Medtronic Inc.’s (MDT) second-quarter fiscal 2015 adjusted earnings per share (EPS) came in at 96 cents, up 5.5% year over year, after adjusting for certain one-time items including a special charge related to an after-tax charitable cash donation made to the Medtronic Foundation and acquisition-related items primarily associated with the pending Covidien plc (COV) acquisition. However, adjusted EPS remained in line with the Zacks Consensus Estimate.
However, the company’s reported net income of $828 million or 83 cents a share were down 8.2% and 6.7%, respectively, on a year-over-year basis.
Revenues in the reported quarter grossed $4.366 billion, up 4.1% year over year (up 5% at constant exchange rates or CER). The top line was also marginally ahead of the Zacks Consensus Estimate of $4.363 billion.
International sales (generating 44% of total sales) grew 3% year over year (up 5% at CER) to $1.910 billion in the quarter. Based on Medtronic’s focus on emerging markets, revenues from these regions experienced continued growth momentum and increased 10% (up 12% at CER) to $554 million. This region now accounts for 13% of the company’s total revenue.
Segment Details
Medtronic generates revenues from two major groups – the Cardiac & Vascular Group and the Restorative Therapies Group. The former encompasses the Cardiac Rhythm & Heart Failure, Coronary & Structural Heart and Aortic & Peripheral businesses; while the latter includes the Spine, Neuromodulation and Surgical Technologies segments.
Cardiac Rhythm & Heart Failure sales jumped 5% year over year (up 5% at CER) to $1.320 billion. Although revenues at High Power fell 5% at CER to $670 million on a year-over-year basis, the top line grew 7% sequentially on the back of the successful U.S. launches of Viva XT CRT-D with its AdaptivCRT algorithm and Attain Performa quadripolar lead in the reported quarter.
Meanwhile, Low Power revenues stood at $524 million, up 11% at CER on the strong global release of the Reveal LINQ insertable cardiac monitor. AF & Other revenues reached $126 million, up a substantial 30% year over year on the back of solid growth in Arctic Front CryoAblation System as well as strong double-digit growth from the international launch of PVAC Gold phased RF system.
Coronary revenues were down 2% at CER to $413 million. On the other hand, Structural Heart recorded revenue growth of 19% (to $330 million) at CER. The company is benefiting from the sales of the drug eluting stent (DES) which showed stable growth driven by significant share gains of the Resolute Integrity drug-eluting stent worldwide. Strong Structural Heart sales were supported by successful execution of the U.S. launch of the CoreValve transcatheter aortic heart valve and emerging market expansion.
At the Aortic & Peripheral segment, sales came in at $223 million, up 3% year over year and 2% at CER. The ongoing adoption of Endurant II and Valiant Captivia stent grafts globally contributed to growth in Aortic. In Peripheral, the IN.PACT Admiral and Pacific drug-coated balloons continued to deliver strong growth.
The sluggish trend for Spine persisted and translated into flat year-over-year (up 1% at CER) revenues. Core Spine revenues were also flat while the bone morphogenetic protein or BMP increased 9% offsetting the decline in Interventional Spine (down 5%).
Meanwhile, Surgical Technologies revenues grossed $410 million (up 10% at CER). Revenues at Neuromodulation came in at $494 million (up 4% at CER) while at Diabetes, the same stood at $430 million (up 10% at CER).
Margins
Gross margin during the reported quarter contracted 17 basis points (bps) to 73.8%. Adjusted operating margin contracted 75 bps year over year to 29.3%, with a 4.8% increase in selling, general and administrative expenses (to $1.507 billion); a 0.5% improvement in research and development expenses (to $374 million) and a 90.9% surge in Other expenses to $63 million.
Guidance
Medtronic reaffirmed its EPS outlook for fiscal 2015. The company still expects full-year EPS in the range of $4.00−$4.10 (implying annualized growth of approximately 7−10% from earlier projection of 6−9% after adjusting for the expected impact from foreign exchange).The current Zacks Consensus Estimate for EPS stands at $4.04, close to the mid-point of the guided range.
However, the fiscal 2015 revenue growth outlook has been narrowed to 4−5% at CER from the earlier guided 3−5%. The current Zacks Consensus Estimate is pegged at $17.725 billion.
Our Take
Medtronic posted an unimpressive fiscal second quarter with in-line earnings and revenues only closely beating the Zacks Consensus Estimate. The company’s still-weak performance in some of its core segments remains a matter of concern. Margin pressure also adds to the woes.
However, according to the company, Medtronic is well aligned with its three primary strategies – therapy innovation, globalization and economic value. The company expects the impending acquisition of Covidien will meaningfully accelerate these three strategies, strengthen long-term market competitiveness and drive further sustainability and consistency in long-term financial performance.
We take note that in order to offset the impact of a high U.S. corporate tax rate (35%), in Jun 2014, Medtronic had announced its Covidien acquisition plans, to shift its tax base (termed as ‘inversion’) to Ireland (a mere 12.5% tax rate). However, in September, the U.S. Treasury Department announced its first steps to curb tax benefits being availed through corporate inversions, underlining a set of new rules effective immediately.
However, while many pharma and Medtech majors are cancelling their offshore deals following this new rule, Medtronic has decided to go on with the same. This indicates that the company is reasonably confident of a successful integration coupled with high growth synergy likely to emerge from the impending Covidien acquisition.
However, Medtronic revealed a new financing plan post the announcement of the tax reform. Per the new strategy, it will no longer utilize cash from its foreign subsidiaries, as previously planned, but will use an external debt of $16 billion to finance part of the Covidien acquisition deal.
Currently, Medtronic carries a Zacks Rank #3 (Hold). However, investors interested in the Medical Product sector may consider Boston Scientific Corp. (BSX) and Abaxis, Inc. (ABAX), both of which carry a Zacks Rank #2 (Buy).
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