Medtronic Inc. (MDT) reported an adjusted EPS of 84 cents in the second quarter of fiscal 2012, a couple of cents above the Zacks Consensus Estimate and the year-ago quarter.
Revenues were $4.132 billion in the quarter, up 6% (up 3% at constant exchange rates or CER) year over year and higher than the Zacks Consensus Estimate of $4.066 billion. Medtronic recorded 44% of its total sales from the international market during the quarter, which climbed 14% year over year (6% at CER) to reach $1.832 billion.
As a result of the company’s focus on emerging markets, revenues from these regions increased 21% (19% at CER) to $414 million.
Segment Details
Medtronic earns revenues from seven divisions – Cardiac Rhythm Disease Management (CRDM), Spinal, CardioVascular, Neuromodulation, Diabetes, Surgical Technologies and Physio-Control. During the quarter, these segments generated corresponding sales of $1.268 billion (up 2% year over year but down 2% at CER), $839 million (down 1% or down 3% at CER), $830 million (up 12% or 8% at CER), $421 million (up 9% or 6% at CER), $367 million (up 13% or 10% at CER), $298 million (up 22% or 20% at CER) and $109 million (flat or down 3% at CER).
Earlier this week, the company decided to sell its Physio-Control business to Bain Capital for $487 million in cash. The transaction is expected to be completed in the first quarter of calendar year 2012.
Maintaining the lackluster trend seen in the past few quarters, CRDM continues to disappoint. Although pacing systems increased 8% (up 4% at CER) to $511 million, defibrillator sales declined 5% (down 8% at CER) to $708 million. CRDM sales were affected by declining procedure volume, partially offset by growth of AF solutions business.
While revenues from Core Spinal remained flat at $631 million (down 3% at CER), Biologics declined 4% (reported as well as at CER) to $208 million. The decline in Biologics business was due to declines in the sales of Infuse (following the publication of articles in The Spine Journal), partially offset by revenue growth from Other Biologic products.
Revenue growth in the CardioVascular segment was driven by robust performance in all three businesses. Within this segment, revenues from Coronary, Structural Heart, and Endovascular & Peripheral businesses increased 7% ($376 million), 12% ($266 million) and 25% ($188 million), respectively.
Endovascular revenue was driven by the US launch of the Endurant stent graft for the treatment of abdominal aortic aneurysms and growth in Peripheral, including drug-eluting balloons, in international markets. In Structural Heart, transcatheter valves continued to show strong growth.
Margins
Gross margin during the reported quarter remained almost unchanged at 75.5%. Moreover, operating margin improved 80 basis points (bps) year over year to 31.5% despite a 5% increase in selling, general and administrative expenses and a 1.6% rise in research and development expenses.
Guidance
Medtronic expects to report a 1−3% revenue growth (at CER) in the second half of fiscal 2012. The company reiterated its adjusted EPS guidance of $3.43−$3.50, which considers 4−6 cents of dilution from the Ardian acquisition. After adjusting for Ardian dilution and 10 cents of one-time tax benefits received in fiscal 2011, the company expects to report a 6−9% growth in EPS.
Our Take
For the last few quarters, Medtronic has been reporting weaker sales of its two largest segments – defibrillators and spinal implants due to constrained hospital budgets and reduced procedures. The US ICD market has been affected by a number of challenges, namely the adverse Journal of the American Medical Association (JAMA) article published in January 2011 and the Department of Justice (DOJ) investigation of hospitals. Medtronic’s competitors, Boston Scientific (BSX) and St Jude Medical (STJ), also face a similar situation and are trying to increase their respective market share amidst declining ICD market growth.
To overcome these challenges, Medtronic is trying every means to revive growth. This includes penetration of international markets, portfolio expansion and restructuring initiatives, which should benefit the company over the long term.
We believe Medtronic’s recent decision to divest the Physio-Control business is a good move as it will help it to focus on its core segments. Besides, the divestiture of this low-margined business would also aid the company’s financials.
We currently have a Neutral recommendation on Medtronic, which also corresponds to the Zacks #3 Rank (Hold) in the short term.
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