, I am excited about the opportunity we have before us to deliver innovative technologies. These technologies will help us capture customer mind share and continue to differentiate us from our competition.

For example, our recent investments in AF ablation technology and transcatheter valve technology have created a lot of customer excitement. These therapies clearly positioned us well for long-term market leadership.

Looking further out, we will deliver new technologies to close the loop to dramatically simplify the management of diabetes. We will expand the application of our deep brain stimulation therapy to treat an increasing number of movement and psychiatric disorders and neuromodulation.

We also will continue to invest in our ventures group in several new markets to expand our business. The future of our diversified portfolio of technology has never been brighter.

Next, let me say a few things about quality. While we have had our issues, there is nothing more important to us than quality. We were clearly disappointed to receive a warning letter in CRDM following the inspection of our Kappa, Sigma field action this summer. However, we are working diligently with the FDA to resolve this in an expeditious manner.

At this time, we do not anticipate any impact to our customers or patients or to delivering on our pipeline commitments. While I was not happy to receive a warning letter, I was encouraged by language in the letter where the FDA clearly noted that our, “promised corrective actions appear to be adequate.”

We are continuously improving our capabilities of failure analysis, post market vigilance, supplier management, corrective and preventative actions, and design for reliability and manufacturability. We are very confident that we have best-in-class quality systems. We will continue to raise the bar for ourselves and the industry.

Next, let me comment on some of our recent organizational changes, which will help us accelerate our market leading performance and one Medtronic strategy. As was announced in August, we realigned the businesses under two group presidents. Their focus would be on driving our growth plans and capitalizing on significant synergies that exist across our businesses.

Rick Kuntz assumed an important new role focused on our R&D portfolio management as well as optimizing the clinical reimbursement and regulatory functions across the in-process. James Dallas will continue to lead our global quality, IT and operations.

Collectively, these changes will enhance our operating performance and enable us to more effectively leverage knowledge, technologies, capabilities and talent across the organization.

Now, let's turn to some key highlights within our businesses, starting with our Cardiac Rhythm and Disease Management. Growth was in line with our expectations. I was particularly pleased with our ICD results. It is clear that our pipeline, strong management and exceptional field talent are once again making the difference.

Our results also reflect the continued stability of the global ICD market and our relative market share. The worldwide ICD market continues to grow in the mid-single digits. We are pleased to be maintaining ICD share in the US and seeing some modest share gains in international markets.

In the US, we did not experience a slowdown in customer buying patterns. ASP pressure remained in the low single digit range, consistent with what we have seen in previous quarters.

Our strength continues to be driven by our market leading exclusive technology including OptiVol fluid monitoring and our Attain family of Left-Heart Leads and delivery systems.

In AF solutions, I am very pleased with the progress we are making. Earlier this month we reached the one year anniversary of our CryoCath acquisition. Our comprehensive integration activities of both CryoCath and Ablation Frontiers continue to go very well. We are quickly making progress and becoming the undisputed leader in one of the fastest growing areas of Med Tech.

We remain on track to gain FDA approval for our Arctic Front balloon catheter and Ablation Frontiers catheters in the first half and second half of FY11 respectively. Together, these innovative technologies position us well to become the first company to have labeled indications for all stages of AF.

Turning to cardiovascular, the business delivered another strong quarter. Growth was balanced across all segments of the business. We gained momentum in our coronary franchise, continue to successfully integrate our trans-catheter valve acquisitions and posted another quarter of exceptional growth in our Endovascular business. In Coronary our stent share remains strong. We continue to establish a powerful body of clinical evidence supporting the safety and efficacy of our drug alluding stents.

The successful launch of Endeavor in Japan continued this quarter and we remain on track to bring resolute to market in the US in FY12. The integration of CoreValve is also progressing extremely well as the business delivered another quarter of strong results. We remain the leader in the transfemoral transcatheter valve in the market outside the US, which has emerged as a method of choice for Aortic transcatheter valve placements. We are optimizing our distribution channels in Europe and leveraging our US and international manufacturing capabilities.

We also continue to make progress on the pathway to a US IDE. Before moving on, I did want to pay tribute to Dr. Don Bain who recently passed away. Don's contributions to the field of interventional cardiology are legendary. He will be missed but not forgotten.

Turning to slide on biologics, the overall market remains robust with growth of approximately 10% in the US and low teens growth in international markets. We continue to work toward returning this business to market growth by the end of FY '11.

In core spine, our team continues to reestablish our innovation leadership by enhancing the most comprehensive line of products on the market. Over the next 12 months we will launch two new posterior fixation systems. I am also encouraged by the mid-single digit growth in core metal constructs in the quarter.

Biologics performed well in the quarter driven by growth and end use. We continue to invest in initiatives to drive the long-term value of this franchise. As we discussed at our analyst meeting in June we are working on eight clinical studies designed to expand indications for the use of INFUSE.

In the near-term we anticipate the approval of AMPLIFY our BMP-2 product for use in posterolateral applications in FY '11.

Before moving on I would like to make a couple of comments on Kyphon. If I had one disappointment this quarter it would be here. We did not execute and on top of this we were negatively impacted by the recent vertebroplasty articles in the New England Journal of Medicine. While our customers understand the value of BKP, as demonstrated in the FREE study, the negative vertebroplasty news impacted the perception of referring physicians.

We are focused on improving our marketing execution and differentiating balloon kyphoplasty from vertebroplasty with our customers and the referral channels.

Moving to Neuromodulation. Results this quarter were driven by continued strong performance of our Activa deep brain stimulation therapy for movement disorders and our InterStim Therapy for incontinence, both of which continue to grow greater than 20%.

Adoption of Activa RC and PC, the most advanced DBS devices, continues to accelerate in markets around the world. Our focus on referral channel development and educational activities over the last several quarters is paying off. The pain stim market continues to grow at a healthy rate in an extremely competitive marketplace.

As I acknowledged last quarter, we continue to feel competitive pressure and are focused on a number of key initiatives aimed at improving our sales force effectiveness.

Tom Tefft, the recently announced President of Neuromodulation has already made a number of sales leadership changes and is driving the organization towards more disciplined sales and marketing execution.

Our Diabetes business delivered another strong quarter of double-digit growth, driven by both insulin pumps and continuous glucose monitoring products. Continuous glucose monitoring experienced double-digit growth across all markets where it is available.

Lastly, growth in our Surgical Technologies business was driven by our ENT and NT segments. While capital equipment sales in the low to mid-price range performed well, we experienced a slowdown in high-end capital equipment products due to macroeconomic factors.

Looking at our business from a geographical perspective, our international sector delivered yet another quarter of strong double-digit growth. Our CardioVascular business was a large contributor to international growth, driven by the success of Endeavor DES in Japan as well as the continued growth of our CoreValve business in Europe. We also saw strong international growth in our ICD and Core Spine businesses. We expect international revenues to continue to pace our growth going forward.

We are committed to our focus on geographic expansion. In the quarter, we announced our decision to establish a manufacturing facility in Singapore to support the rising demand for our products in the Asia Pacific market. We were also honored to receive the Presidential E Award earlier this month in recognition of our efforts to promote and increase US exports.

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

Gary Ellis

Thanks, Bill. As mentioned earlier, second quarter revenue of $3.838 billion grew 8% after adjusting for a $16 million unfavorable impact of foreign currency. Breaking this out geographically, revenue in the US was $2.297 billion, up 5% while sales outside the US were $1.541 billion, increasing 13%.

After adjusting for a litigation gain as well as the non-cash charge to interest expense due to the change in accounting rules governing convertible debt, second quarter earnings and diluted earnings per share on a non-GAAP basis were $850 million and $0.77 respectively. GAAP earnings and diluted earnings per share were $868 million and $0.78 respectively.

The second quarter of fiscal year 2010 was impacted by two items that we have reconciled for our non-GAAP results. First, we recorded a $70 million gain related to the resolution of outstanding patent litigation with W.L. Gore & Associates related to selected patents in Medtronic's Jervis and Wiktor patent families. Second, $41 million of non-cash interest expense was recorded in the second quarter in accordance with our adoption of the new convertible debt accounting rules.

Moving on to a more detailed analysis of our results, CRDM revenue of $1.278 billion increased 3%. Worldwide ICD revenue of $754 million grew 6%. The US ICD market continued to grow in the low to mid single digits and the global ICD market grew in the mid single digits.

We continue to see strong demand for our high power devices with OptiVol, which is driven by positive US reimbursement changes made in January and the recent FAST study, which demonstrated OptiVol was three times better in predicting heart failure events than weight monitoring alone.

Pacing revenue of $498 million declined 2%. We were able to maintain share despite a slowdown in Japan where we continue to feel pressure from the previously announced Kappa, Sigma field action. We are excited about the anticipated launches of the EnRhythm MRI in the US and Advisa MRI in the international markets this coming summer. We believe this differentiated technology will allow us to stem the mid-single digit price erosion and pacing and allow us to maintain our market leading share position.

CardioVascular revenue of $696 million grew 18%, Coronary revenue of $369 million increased 18% and we estimate that our worldwide unit share for all coronary stents is above 20%.

International coronary grew 21% reflecting the continued momentum of our Endeavor launch in Japan which again contributed over $30 million in revenue this quarter.

In the US, Endeavor continued to perform well and we estimate that it gained approximately 300 basis points of unit shares sequentially.

Structural heart revenue of $206 million grew 11%, driven by 24% growth in international markets on the strength of our CoreValve transcatheter valve.

CoreValve continues to maintain greater than 75% share in the transfemoral TCV market. We continue to achieve our key objectives related to the integration of CoreValve.

The forward integration of our distribution channel is nearly complete and the expansion of the US and the international manufacturing operations remains on track. In fact, we have tripled our daily manufacturing production rate since the acquisition was closed.

Endovascular revenue of $121 million grew 28%. The impressive 43% growth in international markets was driven by ongoing success of our next generation Endurant abdominal stent graft. US growth of 16% was fueled by the continued success of our Talent abdominal and thoracic stent grafts.

Spinal and biologics revenue of $862 million grew 4%. The core spinal revenue of $642 million grew 2% driven by strength in our international business, which grew 10%.

International results were aided in part by a full quarter of sales in our Weigao joint venture in China.

Core Metal constructs continue its mid-single digits growth while Kyphon results had a year-over-year decline, clearing feeling e effects of the New England Journal article on vertebroplasty that Bill mentioned earlier.

Biologics revenue of $220 million grew 12%, reflecting the continued resilience of the business following the number of challenges it has faced over the past year. We also are beginning to see success in our efforts to expand the business beyond BMT with strong growth in BBM's and ceramics.

Neuromodulation revenue of $384 million increased 12%, driven by continued strength in deep brain stimulation and Gastro/Uro. Revenue in our DBS business grew in the mid 20% range. Gastro/Uro revenue continued to grow above the 20% level driven by another strong quarter from InterStim.

Our Pain Stim business grew in the low single digits and our Infusion Pump businesses grew in the high teens. However Infusion Pump growth in the quarter was aided by easier comparisons because of a manufacturing issues that we experienced last year.

Diabetes revenue of $300 million grew 11% driven by continued strength in our CPM franchise. Positive results from several studies including the ONSET trial and the REAL Trend Study continued to build evidence of the benefit of Sensor Augmented Pump therapy

In the US insulin pumps had double digit growth in the quarter. In markets outside the U.S, pump growth was impacted by delayed purchases in anticipation of our Veo Low Glucose Suspend pump launch in Q3.

We reached favorable settlements in the second quarter with key suppliers involved in the recent Quick-Set recall and are confident that this is behind us without a material impact on our financial results for the year.

Surgical Technologies revenue of $224 million grew 6%, driven by growth in monitoring, EMP image guide systems, power disposables and service. Growth was impacted in the quarter by a slowdown in the high value capital equipment in our Navigation business. This was due in part to a lengthening of the contract cycles as customers required higher levels of signoff prior to purchase.

Finally, Physio-Control revenue of $94 million increased 24%. Growth was driven by strong international performance and the recently launched LIFEPAK 15 monitor and defibrillator with the price premium demands.

Growth this quarter was also aided in part by a product availability issue that negatively impacted revenue in the year-ago period. Physio-Control continues to make progress with the FDA and we expect resolution this fiscal year.

Turning to the rest of the income statement, the gross profit margin was 76% compared to 75.3% in the second quarter of fiscal 2009. Gross margins in Q2 versus the prior year were due to the write-off of coronary vascular inventory in the prior year, somewhat offset by negative foreign exchange impact in the current year.

We continue to see the benefits of the initiatives we have underway to reduce our cost of goods sold by $1 billion by fiscal year 2012. For the remainder of the fiscal year we continue to expect gross margins to be between 75.5% and 76%.

Second quarter R&D spending of $369 million represents approximately 9.6% of revenue compared to $326 million or 9.1% of revenue in the second quarter of fiscal 2009. We remain committed to investing in new technologies to drive growth and we anticipate R&D spending in the range of 9.5% to 10% of revenue for the remainder of fiscal year.

Second quarter SG&A expenditures of $1.323 billion represented 34.5% of sales compared to 35.4% of sales in the second 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 provide some tailwind in reducing expenditures. This was partially offset by a 30% increase in legal expenses in the first half of fiscal year 2010, driven by an increasing amount of government scrutiny on the industry. We expect legal expenses to continue to grow at a similar rate for the remainder of the year.

Net other expenses for the quarter was $130 million compared to $143 million in Q2 of last year. The year-over-year decrease primarily as a result of fewer losses from our hedging programs, which were $33 million during the second quarter compared to $42 million in losses in the comparable period last year, slightly offset by an increase in the amortization of intangibles related to our [AF and TCB] acquisitions.

Looking ahead, based on current FX rates, we anticipate hedging losses of $60 million to $90 million per quarter over the remainder of the fiscal year, was more impact in Q4 than in Q3.

Taking this into account, we anticipate net other expense will be in the range of a $190 million to $220 million per quarter during the remainder of the fiscal year. Net interest expense for the quarter was $54 million. Excluding the $41 million non-cash charge interest expense due to the change in accounting rules governing convertible debt, interest expense on a non-GAAP basis was $13 million.

As of October 30, 2009 we had approximately $4.7 billion from cash and cash investments. Looking ahead, we expect our cash to continue to increase. However, lower interest rates will negatively affect our return on the cash. After adjusting for the impact of certain litigation payments, we had yet another quarter of generating greater than $1 billion in free cash flow, defined as operating cash flow minus capital expenditures.

Turning to our tax rate. Our effective tax rate, as reported, was 21.8%. Excluding the tax impact of the litigation gain, our non-GAAP nominal tax rate in the second quarter was 20.8%. We expect our fiscal year 2010 tax rate, exclusive of one-time adjustments, to be in the range of 21% to 22%.

Second quarter weighted average shares outstanding on a diluted basis were 1.109 billion shares. During the second quarter, we repurchased $265 million of our common stock, bringing our year-to-date total to $609 million. As of October 30, 2009 we have remaining capacity to repurchase approximately 60 million shares under our board authorized stock repurchase plan.

During the quarter, we also paid out over $227 million in dividends, as we continue to return a minimum of 40% to 50% of our free cash flow to shareholders. 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 financing details.

Let me conclude by providing an update to our outlook for the remainder of fiscal 2010. As you know, we continue to see significant fluctuations in the currency exchange rates and they remain difficult to predict. Therefore, we continue to provide our revenue growth outlook on a constant currency basis. We believe a constant currency revenue growth rate of 5% to 8% is reasonable for the second half of FY10, as we continue to execute on our product pipeline and monitor the economy and healthcare reform.

If exchange rates remain similar to yesterday for the remainder of the fiscal year, then our revenue for the second half of FY10 would have an estimated favorable foreign exchange impact of approximately $350 million to $370 million, including an estimated favorable impact of a $150 million to $160 million in Q3.

Turning to our guidance on the bottom-line. We are pleased by our execution in the first half of the year where we delivered 12% earnings per share growth on a non-GAAP basis, even with the impact from acquisition dilution. Taking this into account, we feel comfortable in raising our fiscal year 2010 earnings per share guidance to a range of $3.17 to $3.22 per share.

As communicated before, our earnings per share guidance excludes any unusual charges or gains that might occur during the fiscal year and the impact of the non-cash charge interest expense due to the change in accounting rules governing convertible debt and includes $0.06 to $0.07 of acquisition dilution for the full fiscal year.

In particular, our earnings per share guidance does not take into account any potential impact from a US medical device industry tax being proposed as part of broader US healthcare reform. This updated guidance represents FY10 earnings per share growth of 11% to 13% after adjusting for the acquisition dilution.

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

Bill Hawkins

Thank you, Gary. Before we begin our Q&A session, just let me close by reiterating the Q2 was another step in building our track record of delivering consistent performance. I am confident in our ability to execute across our globally diversified portfolio and we will continue to generate 5% to 8% constant currency revenue growth and double-digit earnings per share growth.

I would now like to open things up for Q&A. In the interest of getting to as many questions as possible, we respectably request an each caller limit themselves to one question with one follow-up. Operator first question. Operator?

Question-and-Answer Session

Operator

(Operator Instructions) Your first question comes from Bob Hopkins with Bank of America/Merrill Lynch.

Bob Hopkins - Bank of America/Merrill Lynch

Great, thanks, and congratulations on a very strong quarter. Two questions here; first I just wanted to get a timing update on two issues. Could you just talk a little bit about the timing of the potential hiring of new cardiovascular division head and when we might expect some news from there and also, can you give us an update on the timing of your AF cryo data and then I have a question on CRDM. Thank you.

Bill Hawkins

So, on the group EVP or President, we are moving along nicely and I will let you know as soon as things are confirmed but I'm pleased by the interest. There are some very, very good people that I've been talking to but I will let you know when that happens. In regards to the AF, in terms of the data, we are still hopeful that we will be able to have CryoCath for the first part of FY'011 and have the AF by the second quarter to second half of FY'011.

Bob Hopkins - Bank of America/Merrill Lynch

Okay, and then just to follow up on your comments on CRDM especially on the pricing front, given some of the previous commentary. Bill, could I ask you just a kind of walk through, your comments on exactly where the pricing was for both ICDs and then separately pacemakers in the quarter and how that might have differentiated from recent trends that you have seen and then just share your comments about on where you think pricing is going in the marketplace as well. That would be very helpful. Thanks.

Bill Hawkins

So starting with ICD's as I commented for the quarter we saw ICD prices off in the low single digits and this reflects the value of innovation as we're able to bring forth new products like the Attain family of lef-side of heart leads that helped us to offset the pressures in other areas and net-net we've been able to manage prices in that very low single digits on the ICD side.

Bob Hopkins - Bank of America/Merrill Lynch

So that's consistent with where it has been?

Bill Hawkins

Yes.

Bob Hopkins - Bank of America/Merrill Lynch

Okay.

Bill Hawkins

Yes. On the pacing side, we saw a little bit more price impact and I think in part this reflects, if you will maybe of low end new products and we continue to be very exited about the opportunities with MRI pacemakers and as I mentioned, the Advisor will be in Europe we hope by the end of this fiscal year and Rhythm for the US in the beginning of next fiscal year.

Bob Hopkins - Bank of America/Merrill Lynch

So then just to sum it up, you're opinion on pricing is really that not much has changed in your CRDM business from what you have seen historically. Is that a fair characterization?

Bill Hawkins

That's overall a fair characterization except for the pacing side. I would say we've seen a little bit more impact on pacing recently. So as I mentioned, I think that in part reflects the fact that we haven't seen any new products come out of consequence in the last year or so, but again historically what's enabled us to be able to manage prices has been that the timing of new products.

Operator

Your next question comes from Mike Weinstein with JPMorgan.

Mike Weinstein - JPMorgan

Gary could you start on the SG&A side, we evolved and focused here for last several quarters and this quarter you did particularly a good job of generating leverage. So I was hoping you would give us some incremental insights into the progress there?

Gary Ellis

Well as you said Mike I mean we have been pleased with our progress on the operating leverage side both on the cost of sales and the SG&A where we continue to focus a lot of attention. As I mentioned in my comments, there is a lot of programs that are impacting SG&A that we have been driving across organization.

We have been obviously focused on IT cost, consolidating the facilities, improving processes across the organization as we look at that and as you know we have had kind of a restructuring of the organization over the last couple of years 2008 and 2009 where we have reduced the resources in some of those functions and some of those areas and as a result that has taken the cost down. We are starting to see the benefits of that more here in this quarter as we kind of expected and we would expect we will continue to see those benefits as we move ahead.

So there is a lot of things affecting the SG&A that we are trying to manage and so we are making a lot of progress in a lot of categories. The one that we are not as I mentioned in my comments is we have a little bit of a headwinds that we are fighting right now on the legal expense side, which is been higher for us over the last couple of quarters here, as I mentioned in my comments 30% uplift, really related to this government scrutiny across the industry, which has really added to our cost.

So even with that we have been able to as you see the 80 to 90 basis point improvement in SG&A. We are continuing to focus on as a company and we have the plans in place to deliver on that even fighting some of the headwinds we are fighting.

Mike Weinstein - JPMorgan

The target for the year is still the same, I think you talked about what you call 80 to 100 basis points target for the year?

Gary Ellis

Yes, we still have the same target in mind as far as achieving the overall improvement in SG&A as we've talked about and as you said in the 80 to 100 basis points. As we've indicated previously, we are trying to focus on delivering the operating margin improvement.

So as much as we are still focused on SG&A, its going to come from both SG&A and improvements I think, that we can continue to get in the product cost, because again with where FX rates are going, that actually benefits the gross margin a little bit, makes it's a little bit more difficult on the SG&A side, but overall, we think we get the operating margin improvements we committed to and we are still driving towards that same kind of objective in the SG&A.

Mike Weinstein - JPMorgan

I will just pop in with a couple of pipeline questions just to clarify. Number one, Infuse, Amplify, I think that is slipped a little bit are we now talking fiscal 2011. So please clarify.. Second, the Intercept DBS system for epilepsy, do you have any visibility on a panel and third, I guess, I'll ask Bob's question on the STOP-AF trial, when do you think we might see the data?

Bill Hawkins

So on the epilepsy to start there, we were expecting a panel before the end of this calendar year. Probably it slipped into the early part of next calendar year. So we still think there is a possibility that we can have something in the beginning of FY'011 for epilepsy. What was the first one you asked about?

Mike Weinstein - JPMorgan

Amplify.

Bill Hawkins

Amplify, again, we are looking at the beginning of FY'011 and on the AF, we are still working on it. The Boston AF symposium in January or possibly ACC would be when we would be presenting that data.

Operator

Your next question comes from Bruce Nudell with UBS.

Bruce Nudell - UBS

Bill, just looking at what's on the table on the various Senate and House bills. Do you expect a the likely outcome with higher or similar reimbursement pressure across the Medicare and commercial side at least over the next several years?

Bill Hawkins

Well if you look at in this whole healthcare reform, both the House and the Senate, I would tell you I mean everybody is participating here but the hospitals to some degree have I think faired the best. Their plan is to kind of bend the cost curve so over the next 10 years they will slow the rate if you will or increase and they're not going to cut. They are just going to slow the rate of increase.

So, yes we will see pressure as we do every year as hospitals are looking to better manage their enterprise, but I don't think you're going to see anything sort of unusual or you'll see any inflection because of the healthcare reform.

Bruce Nudell - UBS

Okay, and then my next question kind of follows up with Mike and Bob's question regarding a couple of the spine segments. So, the kind of subterranean talk that we've been hearing pertains to the CMS questioning reimbursement for infuse and/or kyphoplasty on an inpatient basis. Do you feel that on the Infuse side that the regulatory approvals that are in the queue will basically protect that franchise from any kind of change or reimbursement and is there anything going on with regards to kyphoplasty reimbursement in the US Thanks so much.

Bill Hawkins

On Infuse as I mentioned we have eight clinical studies underway to expand indications, the most important being the Amplifier for the posterolateral indication, which as I said will be out, we hope in the first part of FY '11. So I am pretty optimistic that the biologics are in good shape going forward, we have got a lot in hopper there to really protect that franchise going forward.

Bruce Nudell - UBS

On Kyphoplasty.

Bill Hawkins

On Kyphoplasty, they are two. There is good evidence out there with the free study and we have got the [CAVIAR] and the CAFE studies underway right now. Again kyphoplasty is very different from vertebroplasty and if I look back this quarter and say where we could have maybe done a better job it would have been in differentiating kyphoplasty from vertebroplasty. There is very good evidence that supports the importance and the benefit of kyphoplasty and particularly relative to vertebroplasty.

Bruce Nudell - UBS

So I guess just over and just to clarify, so over the next year if you don't see a risk of a significant challenge to reimbursement for either those product categories?

Bill Hawkins

Well Bruce, there is always risk in this business but I don't see anything unusual from where I sit today and looking for and we are always dealing with issues that are coming up here and or coming up there but I don't see any macro trend that would say that there is something on the horizon that could disrupt the kyphoplasty or the biologics and INFUSE.

Operator

Your next question comes from Matthew Dodds with Citigroup.

Matthew Dodds - Citigroup

Couple of questions, first on Kyphoplasty, Gary can you say that business down in the 5% to 10% range and if it was down in that kind of level is there any reason to think it's going to snap back any time sooner. Should we assume at least for the near-term it's going to remain flat to down?

Gary Ellis

Well it was down this quarter in that sort of mid-single digits and we've got a lot underway to, if you will revive that business and I'd also point you to Japan. I mean we are still on track to getting kyphoplasty approved in Japan in early FY'011 so there are a lot of things that we are doing to substantiate that business.

I mean, we still have complete confidence that this is a very important therapy for people with vertebral compression fractures, and particularly for those, with high [restoration] is important so, we're going to work hard and I can tell you, with Chris on Board now and his role and there is a lot of focus on the kyphoplasty business.

Matthew Dodds - Citigroup

Thanks Bill and then, just one quick follow up and ICDs, Bill you said you thought you gained modest share OUS. It was at across the board internationally or was it one major region where you think you did better than others?

Bill Hawkins

No, I think it's pretty much across the board. It's pretty consistent across the board.

Operator

Your next question comes from Kristen Stewart with Credit Suisse.

Kristen Stewart - Credit Suisse

Okay, great, just kind of a follow up with KYPHON, where could we, I guess, when can we expect some of the clinical trials coming out like CAVIAR. When are those expected to be released?

Bill Hawkins

CAVIAR is on its way out. It's a couple of years and similar for CAFE. So probably, the next important point is the two year data on the free study, which will be in the beginning of next year.

Kristen Stewart - Credit Suisse

Okay, and then you have also mentioned with respect to the core valve business, just some progress that you are making on that with the FDA. Can you just share with us whether or not your timing for initiation of the clinical trial, the PMA trial has changed. I think you had said in the next year.

Bill Hawkins

We're on track. Nothing has changed there.

Kristen Stewart - Credit Suisse

Okay, and then I guess just finally on de novo implants in the US would you say that there has been any impact from kind of the macro issues. Are they still trending flattish and what plans do you have to try to help stimulate that market?

Bill Hawkins

Nothing has changed really there. It oscillates around the mean. It's been in that flattish range. We see a quarter where it's up. We see a quarter where it's a little bit down but its pretty stable I would say and the big thing is the JCAH efforts that we have underway, which were really encouraged by and plus to me just the data coming out of them made it CRT plus reverse. So I would say the core measures from JCAH, the made up CRT in the reverse are all things which we believe will give this business a bit of a tailwind.

Kristen Stewart - Credit Suisse

I think a couple of years ago you guys had launched some promotional educational efforts midstream on kind TVR, are there any plans to do that again to jump start the market or is it more to just kind of going and helping the referral channels?

Bill Hawkins

On the ICD's? Well, the [improved chest] study that we did a couple of years ago that we have still have underway is that we think they are very important and something which we are continuing to follow through with as we go into cardiology practices and look at their patterns for who they refer on. So that is something that we are taking more national if you will.

Operator

Your next question comes from David Lewis with Morgan Stanley

David Lewis - Morgan Stanley

Bill you had commentary on 5% to 8% growth for the foreseeable future and this is kind of interesting you are benefiting from an extra selling week but you are really sort of not seeing a significant number of pipeline enhancements next year. You don't have the extra selling but you are getting a significant number of pipeline improvements, or new products coming to market.

So as you think about that balance in this year and next year, are you confident that, that 5% to 8% for the foreseeable future is a reasonable target as you look forward past one or two quarters even the pipelines improving?

Bill Hawkins

Well we are not giving sort of long-term guidance here but I would say that yes, we feel good that we are in right range in the 5% to 8% and I think it's characterized well. I mean if you look at this year we are did benefit in the first quarter with the extra week but if you look at this quarter where we didn't have the extra week we delivered solid 8% constant currency growth and the outlook as Gary gave you for the rest of the year is consistent in terms of that 5% to 8% range.

Going forward you are right we are going to benefit with a number of new products with CryoCath, with the InterStim sequel, Kyphon in Japan, with EnRhythm MRI, with Protecta Soletra, on the other spine side.

So there is a lot in the pipeline that we think will enable us to manage the portfolio and take advantage of the fact that we have a diversified group of products and businesses.

David Lewis - Morgan Stanley

Okay very helpful and though you have been pretty outspoken on the topic of reform, I wonder have you started to formulate in your mind from a corporate standpoint, to the extent that reform does happen and there is some type of tax that impacts your business, are you likely to let that tax fall through to the corporation, just sort of move on or are you likely to look to offset that tax through restructuring cost reductions or buybacks?

Gary Ellis

This is Gary. Let me address we really haven't gotten to the point of seeing what would be, how will that impact and what it would do the organization. Obviously we are trying to understand exactly what's going on the healthcare reform and as you indicated Bill has been and the entire organization has been very instrumental in trying to help shape this and we've been through at the table trying to work on the issue but we haven't made any decisions on whatever that tax ends up being, how that will be impacting the company, what that will do to our pricing, what that will do to our infrastructure cost and how much of that actually drops to the bottom-line. We have not made any decisions on. That will be just something we'll access obviously as we have a better understanding, exactly with the cost, I mean, what is the impact is to Medtronic.

Bill Hawkins

We're still working, obviously spending some time, a lot of time in Washington trying to do the best we can do to minimize the impact and we've got it down to the $20 billion range and we're working on deductibility and start dates and things of that sort. So that's really been where we've been primarily focused.

David Lewis - Morgan Stanley

Okay, and then just here for Bill, and I'll jump back in queue here. International continues to be a significant driver of the business and Bill you highlighted a couple of areas here in this call. Are you comfortable that the infrastructure that you have internationally? Is it enough to support the increased sort of growth outlet you have for that business or do you think there is going to be more significant capital expenditure to support that growth here over the next two and three years?

Bill Hawkins

I don't see any significant capital expenditures that we need to support the growth. Yes, I feel we've got a good solid, global footprint. We've made some significant investments a couple of years ago in China to put a really strong infrastructure and we're seeing the benefits of that. China has been a very strong consistent growth.

Similarly, we've made some investments in India, which is a little bit behind where China is but we think that market will grow very well going forward and I said the same thing about Latin America, In fact I was down there not too long ago for the first time and encouraged by what I see for the foreseeable future for Latin America. I don't think it's not going to require a large capital investment to be able to generate that.

We are continuing to invest disproportionally as it relates to adding selectively field people in different markets, whether that's again in Asia or whether it's in Latin America or whether that's even in some of the underdeveloped East European countries.

Operator

Your next question comes from Larry Biegelsen with Wells Fargo.

Larry Biegelsen - Wells Fargo

Good morning and thanks for taking my question. First, Bill how confident are you that the medical device fee that the House bill when it starts in 2013 will ultimately be adopted versus the Senate starting in 2010. Any speculation on that?

Bill Hawkins

That's a hard question to answer. We're clearly going to put a lot of weight behind the 2013 start date. We're going to learn a lot the next month as the Senate debates the Senate Bill and so I can't comment beyond that other than that we're going really work hard to do what we can to help have it start, commensurate with when we will see the benefit of coverage expansion, which is only logical.

Gary Ellis

Larry, just to add to Bill's comment, that's why in our guidance we made a statement that our guidance even for fiscal 2010 year here does not assume any medical devise tax impact. We just don't know what's going to happen there. Then it's possible that if in 2010 the Senate bill would firm up, than we'd actually have a few months of expense related item even in our fiscal 2010.

So that's why, we don't know as Bill said, we don't know exactly what the answer is going to be. We're just clearly trying to drive towards the 2013 because it makes more sense just from the standpoint of when the benefit is but we'll there's a lot of things that are going to occur between now and when the final bill comes out.

Larry Biegelsen - Wells Fargo

Just some clarification questions on important pipeline products in the Spine business. Kyphoplasty in Japan, at the analyst meeting this year, if I am not mistaken, I thought you said you expected approval in the summer or fall of this year, that seems to have been delayed and Amplify was pushed out. Could you talk about the reasons for the delays in those two products please?

Gary Ellis

Well, first, on the kyphoplasty, we have all along said that we will get approval, but reimbursement, as you know, in Japan lags the actual approval and that reimbursement is not going to kick in until the end of the fiscal year. So we are launching at the beginning FY11.

Larry Biegelsen - Wells Fargo

Do you have approval bill in Japan, or are you just waiting for reimbursement?

Gary Ellis

We haven't got an approval yet for Japan.

Larry Biegelsen - Wells Fargo

Okay. Amplify, any color on what the holdup is?

Bill Hawkins

No. I mean, there is no color. I mean, we do expect that there maybe a panel for Amplify and so beyond if there is a panel, then that's why we have put the timeline out to that early FY11 timeframe.

Operator

Your next question comes from David Roman with Goldman Sachs.

David Roman - Goldman Sachs

Maybe you can just comment maybe broadly on what we have seen so far through Medtronic earnings this quarter. You are one of few companies and I think the only large cap one to generate any SG&A leverage. Maybe walk us through anything you are seeing in the operating environment that your competitor's, or are they getting more aggressive on sales and marketing and trying to build out the infrastructure that you already have, is there something happening from a market share perspective that's different? Then I have one follow-up on the P&L.

Bill Hawkins

I will make a couple of comments and then Gary can add to it, but again this goes back couple of years ago when we pointed the fact that we were making some changes. If you go back two years ago, we actually started on some initiatives to reallocate resources and we took out close to 2,000 people back in FY09 and then this last year, we took out another 1,500 to 1,800 people.

We, to some degree, anticipated, one, with the changes in the market around CRDM that we needed to make some changes and so we have been making those kinds of changes the last couple of years and so we're beginning to see the benefit of that. Now, it takes a little bit of time for things to really kind of kick in. So I think the initiatives that we put in place two years ago and even this last year are starting to pay a few dividends here.

David Roman - Goldman Sachs

Those reductions in the sales force, so you now right size for share stability, share gains, accelerating market growth and maybe just give us some context as to what's on the base assumption regarding headcount now?

Bill Hawkins

I'd say that we have (right sized) the organization in line with what we see the market growth which is in that sort of mid single digits in the CRDM space. So we have we believe a structure that is appropriate for that kind of a market growth assumption and if we see the market continue to accelerate, we will make the appropriate decisions and if we think that the market's going to for whatever reason go the other direction, we've demonstrated that we can be fairly nimble and we'll take the appropriate actions.

Gary Ellis

I'd just add to what Bill said. I mean, as he indicated, we've been obviously focused on this from the SG&A and the cost of sales perspective for a period of time and I guess the way I look at it is, we saw this coming. We predicted that there was going to be a little more of a impact on some of our markets than we expected and that's why we adjusted even our revenue guidance down to 5% to 8% about a year ago, because we could see that the macroeconomic conditions were impacting our markets more than what we as historically have seen.

So we took that down. We made and we obviously were focused on trying to improve our overall operating margins. Even though again I remind all of you that our operating margins are some of the highest in the industry, so it's not like Medtronic has never focused on leverage on both product cost or SG&A. We're constantly focused on that.

As Bill said, I think we feel that we've done the appropriate shift in between businesses and in the organization, get the resources in the right areas to continue to maintain and gain share in most of our markets and we'll continue to focus on those markets that are growing faster which right now is some of the international markets. So we're some making investments in those areas. So we think we have the right mix and we think we have the right programs in place to address this that we've been really working on for the last couple of years.

David Roman - Goldman Sachs

Then lastly, R&D productivity I think is an issue people have addressed, and now looks to be improving. Can you just give us some sense how you think about new products as a percentage of sales and sales growth, maybe this quarter what percent new products sort of made up as percent of sales and where we can see that go over the next couple of years and where that's been?

Bill Hawkins

Well, if I look at the numbers, I mean we're in that sort of 40% to 50% of product sales, have come from products launched in the last couple of years, okay. Arguably, maybe that's moved down from where it used to be, okay. So but we have a major focus on enterprise-wide R&D productivity and we're doing I think a lot better job on enterprise-wide portfolio management and how I did [Rick's] role following on to the structure we put in place a year ago and I think the work we're doing to really make better decisions across the enterprise is beginning to work.

Operator

Your next question comes from Rick Wise with Leerink Swann.

Rick Wise - Leerink Swann

Couple of questions. First, it's been touched on a little bit, but this is the second consecutive quarter that Medtronic has outperformed on top and bottom line. It feels like you are certainly in the inflexion point part of it, I am guessing as you are suggesting is the cost leverage from the programs put in place a couple of days ago. The question is, with operating leverage now more visible, when we think about the possibility of upside from here, is it more from sales like OUS sales, is it mix, is it the cost structure, how do we think about the potential for outperformance from here?

Bill Hawkins

I think it's going to be the success of our new products. The things some of which we have acquired, the CryoCath's of the world, the CoreValve's of the world, some of the things that we have got in the pipeline in the Neuromodulation business, the CRDM space with the launch of Protecta and the continued success we've had with the lead.

So our goal is again to be able to deliver 5% to 8% top-line growth and to generate marginal operating margin expansion on that by growing expenses normally a bit slower and be able to continue to deliver on that operating leverage. So that's kind of the formula we have put in place.

Gary Ellis

Just add to what Bill said, I mean I would say even over the last couple of quarters and we might even say more than that, but over the last couple of quarters, it's not been on the operating leverage that we have overachieved. We have obviously overachieved on the revenue side too.

So as Bill said, I think we are happy to see that we are maintaining margins and gaining our market shares and started to gain market shares in some businesses and with our new product portfolios going forward, it's going to come, that over-performance is going to come both from the top and bottom line.

Rick Wise - Leerink Swann

Bill, you said I think you were excited about the pipeline and you've laid out some of those points and I think that all ties into the point Gary is making about sales, but you also highlighted that in the venture side, you are investing in new markets and Gary was also highlighting the fact, whatever it is, nearly 5 billion in cash and you are generating 8 billion free cash a quarter. Maybe, one, how much of that incremental growth is going to come from new investments outside the company, and, two, maybe just your latest thoughts on this really substantial and rapidly growing cash forward?

Bill Hawkins

Well, we don't build into our plan or our outlook things that we don't have inside or what we have that's a part of Medtronic today. So the guidance that we gave reflects the current outlook for the business, although we have said that we will be doing some small tuck-in acquisitions going forward, but the guidance, the 5% to 8% really reflects I think the underlying fundamentals of our current portfolio.

We are investing for the long run with our ventures group. I don't think you'll see the rewards from that in the next year or two, but these are the kind of things we need to be doing. So that three, four years from now, they will begin to kick in, whether it's the [hep C] or whether some of the things we're doing, sciatica and post-op pain and some other areas that we are pretty excited about that we've been investing in recently. So again, this is all part of the kind of the business model to be able to have a balanced portfolio of investments that will enable us to have sustainable growth over the long run.

Rick Wise - Leerink Swann

The cash balance?

Bill Hawkins

As Gary has already talked about, we're going to return 40% to 50% in dividends and share buybacks. We will be opportunistic with the remaining cash and we do see smaller tuck-in acquisitions. So we may add something here and something there, but we like having fairly conservative position to be able to be in a good position in light of what could happen to the economy.

Rick Wise - Leerink Swann

One last quick one on ICD trends. Obviously, your quarter ends more in the fall has one less summer month than your two major competitors. Can you just give us any incremental color on how the trends in the quarter went? Was August and September in fact just weak with the economy and seasonally more than usual, less than usual, was October particularly strong, are you accelerating as you head into November, December? Just any color would be welcome. Thank you so much.

Bill Hawkins

Rick, I can't really comment. First of all, I don't have in front of me the kind of the details on the kind of the weekly or monthly sales. I mean as I said, this was just a solid quarter for us. We didn't see anything unusual. It's always hard looking at individual quarters, but this has been fairly consistent with we've done for the last year.

In fact, if you look at our performance now in the ICD after a tough couple of years ago with (inaudible), I mean last year I am encouraged that we've seen pretty stable market share position and we're obviously going to do our best to try to improve that with a lot of the new technologies that we have in our pipeline that I've already talked about.

Operator

Your final question comes from Tao Levy with Deutsche Bank.

Tao Levy - Deutsche Bank

Talking about Europe specifically, are there any trends that you're seeing there that's different. I have heard from some other companies where you are seeing some budget constraint healthcare systems that are affecting them some trends there?

Bill Hawkins

Actually Europe was very strong for us this quarter. We had a very solid performance in Europe in part driven by the endovascular and the cardiovascular business I should say, but spine was good for us, the neuromodulation was good. I mean diabetes was good. It was really across the board, I mean we actually did very well in Europe this year, the last quarter.

Tao Levy - Deutsche Bank

When you mentioned the acquisition, you mentioned couple of times the small tuck-ins, is that like sort of a $1 billion in size kind of [CoreValve] in size or are you talking of what?

Bill Hawkins

No. I have definite tuck-ins in the past to be fair less than a $1 billion, but when I say small that means obviously less than considerably less than a $1 billion.

Tao Levy - Deutsche Bank

Got you. I was a little bit surprised Gary I think gross margin you kind of kept the guidance, where is that especially given the currency trends that we are seeing and how much that hurt you earlier on that it wouldn't be higher than where you are kind of indicating?

Gary Ellis

You are correct, Tao. If you look at it going forward, I mean it was a 75.5% to 76% we feel very comfortable with. If foreign exchange rate stay where they are at for the rest of the year, that would actually be a positive on the gross margin side and could actually push you up a little bit above the 76% range.

As you know it did hurt us on the gross margin side especially in Q1 and Q2 and if the trend continues, you could see a little bit of a positive on that side as we go in the back half of the year. We are just being a little cautious right now because we don't know exactly what's going on with FX rates and so that's why we kept the 75.5% to 76%.

Tao Levy - Deutsche Bank

Great. Thank you very much.

Bill Hawkins

Okay. Well again on behalf of the entire management team, thanks again for your interest in Medtronic and your continued support and we wish you all a Happy Thanksgiving. So thanks for listening.

Operator

Thank you, ladies and gentlemen, for your participation in today's conference call. You may now disconnect.

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Source: Medtronic Inc. F2Q10 (Qtr End 10/30/09) Earnings Call Transcript
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