Medtronic, Inc. F1Q09 (Qtr End 07/25/08) Earnings Call Transcript

| About: Medtronic plc (MDT)

Medtronic, Inc. (NYSE:MDT)

F1Q09 Earnings Call

August 19, 2008 8:00 am ET


Jeff Warren - Vice President, Investor Relations

Bill Hawkins - President and Chief Executive Officer

Gary Ellis - Chief Financial Officer


Tao Levy – Deutsche Bank

Matthew Dodds – Citigroup

Rick Wise – Leerink, Swann

Mike Weinstein – JP Morgan

Larry Keusch – Goldman Sachs

Larry Biegelsen – Wachovia

Michael Jungling - Merrill Lynch

Tim Lee – Piper Jaffray


I would like to welcome everyone to the Medtronic first quarter earnings conference call. (Operator Instructions) I will now turn the cal over to Jeff Warren, Vice President, Investor Relations.

Jeff Warren

Welcome to Medtronic’s first quarter conference call and webcast. During the next hour, Bill Hawkins, Medtronic’s President and Chief Executive Officer, and Gary Ellis, Chief Financial Officer, will provide comments on the results of our first quarter which ended July 25, 2008. After our prepared remarks, we will be happy to take your questions.

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

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

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

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

Unless we say otherwise, the comparisons we make today will be on an as reported basis, not on a constant currency basis, and references to quarterly results increasing or decreasing are in comparison to the first quarter of fiscal year 2008. With that, I’m now pleased to turn the call over to Medtronic President and Chief Executive Officer, Bill Hawkins.

Bill Hawkins

Q1 was another strong quarter, further demonstrating our commitment to deliver market leading performance. Revenue of $3,706,000,000 increased 19%. First quarter earnings and diluted earnings per share on a non-GAAP basis were $813 million and $0.72 respectively.

Significant accomplishments for the quarter included the following; a double digit revenue growth in six of our seven businesses including Spine at 33%, CardioVascular at 30%, Neuromodulation at 20%, Surgical Technologies at 17% and Diabetes at 12%. We made over $760 million in ICD revenue, $175 million in DES revenue, revenue growth outside the US of 24% and, on a non-GAAP basis, operating income growth of 29%, which reflected improved margins from our initiatives to drive operating leverage.

In evaluating our results this quarter there are several important factors to keep in mind. First, the diversity of our businesses was once again key to driving market leading performance. Second, given the number of different markets we operate in, at any given time there will be variability around their underlying performance with some markets showing relative strength and others showing relative weakness.

However, on the whole, the broad med tech market continues to show solid growth particularly when compared to other segments of the economy that are not as insulated from current macroeconomic pressures. Finally, our results this quarter clearly demonstrate execution on the four initiatives we outlined at our investor meeting in June. Collectively, these initiatives form the ONE Medtronic approach.

First, driving sustainable long term growth of 9% to 11% through innovation, second, applying a strong focus on improving operating margins by 300 to 400 basis points, third, delivering earnings per share growth of 11% to14% and ensuring disciplined capital allocation by returning a minimum of 40% to 50% of our free cash flow to shareholders each year, and fourth, aligning the organization for relentless and consistent execution.

We will expand on our performance this quarter against each of these broad initiatives during the remainder of the call, beginning with revenue growth. There were two primary drivers for overall revenue growth during the quarter. The first driver was our overall product performance.

Keys to our growth were the stabilization of our ICD product line, solid performance in Brady, slower though not unexpected growth in core spine, growth in Biologics, the addition of Kyphon, good performance in our CardioVascular business fueled by the US Endeavor launch, continued strength in our Endovascular product launches, strong performance with our Neuromodulation products driven by both Pain Stim and InterStim, strength across our Diabetes products led by CGM, and another quarter of consistent performance in our Surgical Technologies business.

In addition to overall product performance, the second key revenue driver during the quarter was strong growth across our OUS markets. Revenue from markets outside the US grew 24%, 10% on a constant currency basis driven by exceptional performance from many emerging markets including Central and Eastern Europe, Middle East and Africa and Latin America which all had revenue growth of more than 20%.

Growth in those markets was led by our Diabetes, Spinal and Surgical Technologies businesses. Strength across all our emerging markets is expected to continue with the growing wealth of the Middle East, Eastern Europe, and Asian markets, including China. Overall our diversified product portfolio enabled us to deliver another strong quarter. Highlights are as follows.

First, global ICD revenue grew 5% to $764 million reflecting the continued stabilization of the worldwide ICD market. With our fiscal year end in April; our first quarter typically results in a sequential decline. With this in mind, we were pleased with our results given that the new Vision 3D portfolio of products has yet to launch.

During the quarter we received FDA approval for the Attain StarFix left ventricular lead with deployable lobes, the first ever active fixation left heart lead. Attain StarFix establishes a new standard for steerability and fixation and has demonstrated a zero percent chronic dislodgement rate.

Looking ahead to this fall, we believe the availability of the Vision 3D product line coupled with the launch of Attain StarFix will help us maintain our market share, which remains in the 50% range over a 12 month rolling average. Consistent with what we communicated at our June analyst meeting, we estimate the worldwide ICD market is continuing to grow in the mid to high single digits on a constant currency basis.

Turning to Pacing systems, worldwide revenue in the first quarter grew 7% to $526 million. This growth was in line with overall market growth. In the US, revenue was down slightly year over year although our share position remains above 50%. Finally, during the quarter we continued to enroll patients in our EnRhythm MRI clinical trial with over 460 patients enrolled to date.

We anticipate launch of the MRI SureScan pacing technology in select markets outside the US later this calendar year and the US launch in fiscal year 2010. We believe this unique capability will be beneficial for patients and will provide us a significant competitive advantage.

Turning to our Spinal business, revenue of $859 million grew 33% including $161 million in revenue from Kyphon. Excluding Kyphon, Spinal growth in the quarter was 8%. Our performance this quarter reflects the rebuilding underway with Steve La Neve. Steve took over as President of Spinal and Biologics at the beginning of last quarter and is working hard to solidify his management team.

Included in our spine results is an $8 million revenue credit associated with the buyout of inventory from one of our main distributors in China. This is related to our plans for commencing our joint venture with Weigao which is on track to begin operating on September 1st. As we have described previously, although the market for core spine products in the US continues to grow in the low double digits, our market share position remains under pressure primarily from the proliferation of smaller, privately held companies.

Strong performance in Biologics continued again this quarter with growth of 16%. During the quarter, we announced approval to market two smaller kit sizes of INFUSE Bone Graft for use in certain spinal fusion and oral/maxillofacial procedures which helped contribute to the largest revenue quarter ever for INFUSE. We estimate the OMF market potential for INFUSE to be in the $200 to $250 million range.

Since its market introduction, INFUSE has been successfully used to treat thousands of patients. Expanding our portfolio of INFUSE products will help broaden availability to a larger group of patients.

With regards to Kyphon, revenue of $161 million was up $11 million sequentially driven by a 10% sequential increase in balloon Kyphoplasty revenue. The overall Kyphon revenue run rate is tracking a little lower than our earlier expectations driven primarily by softness in the X-Stop interspinous process decompression device. We have several initiatives in place designed to reaccelerate X-Stop revenue.

At the same time, we remain confident in Kyphon’s important strategic fit and its ability to make increasing contributions to the long term growth of our Spinal business. A key to our future success in the Spinal business will be our commitment to driving long term innovation.

This commitment is reflected in the breadth of innovative products in the long term Spinal product development and clinical pipeline including our Bryan cervical disc, our new Atlantis translational plate, the CD Horizon Legacy family which includes our very successful PEEK rod and Hydroxyapatite coated screws, the APERIUS Device which is a next generation interspinous device being introduced in Europe, the Osteogrip family of screws, the upcoming launch of Balloon Kyphoplasty in Japan and finally a series of expanded indications for our INFUSE Bone Graft.

These innovative products will strengthen our existing portfolio and position us to continue our market leadership.

To conclude on Spine I’ll be the first to say I am disappointed with our performance the last couple of quarters. We have some work to do and I expect it will take us a few quarters to get things back to where we want them to be. I can assure you however we are wasting no time in making the appropriate changes. Steve La Neve recently announced a number of moves with his senior leadership team.

On a positive note, demand is still strong, reimbursement is appropriate, our pipeline is full and our OUS markets continue to have a lot of runway. Net net, we remain committed to this business and excited about its future potential.

Our CardioVascular business generated very strong growth of 30% delivering revenue of $631 million. Coronary and peripheral product growth of 41% was fueled by $175 million in DES revenue, including $80 million in the US. Endeavor market share in the US was stable at approximately 19% despite two new competitive entrants.

We continue to maintain a disciplined pricing strategy for Endeavor and the average selling price remains consistent with the current US market average. We believe the Endeavor launch has helped to strengthen the ongoing recovery in the DES market.

We estimate the DES penetration rate in the US has improved to approximately 67% its highest level in a year.

DES revenue in markets outside the US of $95 million reflected stable market shares and a relatively flat global DES market. Our clinical evidence continues to build for Endeavor and Endeavor Resolute further validating their uniqueness and exceptional performance in real world patients. Endeavor is the most studied of the new drug eluting stents, with a wealth of long term data that far exceeds the competition.

Our Endovascular business grew 26% in the quarter, including 35% revenue growth in OUS markets driven by the strong performance of our thoracic product line. We continue to advance the strongest endovascular product pipeline in the industry. In the US, growth of 17% was driven by the recent approvals of the Talent Abdominal and Thoracic Stent Grafts, which broaden our industry leading portfolio of aortic repair technology.

Outside the US, during the quarter we began the launch of our next generation Endurant stent graft. Together, these products should help accelerate Endovascular revenue during the remainder of fiscal 2009 and beyond.

Structural heart disease revenue of $78 million grew 15% driven by strong growth in tissue valves in our OUS markets, continued adoption of our Melody transcatheter valve and favorable comparisons. Revenue in our Revascularization business grew 15% driven by a series of new product introductions and strength across our OUS markets.

We had another strong quarter with our Neuromodulation products as revenue of $348 million grew 20%. Adjusting for the impact of the divestitures of our diagnostics related product lines last fiscal year, Neuromodulation revenue grew 23% in the quarter. The neuromodulation market continues to show robust growth with the worldwide market for pain management growing in excess of 20%.

Revenue from our Pain Stim products grew over 30% as we took share with the successful launch of RestoreUltra and our market exclusive patient controlled pain programmer called Target MyStim. I was recently with several of our Neuro reps and they commented that RestoreUltra was one of the strongest product launches in recent history.

Together with the 5-6-5 surgical lead launched late last year, the RestoreUltra system has quickly become the most widely used spinal cord stimulator in the market and has enjoyed rapid adoption, particularly for initial implants.

Our Movement Disorders product lines grew 20% in the quarter driven by growth of our Activa DBS therapy for Parkinson’s disease. Revenue from Gastro/Uro products also grew over 23% driven by another strong quarter from our InterStim product line. This was our ninth consecutive quarter of greater than 25% growth in InterStim. This product line is now annualizing at over $200 million.

As we stated at our Investor meeting in June, the neuromodulation space is one that we believe has significant potential for future growth. To this end we have increased our investment in R&D and are currently in clinical trials on a number of new therapies using our platform technologies. During the quarter we observed a series of milestones in the broad clinical programs we have underway designed to expand our DBS franchise into new indications and further extend our industry leadership.

Diabetes revenue of $269 million grew 12%. Growth was driven by our rapidly expanding continuous glucose monitoring business. Sales of consumables were also particularly strong around the globe, reflecting the strength of our installed base coupled with the positive impact from multiple programs we currently have underway designed to improve our consumer’s overall experience.

It should also be noted that this quarter reflects the impact of difficult comparables, given the Diabetes business saw 23% growth in the prior year period. Insulin pump growth was highlighted by strong performance in many OUS markets where the Paradigm Real Time System has been more recently introduced, offset by a slowdown in the US as we complete the initial wave of upgrades to our latest insulin pump technology among our installed base of pump patients.

Our Surgical Technologies product lines are fast approaching a billion dollar segment and once again had a very good quarter as revenues grew 17% to $202 million. ENT product growth of 16% reflected the continued successful launch of Fusion, an advanced Image Guidance Surgery System to facilitate sinus surgeries.

In addition we saw strong performance in nerve monitoring and power systems. Neurologic Technologies products growth of 15% was fueled by strong acceptance of the Strata programmable valve for hydrocephalus. Finally, Navigation growth of 29% was propelled by strong sales of the O-Arm navigation system coupled with strength in service contracts.

During the quarter we also completed the Restore Medical acquisition and we are actively integrating Restore’s obstructive sleep apnea product line into the Surgical Technologies business. This acquisition will deliver new growth by providing us with a proven office based procedure in a very fast growing segment of the obstructive sleep apnea market.

Finally a couple of comments on Physio Control, we made good progress during the quarter toward resuming full shipments. Revenue in the quarter was $94 million reflecting ongoing sales to critical care customers, governments and OUS markets. We are working with the FDA to return to full shipments. Our intent to spin off this business remains unchanged.

Looking ahead to the remainder of the fiscal year, we continue to see the potential for strong growth in Neuro, CardioVascular and Diabetes and for solid double digit growth in Surgical Technologies. We see our CRDM business stabilizing in the 5% to 7% growth range supported by a solid share position.

Considering the challenges I discussed previously for our Spinal business, for the remainder of the fiscal year we expect growth in the range of what we saw this quarter as strength in Biologics and OUS markets continues to offset pressure on the core business in the US market.

Beyond the revenue performance, during the quarter we made solid progress on executing against the other key ONE Medtronic initiatives. We are starting to see the benefits of our operating leverage initiatives as a result of the restructuring we did in CRDM and the sales leverage we are seeing in both Diabetes and CardioVascular. We also made good progress this quarter in further strengthening our team’s focus on reducing costs.

James Dallas’ Medtronic Operations organization is now in place and we are moving ahead on many fronts. Gary is going to comment in more detail in his remarks on the progress we’ve made and the efforts underway across the organization to drive meaningful operating leverage and grow earnings per share in the 11% to 14% range.

During the quarter we took decisive action relative to the new capital allocation strategy that we outlined on June 2nd. With the increase of our dividend by 50% we have reinforced throughout the enterprise the importance of financial discipline. With that I will now turn the call over to Gary and then I will conclude with a few closing remarks.

Gary Ellis

As Bill mentioned earlier, first quarter revenue of $3,706,000,000 grew 19%. Breaking this out geographically, revenue in the US was $2,240,000,000 up 16%. Outside the US, revenue of $1,457,000,000 increased 24% including a $157 million positive impact of foreign currency.

After adjusting for restructuring, first quarter earnings and diluted earnings per share on a non-GAAP basis were $813 million and $0.72, respectively, reflecting EPS growth of 16%. GAAP earnings and diluted earnings per share were $747 million and $0.66, respectively. On a non-GAAP basis, our operating income grew 29% to 32.6% of revenue, reflecting solid operating leverage.

In the quarter we recorded restructuring charges of $96 million related to a global realignment initiative that we announced last fiscal year. This initiative, which is part of our ongoing efforts to streamline the organization, focuses on shifting resources to those areas where we have the greatest opportunities for growth while eliminating unnecessary costs.

This realignment, which also resulted in charges in the fourth quarter of last fiscal year, impacts most businesses and geographies. As previously announced, this initiative resulted in the elimination of approximately 1,100 positions. This charge, including the respective tax impact, had a $0.06 negative impact on our first quarter diluted earnings per share.

Turning to the rest of the income statement, the gross profit margin was 76.9% compared to 74.7% in the first quarter of last year. Gross margin was positively impacted by favorable foreign currency, overall efficiencies in manufacturing of product due to increased volume, ongoing initiatives to reduce product costs and a 50 basis point benefit from the impact of Kyphon.

We expect our gross margin to be slightly above 76% for FY09 as 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. As we described at our Investor meeting in June, we are seeing good traction from our Design for Manufacturing, Lean Sigma and manufacturing consolidation initiatives.

First quarter R&D spending of $324 million increased 8% compared to $300 million in the first quarter of 2008 and represented 8.7% of revenue. This includes a reclassification of approximately $11 million of certain legal and patent expenses from R&D to SG&A. Before this reclassification, R&D would have been approximately 9% of revenue, up 12%.

R&D was below our expectations due to timing issues associated with shifting of R&D resources among the businesses. We remain committed to investing in new technologies to drive future growth and going forward we anticipate R&D spending will approximate 9.5% of revenue, after adjusting for the ongoing reclassification.

First quarter SG&A expenditures of $1,318,000,000 represented 35.6% of sales compared to 35% of sales in the prior year first quarter. Kyphon had an 80 basis point negative impact on the current quarter. In addition, the R&D reclassification I previously mentioned increased SG&A expense in the quarter by approximately 30 basis points. SG&A without Kyphon and the reclassification would have been 34.5%.

As we outlined at our June investor meeting, we have several initiatives underway to leverage our cost structure and in the first quarter we started to see the benefit of these efforts. For example, SG&A expenses in Diabetes and CardioVascular grew less than half as fast as revenue during the quarter.

Consistent with our previous forecasts, net other expense for the quarter was $151 million compared to $57 million in the prior year first quarter. This large increase is primarily due to $65 million in currency losses from our hedging programs. Net interest expense for the quarter was $9 million compared to $44 million income in the prior year period which reflects the impact of cash utilized to finance the Kyphon acquisition as well as lower interest rates.

As of July 25, 2008, we had approximately $4,314,000,000 in cash and cash investments and debt of $7,134,000,000. We continue to generate an average of $750 million or more of free cash flow per quarter, defined as operating cash flow minus capital expenditures.

Let’s now turn to our tax rate, our effective tax rate exclusive of non-GAAP reconciling items was 22.5% compared to an effective tax rate of 21% for the prior full fiscal year. Including the $30 million tax benefit related to the impact of restructuring charges, our reported tax rate was 21.6%.

As previously stated, we expect our fiscal year 2009 effective tax rate, excluding unusual charges, to be in the range of 22% to 23%. It is important to note this estimate does not reflect the potential renewal of the R&D tax credit.

First quarter weighted average shares outstanding, on a diluted basis, were 1,129,000,000 shares. During the first quarter, we repurchased $175 million of our common stock, which represents over 3.4 million shares. As of July 25, 2008, we had remaining capacity to repurchase over 30 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 commenting on full 2009 fiscal year guidance. As you know, we limit our guidance to one year at a time and keep our guidance more directional in nature. Based upon our first quarter results, our fiscal year 2009 guidance remains unchanged from last quarter.

To reiterate, we continue to anticipate our fiscal 2009 revenue to fall in the range of $15 billion to $15.5 billion at today’s foreign currency exchange rates. We also continue to anticipate our fiscal 2009 earnings per share to fall in the range of $2.94 to $3.02. Considering the solid progress we continue to make on our initiatives to deliver meaningful operating leverage, we are comfortable with current Wall Street consensus, which is at the midpoint of that EPS range.

As in the past, all of my comments on guidance do not include any unusual charges or gains that might occur during the fiscal year. I’ll now turn things back over to Bill who will conclude our prepared remarks.

Bill Hawkins

Before we begin our Q&A session, let me make a few final comments. We are pleased with the solid results we delivered in the first quarter. We are making good progress executing against our recently announced ONE Medtronic initiatives. We expect progress will continue in the upcoming quarter and throughout the balance of this fiscal year and we are confident in our ability to continue to deliver market leading performance.

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

Question-and-Answer Session


(Operator Instructions) Your first question comes from Tao Levy – Deutsche Bank.

Tao Levy – Deutsche Bank

If you could first touch on the US ICD market what’s the latest that you’re seeing are we behind any issues with Fidelus and do you expect going forward that the US portion to improve in growth. My second question is on the pacemaker on the MRI safe product, I think there’s some data that’s going to be coming out later on this month any expectation on what that data is going to show?

Bill Hawkins

Let me just make a couple comments about the ICD market. As I said in my remarks we see the market growing in the mid to high single digits as we had discussed at the June analyst meeting and with the US being at the low single digits and OUS being in the low double digits. In terms of our position, we’re pleased with the progress that we’re making; as I said we didn’t have the Vision 3D and we did launch the Attain StarFix which we think is making some good traction.

We will be launching the Vision 3D platform this quarter. We feel very confident about our position in the ICD market. We think the market is stable and growing in the range that we indicated before.

On the Pacemaker side, we will be presenting some data at the ESC on the SureScan MRI technology. We’re excited about this; we think that this will really differentiate our pacemakers in the marketplace when we launch it outside the US by the end of the calendar year and as I said 2010 here in the US.

Tao Levy – Deutsche Bank

The single Quattro, did that get approved or is that still?

Bill Hawkins

No, we’re still going through qualifications on that and we’ll launch that when we’re ready to launch it when it meets our internal standards.


Your next question comes from Matthew Dodds – Citigroup.

Matthew Dodds – Citigroup

On the gross margin you said Kyphon was 50 basis points year over year increase but if you look at the last couple quarters you’ve steadily marched up there as well. Can you tell us a little more detail how much of that’s foreign exchange versus everything else? For the Resolute when can we see the start of the US trial?

Gary Ellis

As I indicated in my comments, there are a lot of factors driving the gross margin improvement that we’ve seen not only versus the prior year obviously but even as you indicated over the last few quarters. You’re right; the benefit of Kyphon has been in there the last few quarters. Obviously it wasn’t in there in the prior year and that’s why we mention it versus the prior year. It has been in the last few quarters.

Currency, as I indicated in my comments was about 120 basis points of the improvement versus again the prior year. Some part of that would be an improvement over the last couple quarters because there have seen the dollar continue up and through our first quarter obviously the dollar had continued to weaken. Here in August it obviously has turned around and has started to strengthen so some of that benefit will be gone as we go forward.

That’s why we’re still saying our gross margins we think will be maintained just above 76% for the rest of fiscal year because we do think some of the [inaudible] is going away. I don’t want to minimize the issue and the benefit we are getting from our operating leverage initiatives. As you know, we started this initiative to reduce of cost of sales and our product costs by $1 billion about 18 months ago. We are clearly starting to see some significant benefits on those programs and that is starting to come through and basically across all of our business we’re starting to see improvements in their gross margins.

There are a lot of factors driving the gross margin. We were happy with the results for the quarter. I think the currency will be a little bit of a negative versus this quarter based on where the current FX rates are as we go forward but we still think our gross margin will be above 76% for the rest of the year.

Matthew Dodds – Citigroup

One last thing, because of the way inventory works you still think this is the high watermark for the FX benefit was Q1?

Gary Ellis

Based on what’s happened with FX rates the answer is yes. The dollar here in August has strengthened 5% to 7% and so as the result of that some of that benefit from the 120 basis points will not be there based on where the current FX rates are. If you had response back to what we saw in Q1 again you would still see that kind of level benefit on the gross margin. I’m just saying based on where current rates are, no, it will be a slightly lower benefit for the rest of the year if that stayed.

Bill Hawkins

There are two trials, there’s the Resolute III and then there’s the Resolute US Trial. The Resolute US will begin this quarter and the Resolute III which is an All-Comers trial which randomizes 2,000 plus patients one to one resolute versus Xience is well under way in about 15 to 20 centers outside the US. We’re moving along on both fronts.


Your next question comes from Rick Wise – Leerink, Swann.

Rick Wise – Leerink, Swann

Endeavor share was stable for the quarter I think you said at 19% or so. Can you talk a little bit more about July or maybe as you exited July and maybe early sense of August obviously you’ve had some significant competitive launches, maybe help us think through how we should be envisioning Endeavor in this trialing period that’s likely to go on for Xience and Promus?

Bill Hawkins

If you look outside the US where we competed with all the stents for now year plus. We’ve seen our position to be very stable. We feel that market share has been in the 20% range outside the US and the addressable market, we’re not in Japan yet which is a big market. If I look there and say is that a surrogate for what you could expect in the US and yes granted we don’t have the rapid exchange in the US like we do outside the US but nonetheless there’s a large over the wire segment and MX has been very well received.

I’m not going to suggest that we wouldn’t give up maybe a point or two but I don’t think it’s going to be much more.

Rick Wise – Leerink, Swann

About the market shares, you think it’s a point or two coming quarter in the US?

Bill Hawkins

We feel very good about the stickiness of our business and the uniqueness of the Endeavor as I pointed out in terms of the reason that people are using it is different from the reason that people are using the other competitive stents.

Rick Wise – Leerink, Swann

Kyphon you expressed your optimism about getting on track and clearly sequentially looking better. Help us in what’s required to get Kyphon to where you want it. What actions need to be taken and when is that likely to happen. A brief one on US Diabetes it seems to be stalled out in the $170 million per quarter range the last four quarters plus or minus a tad. Color on why when how it starts to move beyond that level?

Bill Hawkins

On Kyphon the balloon Kyphoplasty the BKP business we feel very good about. We’re working to reaccelerate the growth in the inner spine process devises the St. Francis products that we had which we have some work to do on market development. It’s interesting, Lee Trevino is one of the beneficiaries of this technology and is a terrific spokesperson and so we’re probably using Lee and doing some other things to talk about the value of this.

That’s where we had some softness in the last quarter was on the St. Francis component. The BKP is looking good and as I’ve said, we’re yet to get into Japan. When Japan opens up I think we’ve got a lot of head room for growth in that side of the business.

On the Diabetes business I think we pointed at the June analyst meeting that we had some tough comparables and the replacement pump part of our business has they’re cycles when it benefits us and there are cycles when it goes against us. We’re a little bit in one of those cycles when it’s going against us but as we introduce new products over the next year or two I think you’re going to see continued solid strong growth.

The CGM, Continuous Glucose Monitor is doing terrific. Our consumables are strong, our OUS business is strong. We’ve just had in the US with the cycle we’re in with replacements and we’re up against some competition now who have new pumps. As we introduce our new products I’m very confident you’re going to see very strong solid growth in the Diabetes business.


Your next question comes from Mike Weinstein – JP Morgan.

Mike Weinstein – JP Morgan

Let me just start with the quarter and then the guidance. You came in above the street consensus by $0.03 this quarter. You don’t give quarterly guidance so it doesn’t necessarily draw to your fiscal ’09 guidance but by the same token you did not raise for the fiscal year. Was this quarter in line with your expectations and that’s why you didn’t raise guidance or are you being cautious on the balance of the year for any particular reason?

Gary Ellis

I would say I’m not being cautious for any particular reason on the rest of the year. As we talked about through our comments we start off the year we’re very strong and we feel good about it. We did have the quarter for our perspective was closer to our expectations than where we would have expected the quarter to be at. As a result we thought we’d probably exceed where the street was at in the first quarter. We had looked at higher expectations but we ended up even exceeding ours a little bit by where we ended up.

What we’ve done is back in the guidance, as you recall the range of the guidance is the same when we gave it at the end of our fiscal year ’08 we gave the same guidance and we said at that point in time until we saw some of the quarters moving through we were more comfortable with the lower end of the range. At this point in time basically the consensus is at the mid point of the range and we’re saying that based on what happened this quarter, the fact that we did exceed expectations.

We’ve moved up and said alright, we’re comfortable with that mid part of the range and we’ll continue to get more confidence as we go through the rest of the year as those quarters continue to be hit and exceeded as we move through the rest of the year. Right now it’s a little cautious but there’s nothing from the standpoint of what’s going on in the business that gives us caution it’s just we want to make sure that we continue to show strong results before we continue to take guidance up.

Mike Weinstein – JP Morgan

Let me turn to the Spine business, the Spine business is struggling both the base business and Kyphon. If we could spend a little bit of time on X-Stop which my question there is basically is X-Stop down year over year and then on the pipeline there are a number of products in the pipeline I’d love you just to comment on maybe rattle them off on the Bryan and then Prestige LP, [Amplify] for Infuse and [Deon] would be another one just to give us an update on.

Bill Hawkins

The soft spot on the Kyphon part of the business was X-Stop. The data is really strong there, the control trial that we had demonstrates the value of this technology. There’s a bit of a history here in terms of when St. Francis was first out there and I think there’s a question about patient selection. We have taken a little bit of a step back and making sure that we are addressing the right patients with the technology.

We’re continuing to invest in new products. We’ll be launching the PEEK version of X-Stop later this fiscal year which I think is going to be a real opportunity for us to come out and re-launch this product. There are some competitors out there that don’t have X-Stop devises but are doing some things to position their products a little bit like X-Stop.

We’ve got a great pipeline with APERIUS which is already approved outside the US. We’ve got Deon which is in a trial here but it’s going to be a couple years before it will be here in the US. I think in the US it’s all about the PEEK version, it’s really about us re-launching this product as I mentioned. Lee Trevino has become an avid spokesperson for the technology. There are some things that we’re going to do to try to really re-launch the X-Stop.

The rest of Spine, you’re right, we’ve got a lot in the pipeline when you look at some of the next generation or the modification of the disc portfolio that we have with the Prestige and the Prestige LP which we think will be in the FY10 timeframe. We have the Bryan which we have an approvable letter, we think that the end of this quarter we’ll get approval but we probably will modify the launch until we get the toolset approved which is really key to that product not just the product itself but it’s how you deliver that product. That will slow our launch down a bit until we get that approved.

Other products in the Spine portfolio we’ve got the translational plates which we’re really exited about, the Osteogrip which is a differentiated screw, the [Setstep] continues to do very well, the whole PEEK rod family continues to do very well. We’ve got a lot in the pipeline that again is part of our strategy to move the technology upstream, differentiate ourselves and really sell on technology.

We’re all over the Spine business right now. I can tell you and I’m confident that this business is going to be a strong business for Medtronic. As I mentioned the Biologics continues to do very well with the new two new small kit sizes we’ve got a dedicated sales force going after the OMS marketplace and we’re beginning to see some traction there. I’m optimistic and very confident in the Spine business. Steve La Neve he is doing a terrific job.


Your next question comes from Larry Keusch – Goldman Sachs.

Larry Keusch – Goldman Sachs

Bill I think that you mentioned this in your prepared comment or maybe Gary I apologize. There was redirection in R&D as you are allocating through different businesses. Could you walk us what’s going on there. I know this is in relationship to your overall plan but who’s getting the money now, where’s it coming from and how long do you think that timing disruption will be in place.

Bill Hawkins

I don’t know what you mean by timing disruption but as we pointed out at the June analyst meeting part of our job is to take a step back and to look at the portfolio of therapies that were in and to try to make judgment calls of where we think the most headroom for growth is and where we have the biggest opportunities. Right now, as I pointed out in June, we think that the Neuromodulation space is some really neat mid term and long term opportunities.

We’ve redirected some of our resources to fund the things like the treatment resistance depression trail, we’ve got the epilepsy trial underway, and we’ve just gotten HDE approval for OCD, Obsessive Compulsive Disorder. We’ve got a lot of work to develop next generation pain stem devices, the inner stem product line as I pointed out to you has grown nine quarters of over 25% so we continue to invest in the inner stem product portfolio.

There’s a lot that we believe of headroom for growth in that side of the business. The Diabetes, despite the fact that this quarter was a little bit lighter than maybe what you were expecting but we anticipated that we would be a little light because of some replacement headwinds that we had from comparables last year. We see a lot of upside in the Diabetes business and we’re investing appropriately.

We’ve increased our investment for a range of new pumps that we think will differentiate us in the marketplace and actually give us the ability to more from the Type I to the Type II diabetic. Also, the opportunity for us moving to the hospital market. The Diabetes business is one that we’re investing in.

CardioVascular we have been investing and we’re still investing because of the size of that market. The transcatheter valves, we’ve got a lot in the pipeline that we think is going to serve us well over time and we’ve got our Pulmonic Transcatheter Valve, the Melody Valve out there. It’s consistent with what we said in June. We’re looking to make sure that we are not just running this as a portfolio but taking a big picture view and making sure we’re allocating resources to drive short term and long term growth for Medtronic.

Gary Ellis

The timing aspect it is consistent with the message we’ve been communicating of investing in Neuro and Diabetes. The timing issues gets back to the fact that as you try to accelerate investments in certain businesses like to Neuro or Diabetes going forward it just takes time to ramp up to get people hired, get clinical trial started versus using CardioVascular as an example, the clinical trial they’ve been running have fallen off because we were completing some of that.

That expense falls off faster than being able to ramp up in some of the other businesses. That’s about a quarter or two. I would expect here as we get into the second quarter you’re going to continue to see, as we talked about getting closer into the 9.5% of revenue was we move ahead because investments will start to accelerate.

Larry Keusch – Goldman Sachs

Coming back to Endeavor you’ve obviously had a chance now to get a sense of how the US market is developing with Xience and Promus out there. If you could talk a little bit where as you look forward where you think Endeavor will get its usage, what sort of lesions is it going to be used in, what intelligence are you going in that direction now.

The one thing I think about relative to your performance in Europe is it is my understanding that Resolute is the majority of the mix now where it is approved in Europe. I wanted to get a sense of how you think of the US without having the product right now and maintaining that stable share that you’re talking about.

Bill Hawkins

Endeavor is by a long shot the preferred product, believe it or not, in Europe. Resolute is an important part of that portfolio but it’s predominantly Endeavor. The reason for that, which is why we feel confident about our position in the US, is the safety message. The fact of the matter is, the long term safety data that we have on Endeavor is unparalleled by our competitors.

That’s the reason that people are using Endeavor more than any other reason, couple that its deliverability and its ability to access distal torturous lesions is another key think that differentiates this product. We have established a very important niche for those patients who you have concerns about their compliance with replacement therapy which is not an insignificant group of patients that’s a subset of patients that physicians are realizing the value of Endeavor. Secondly, it’s the deliverability of the product.

You combine those two, that’s a sizeable part of the market. I’m feeling pretty bullish about the stickiness of this product. We’ve got Promus and we’ve got Promus and Xience out there right now that are battling it out trying to get into the labs and I wouldn’t be surprised if you see some modest small single digit share exchange over the next quarter.


Your next question comes from Larry Biegelsen – Wachovia.

Larry Biegelsen – Wachovia

One part of the guidance I didn’t hear you give an update on was the SG&A for the full year. Do you still expect it to come in at 33.8%?

Gary Ellis

I didn’t give any guidance for the SG&A but you’re right, we had provided 33.8% previously. With this re-class issue that I just mentioned between R&D and SG&A that would move it up about 30 to 40 basis points. You’d be closer to the full year we still expect to be 34.1%, 34.2% because of that re-class issue. Otherwise we still have the same expectations around the fact that we’re going to be leveraging SG&A.

I want to make sure I’m clear also when we give that guidance we’ve said plus or minus half a point because I can’t predict exactly where that numbers going to because you’re predicting revenue and expense line. It’s going to move up a little bit because of this re-class issue but overall we still expect to see the same leverage as we move ahead and we still have expectations that the SG&A number will continue to come down as we go through the year.

Larry Biegelsen – Wachovia

On Endeavor, rapid exchange in November, how confident are you that you’ll be able to launch that you won’t be blocked. I didn’t hear an update on Maverick?

Bill Hawkins

On the rapid exchange, as you know Abbot has filed for an extension with the patent office. We filed a motion challenging their ability to extend and there’s a hearing scheduled for the middle of September and we believe we have a very strong case in front of the judge there. That’s where it is, I can’t make any predictions other than to say that we think we have a very strong case.

Larry Biegelsen – Wachovia

On the Maverick, I didn’t hear you give an update on the timing of that when you talked about Spine.

Bill Hawkins

On Maverick, it’s outside the US already. We got an approvable letter in the third quarter of FY08 so we got an approvable letter. We expect to get FDA approval in the fourth quarter of this fiscal year. On the Maverick some of what I mentioned to you on the Bryan the key is the deliverability. The first generation Maverick while it’s a good product we think the real product is going to be the A-Mav. We will more than likely be really moving when we get the FDA approval then we’ll submit a PMAS for A-Mav and that will be the product that we’ll really put the most focus on.


Your next question comes from Michael Jungling - Merrill Lynch.

Michael Jungling - Merrill Lynch

Could you please give the constant currency gross rates for low power, high power, your core spine beaters and Diabetes? A question on operating cash flow, it decreased in the first quarter can you explain why the accounts payable and the accrued liabilities why they increased what appears to be the core reason for the decrease in operating cash flow?

Gary Ellis

With respect to the constant currency by all the businesses, I’ll ask you to talk to Investor Relations offline and get those numbers I don’t want to get into all the detail on that in the call here. Why don’t we just get that offline. As far as the cash flow, the operating cash flow, our operating cash flow in the first quarter is always a little bit lower because you have all the incentives being paid out from the prior year etc. so it’s always a little bit lower as a result of that.

In the current year here it is lower than the prior year primarily because of two unusual payments that were made. One related to the Marquee settlement we talked about previously and we talked about end of the fourth quarter. That payment was made that was about $115 to $120 million. Also the payment was made related to the Kyphon key tem that they had accrued prior to our acquiring Kyphon of $75 million both those payments were made almost $200 million in effect unusual payments in the first quarter.

Otherwise from a true operating perspective our cash flow continues to be very, very strong and tracking right along with what we would expect. As I mentioned, our free cash flow continues to be in excess of $750 million per quarter and we would expect that to continue as we go through the year.

Michael Jungling - Merrill Lynch

What is your appetite for making some divestments given that some of your core businesses seem to slow down on a constant currency basis?

Bill Hawkins

Let’s be careful here, as we talked about in June, I like the portfolio that we have, the diversification we have with a number of different therapies and as I mentioned in my remarks all of our businesses go through certain cycles but if you take a step back and look at the fundamental markets for all of our businesses, CRDM included. The reality is they’re still large unmet clinical needs out there for many of these businesses. I feel very good about the overall markets we’re in.

Having said that, we are always looking at our products and determining whether or not they fit better with Medtronic or could perform better outside. We made that determination with Physio-Control and our intent is still to spin off that business. We made that decision with a number of our diagnostics related businesses and we spun of Gastro/Uro and Neuro Diagnostics businesses. We’re always looking at the overall portfolio of products and making judgment call.

Right now I feel good about the mix and that helps us to deliver strong diversified results.

Michael Jungling - Merrill Lynch

The conclusion would be that we should see no material divestments over the next four months?

Gary Ellis

As Bill said, Physio-Control we are planning on an initiative to divest and I don’t think we’re going to announce here until we have any other divestitures during that period of time. Both acquisitions and divestitures we don’t comment on other than what we’ve already told you about which right now we’ve communicated Physio-Control.


Your last question comes from Tim Lee – Piper Jaffray.

Tim Lee – Piper Jaffray

A quick follow up on the drug relating stents how important is getting the rapid exchange catheter and how should we think that impacts your market share position if Abbott is successful in extending it or on the flip side how should we think about your market share if they don’t get extended?

Bill Hawkins

All of our guidance is predicated on what we are selling today. We haven’t put into our models that we need our RX to be able to maintain our share. We feel good about the learning curve that people have been through with MX. Many people commented that MX there are certain attributes about MX in terms of wire exchange that you don’t get with a rapid exchange.

None of our assumptions about guidance going forward, when we talked about the 10% to 14% growth include us getting RX. If we get RX, yes there could be some upside for us. It’s not built into our models.

Tim Lee – Piper Jaffray

How should we think about the FX impact in terms of the top line impact and particularly given the surge of the US dollar here of late? Could we start to see a headwind as we get to the later part of fiscal ’09?

Gary Ellis

At today’s rate it is still a positive and would be positive really through all this fiscal year. If you look back at what’s happened the dollar it strengthened dramatically really in the end of March, April timeframe and it’s been that way for the last four months. Now it’s back to where it was at the March, April timeframe with the current strength that you’ve seen recently it’s got it back down to where it basically was previously.

That being said, right now for the rest of the year you would still see a positive on FX on the top line and we’re hedged so it doesn’t affect us too much on the bottom line but on the top line you would clearly still continue to see a positive as you go through the year. At current FX rates however it would be probably in the neighborhood of $50 to $55 million less than what it was in Q1. I will have an impact on it if these rates stayed the same for the rest of the year it would be not quite the positive we saw here in Q1 but it would continue to be a positive.

Bill Hawkins

As you heard in the call, we’re pleased with the quarter. This quarter on the back of a strong finish to our last fiscal year I hope demonstrates our commitment to execution and the confidence that we have in the diversification of our businesses and the outlook that we have for the next quarter and for the remainder of the fiscal year. I’m pleased with how things are going and I look forward to updating you as we go forward. On behalf of our entire management team, thanks for your interest and continued support.


This does conclude the Medtronic first quarter earnings conference call.

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