美敦力 (MDT) 2008 Q2 法說會逐字稿

Welcome to the Medtronic second-quarter earnings conference call. (OPERATOR INSTRUCTIONS). As a reminder, the conference is being recorded. I would now like to turn the conference over to our host, Ms. Martha Aaronson.

Thank you. Good afternoon and welcome to Medtronic's second-quarter conference call and Webcast. During the next hour we will review the results of our second quarter of fiscal year 2008, which ended October 26, 2007. Following these introductory remarks, Bill Hawkins, Medtronic President and Chief Executive Officer, will provide comments on the second-quarter results. Gary Ellis, Chief Financial Officer, will follow with a financial summary of the quarter, the impact of the Kyphon acquisition, and comments on analyst estimates for the remainder of the fiscal year. After our prepared remarks, we will take your questions. Joining us for the question and answer session are Michael DeMane, Chief Operating Officer, and Pat Mackin, President of our Cardiac Rhythm Disease Management business.

A few logistical comments. This call is being Webcast via our Web site, www.Medtronic.com. Our press release, earnings statement, balance sheet, cash flow, revenue by business summary, non-GAAP to GAAP reconciliations, as well as a transcript of the prepared remarks, will all be posted on our Web site. The transcript will remain available on our Web site 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 are unable to access the press release or the transcript.

Today's Webcast include 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 is 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 Medtronic's Form 10-K for the year ended April 27, 2007, 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 second quarter of fiscal year 2007.

One final note, we've been collecting feedback from many of you regarding the timing of our earnings conference call, and next quarter we will hold the earnings call in the morning prior to the market opening.

With that, I'm now pleased to turn the call over to Medtronic's President and Chief Executive Officer, Bill Hawkins.

Thank you, Martha. This afternoon we released our fiscal 2008 second-quarter financial results. Revenue of 3,124,000,000 increased 2%, including a positive impact of 73 million from foreign currency. Excluding the impact of Physio-Control, our Fidelis field action and the divestitures of our Neuromodulation diagnostics product portfolio from both periods, revenue growth would have been approximately 8%. Net earnings for the second quarter of 666 million decreased 2%, and resulted in diluted earnings per share of $0.58, which also decreased 2%.

Needless to say, this was a tough quarter. Our announcement on October 15 to voluntarily suspend distribution of the Fidelis family of defibrillation leads, while the right decision, was a difficult one, principally due to the concern it would raise with patients. It is in these types of circumstances that the character and the strength of an organization and its leadership are truly tested. I'll go into more detail on the actions and implications in a moment.

But, despite the challenge of Fidelis, we did have some good news during the second quarter -- a positive FDA panel recommendation for our Endeavor drug-eluting stent; another quarter of solid growth in our diabetes business; improved momentum in our Neruomodulation business; continued progress with our Prestige Cervical Disc; and in the first week of the third quarter, the close of the Kyphon transaction.

So, turning back to Fidelis, I'll start by giving you a sense of how the field action impacted our second-quarter results, as well as provide you an update on the current status of Quattro manufacturing capacity, the regulatory status in Japan, and customer reactions.

By way of background, prior to the announcement of the Fidelis field action, Wall Street's second quarter consensus ICD estimate for Medtronic was approximately $750 million. Although our European business was a little softer than we'd seen in previous quarters, we were tracking very close to this estimate. Pre-Fidelis, we estimated a US market with growth in the low single-digits, and an OUS market with growth in the mid-teens. Compared to the first quarter, we were also estimating relatively stable Medtronic market share. Our actual second-quarter global ICD revenue of 639 million reflects an estimated negative impact of 115 million due to the Fidelis field action, which is comprised of 35 million in Fidelis product returns and 80 million in lost sales due to an inability to fulfill orders in the last two weeks of the quarter, including a $10 million impact in Japan.

Prior to the Fidelis announcement, our worldwide lead manufacturing capacity reflected a product mix of approximately 75% for Fidelis and 25% for Quattro. After announcing the field action, we moved aggressively to transition all of our Fidelis manufacturing capacity over to Quattro. By re-engineering our supply chain, we were able to meet nearly all of our customers' implant needs. With increasing supply in November and December, we expect to reach our target inventory levels in January. Going forward, we do not anticipate any major disruptions due to supply constraints for the majority of our customers.

We have also been working diligently to minimize the impact of the Fidelis field action in Japan, given the fact that today we do not have Quattro approved in this market. We filed for regulatory approval of Quattro in late September, and have been in continuous dialogue with the Japanese regulatory authorities. We expect Japanese regulatory and reimbursement approval late in this fiscal year.

There has been a great deal of discussion regarding the impact of Fidelis on the overall ICD market recovery. Feedback from customers and the initial market research we've seen appears to indicate that Fidelis will not have a significant impact on the market growth rates in the long run. However, it is safe to say that Fidelis will likely increase the difficulty of further penetrating the primary prevention market in the short-term.

Over the past five weeks, we have spent a considerable amount of time getting feedback from customers all over the world regarding our handling of this issue. Although we realize that our decision to remove Fidelis from the market has resulted in heightened patient concerns and meaningful logistical challenges, we have been gratified by the support we have received for our customers. From the very beginning, our first priority with Fidelis has been patients. The majority of our customers recognize and acknowledge this. We feel we have made solid progress over the past five weeks, but clearly, much work still remains. Our entire CRDM organization is working on multiple fronts to address these issues and respond to the associated competitive pressure.

Pacing revenue in the second quarter grew 5% to $495 million. As a result of Fidelis, we missed an estimated $15 million of Pacing revenue during the quarter associated with sales that we otherwise would have made under combined ICD and pacemaker contracts. Pre-Fidelis, we estimated 8% growth in Pacing revenue at approximately $510 million, reflecting US market growth of approximately 5%, OUS market growth in the low double-digits, and Medtronic market share remaining relatively stable.

Looking ahead to the remainder of this fiscal year, in the fourth quarter, we are expecting to receive regulatory approval for the Secure and Maximo II ICDs and the Consulta and Maximo II CRT-D products in markets outside the US. These devices comprise the first offering within our Vision 3D product family, our first-generation common platform across CRT, high-power and low-power. These products will extend our wireless high-power offering, provide enhanced follow-up and automaticity features, and create meaningful manufacturing synergies.

So, turning to our spine business, we saw 10% growth in the quarter, driven by sales of biologics and strong growth outside the US. In the US we continue to face headwinds from the proliferation of smaller physician-affiliated competitors. This has led to some share erosion and a gradual deceleration in growth. We are focused on developing the cervical disc market. To date, we have trained over 1800 physicians on Prestige. We feel that motion-preserving cervical discs are a meaningful advance for patients, and we are focused on driving this therapy toward standard of care. We are making progress on the reimbursement front, as reflected by a recent positive coverage decision from Aetna. We remain committed to our strategy of raising the bar in this marketplace. Our move to bring the Bryan Cervical Disc into the US market by the end of the fiscal year is an example of the type of technologies small companies will have difficultly emulating.

Looking ahead, the integration of Kyphon will help support future growth in spine. Two weeks ago, I visited the Kyphon headquarters for some of the closing activities. We are off to a solid start and we are well on our way to executing on our integration plans. We are excited about the long-term potential of this new platform and our ability to participate in the (inaudible) spine market.

Turning to one of our biggest near-term opportunities, our CardioVascular business, we continued to make steady progress during the second quarter towards the launch of Endeavor in the approximately $2 billion US drug-eluting stent market. We achieved an important regulatory milestone when Endeavor received a unanimous approval recommendation from an FDA advisory panel in October. We continue to anticipate final approval for Endeavor by the end of the calendar year, and we're fully ready to launch this product upon approval.

In mid-October, we also announced the OUS launch of Endeavor Resolute, our next-generation drug-eluting stent. With the addition of this product, we now offer physicians the option to choose the drug-eluting stent that will best address each patient's specific needs. Although we launched the product line -- product less than one month ago, we have received very positive feedback on the deliverability of Resolute and the ease of stent placement, even on those difficult and complex lesions. Endeavor Resolute is a great addition to our product line in Western Europe and in the other markets where the product has been launched around the world.

Despite the continued contraction in some drug-eluting stent markets, overall stent revenues increased 13% to $149 million, and DES revenue for the quarter was $80 million, up 10%. These results reflect stable market share in the face of new entrants. US bare metal stent revenue grew 75% in the quarter, driven by the pullback in DES penetration and modest inroads in the short wire segment with our MX2 delivery platform.

Our endovascular business grew 11% in the quarter, driven by 26% growth of our thoracic products in OUS markets. Looking ahead, we continue to advance one of the strongest pipelines in the industry, and we expect the US launches of the Talent thoracic and Talent abdominal stent grafts next fiscal year. I am pleased to announce that the first human use of the Endurant next-generation abdominal stent graft occurred last week.

We made progress this quarter in our Neruomodulation business, which grew 10%. Adjusting for the impact of the previously announced divestitures of our three diagnostic-related product lines, the Neruomodulation business rebounded in the quarter to grow 15%. This recovery was driven by the continued adoption of our new 565 lead and the benefit of improved field focus resulting from the implementation of a new organizational structure in the first quarter. We believe the positive momentum will carry through to the launch of Restore Ultra early in calendar year 2008. We remain optimistic about the prospects of the Restore Ultra as it will be the thinnest neurostimulation device on the US market. In our InterStim product line, recent market development efforts to reach out to new implanting physicians resulted in revenue growth of more than 25% again this quarter.

Our diabetes business continues to be a strong performer, as we saw a 16% increase in revenue, driven by insulin pump growth and a robust uptake in continuous glucose monitors. Even without widespread reimbursement coverage, continuous glucose monitor revenue more than doubled and is currently annualizing at a rate close to $50 million.

Our Ear Nose & Throat business showed continued momentum, with 16% growth in the second quarter. Our growth outside the US slowed during the quarter, reflecting the negative impacts of Fidelis and the DES market contraction. On a positive note, we saw strong growth in spine and diabetes, which both increased more than 25%. Robust growth also continued in China, where revenue increased 32% in the quarter, led by the cardiovascular -- led by cardiovascular and spine.

Finally, a quick update on Physio-Control. Our team continues to work with the FDA regarding appropriate corrective actions, and we anticipate resuming full US shipments in the fiscal fourth quarter. I want to reemphasize that we remain committed to the spin-off of Physio-Control at the appropriate time.

Gary?

Thanks, Bill. As you heard earlier, second-quarter revenue of $3,124,000,000 grew 2%. Breaking this out geographically, second-quarter revenue in the US was $1,958,000,000, down 4%. Outside the US, revenue of $1,166,000,000 increased 12%, including a $73 million positive impact of foreign currency.

Before turning to the rest of the income statement, I will provide some additional details on the impact of Fidelis in the second quarter, and also share some additional information on the Kyphon closing, which occurred during the first week of our fiscal third quarter.

In terms of Fidelis, the estimated negative CRDM revenue impact in the second quarter was $130 million, compared to the 150 to $250 million we originally estimated on October 15th. This amount was less than initially anticipated because of the favorable ramp in Quattro supply, strong customer support, and the coordinated efforts of our physical distribution, sales and supply chain team. We would expect a portion of the second-quarter revenue impact to reverse in the back-half of the fiscal year as the Quattro supply improves and we are able to fulfill customer orders for inventory.

In addition to the revenue impact, included in the cost of sales was $31 million in inventory write-offs and other direct costs related to Fidelis. We estimate the aggregate revenue and cost implications of Fidelis had a negative earnings per share impact of approximately $0.09 to $0.10 in the second quarter. As we mentioned on October 15th, the impact of the Fidelis decision was expected to be the most significant in the second quarter, due to the lack of Quattro inventory and various onetime costs. Looking ahead, we would expect significantly less direct impact on any subsequent quarter.

As always, we will continue to actively assess the cost structure of our CRDM business relative to the anticipated growth rate. To date, our current CRDM staffing levels are down by over 800 people in the US compared to last year.

Let me now shift gears to the closing of the Kyphon acquisition. The approximate $4.2 billion acquisition was financed through a combination of approximately $3.3 billion of cash on hand from outside the US and $900 million of cash financed from the US. Looking ahead, we still expect Kyphon to generate approximately 700 to $750 million in revenue in calendar year 2008. In terms of the remainder of our fiscal year, we would estimate a revenue range of 300 to $325 million to be reasonable.

In terms of the transaction's earnings per share impact on the remainder of our fiscal year, we estimate a $0.06 to $0.08 dilutive impact, excluding an IPRD charge that will be recorded in the third quarter. We still expect the transaction to be earnings neutral in FY '09 and accretive thereafter.

For our three major purchase accounting adjustments related to the Kyphon transaction, IPR&D is anticipated to be in the range of 175 to $300 million. Intangible assets are anticipated to be in the range of $1 billion to $1.4 billion, with an amortization period of 10 to 12 years. And inventory adjustment, consisting of the markup of finished goods and work-in-process inventory, is anticipated to be in the range of 40 to $60 million, which will be amortized over the remainder of fiscal 2008, impacting cost of goods sold.

Let we now turn to the rest of the income statement. This quarter's gross profit margin of 73.1% is below our first-quarter margin of 74.7% and last year's second-quarter margin of 74.1%, and was primarily impacted by Fidelis. Lower ICD revenue, combined with increased scrap and other direct costs associated with the Fidelis field action, negatively impacted the gross margin by as much as 150 basis points.

Physio-Control's negative impact on the gross margin was approximately 20 basis points. We would expect gross margins in the back half of the year closer to 75%, and with the potential for modest improvement in subsequent fiscal years as we integrate Kyphon.

Second-quarter R&D spending of $298 million represented 9.5% of revenue. We saw a decline in clinical costs as the enrollment phases in several large clinicals were completed, particularly in the cardiovascular business. In addition, we saw the first full quarter of benefit relating to the CRDM restructuring we announced at the end of FY '07. We expect R&D to continue around 9.5% of revenue for the remainder of FY '08.

Second-quarter SG&A expenditures of $1,107,000,000 increased 7% over the prior year, mostly in marketing and selling, due to the building of the sales organization in the US for the Endeavor and Prestige launches, and represents 35.4% of sales. We expect to leverage these investments in the back half of the year and, therefore, expect to exit the fiscal year at approximately 33% of sales, as we had previously discussed.

Net other expense for the quarter was $72 million, compared to $50 million in the prior-year second quarter. This change is primarily due to lower currency gains from our hedging programs in the current quarter. Going forward, we expect to see an increase in this line item primarily impacted by higher Endeavor royalties and Kyphon intangible asset amortization expense.

Net interest income for the quarter was $61 million, compared to $37 million in the prior-year period. As of October 26, 2007, before the impact of Kyphon financing, we had approximately $6.9 billion in cash and cash investments, compared to debt of 6.4 billion. We continue to generate in excess of $700 million of free cash flow per quarter, defined as operating cash flow minus capital expenditures. In the third quarter, we expect net interest income to decline approximately $50 million due to the utilization of cash to finance the Kyphon acquisition and lower interest rates.

Let's now turn to our tax rate. After lowering our effective tax rate in the first quarter, our rate remained [the same] in the second quarter at 23.25%, and reflects the continued success of a number of actions taken over the last several years. As we move into the second half of the fiscal year, several factors could impact the rate, including the addition of Kyphon, timing of the release of Endeavor, and the overall product line mix. We expect our fiscal year 2008 tax rate, excluding unusual charges, to fall in the range of 23 to 24%.

First-quarter weighted average shares outstanding on a diluted basis were 1,148,000,000 shares. During the quarter, we repurchased $401 million of our common stock, which represents over 7.9 million shares. As of October 26, 2007, we had remaining capacity to repurchase over 47.5 million shares under our board-authorized stock repurchase plan. We will continue to be opportunistic with our stock repurchasing activities.

As before, we have attached an unaudited balance sheet and cash flow statement to this quarter's press release, and I direct your attention to these statements for additional financial detail.

Let me comment on the analyst estimates for the remainder of fiscal year 2008. As you recall, at the beginning of the fiscal year we decided to limit our guidance to one year at a time and keep our guidance more directional in nature. Keeping that in mind, while looking ahead to the remainder of the fiscal year, it is important to consider the following factors.

First, we had always expected and previously communicated that the first half of FY '08 would be challenging due to tougher comparisons, and that the revenue growth would accelerate in the back half of the year. Fidelis clearly impacted the first-half comparisons. Even though it is difficult to know how Fidelis will continue to impact the market and our CRDM revenue in the short-term, we still expect Medtronic revenue growth to accelerate significantly in the second half due to adequate supply of Quattro to meet all demand, lunch of Endeavor in the US, introduction of Restore Ultra in our Neuromodulation business, addition of Kyphon to our spinal platform, resumption of full US shipments of Physio-Control products, continued progress with our Prestige launch, and improved foreign exchange.

Second, as previously discussed, although Fidelis had an estimated $130 million revenue impact and a negative $0.09 to $0.10 earnings per share impact on our second quarter, most of which was onetime in nature, it was at the low end of the range we had previously communicated and below what many analysts had put in their models.

Third, as I mentioned earlier, although we expect the Kyphon transaction to be earnings neutral in FY '09, we estimate it will have a $0.06 to $0.08 dilutive impact in fiscal 2008, primarily due to inventory write-ups and integration costs.

Let me try and put all this in perspective. Recent Wall Street fiscal 2008 earnings per share consensus of $2.52 has a lot of noise in it. Many have overestimated the Fidelis impact, especially in the second quarter, while others have no Fidelis impacts currently incorporated at all. On top of that, only a few have tried to estimate the Kyphon impact. Taking all of this into account, after adjusting for the factors I just discussed, we would not be surprised to see fiscal [2000] earnings per share consensus remain where it is, plus or minus a few cents. We also continue to assume Physio-Control is included for the full year, although we remain committed to the spin-off of that business. As in the past, all of my comments on analyst estimates do not include any unusual charges or gains that might occur.

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

Thanks, Gary. Before we open up to Q&A, let me make a few additional remarks. First, as I said at the beginning of the call, this was a tough quarter, primarily due to our actions around Fidelis. When I became CEO in August, we all truly felt we had some momentum building with the excitement we had and still have with Endeavor, with Prestige, Kyphon, and pending resolution of issues at Physio. Gary and I believe with the leadership transition that this will be a good time to get out and meet with [investors] to communicate our passion for what we do and the confidence we have in this business. We saw this as an opportunity to reconnect with many in the investment community we already knew, and to the others we knew less well. Unfortunately, soon after our visits, a couple of unforeseen events occurred.

Once we confirmed we had an issue with Fidelis, we dealt with it. Despite the uncertainty it has created in the short-term, I am proud of how we managed it, and proud of the thousands of employees who have worked tirelessly to, first and foremost, reassure patients and their physicians of the appropriate actions to take. While we still have much work to do, in the end, I believe, we'll be recognized for doing the right thing. We will vigorously defend our hard-earned position with our customers. I also believe the market will stabilize and strengthen again as the lifesaving benefits of ICDs remain indisputable.

Looking ahead, we have much to be excited about. Last month we shared our strategic plan with the Board of Directors, and it was very well received. We communicated a broader vision for how we define our business and the possibilities we see ahead to drive exceptional performance. We are in challenging times, but we have a strong mandate from the Board to be bold, and I don't simply mean by doing acquisitions, although we will continue to evaluate opportunities that may augment growth and diversify our geographic, payor or business mix. More importantly, we have a myriad of internal growth platforms that we fully intend to nurture and incubate.

We are confident that our continued focus on existing platforms, new internal businesses, and select acquisitions such as Kyphon will reinforce the fact that Medtronic is indeed a mission-driven company committed to delivering meaningful future growth. Our management team is convinced of the opportunities before us, and we are aligned around our corresponding strategies and execution plans. We look forward to demonstrating our progress to you via our financial results. At the end of the day, as an organization, the ultimate measure of our success will continue to be the number of patients we serve.

Now I'd like to open things up for Q&A. As Martha mentioned at the beginning of the call, Michael DeMane, our Chief Operating Officer, and Pat Mackin, who runs our Cardiac Rhythm business, have joined Gary and me to address your questions. Operator, first question please.

(OPERATOR INSTRUCTIONS). Matthew Dodds, Citigroup.

A couple questions; first, I guess, for Gary, and maybe Pat. The 130 million in lost sales, you have to have, I assume, some estimate of how much that might come back. The Fidelis leads -- I'm sure the 35 million will come back. On the lost orders, can you tell yet how much were made up by competitors versus how many are still out there? And then the second question is the comments about Quattro in Japan in April, is that assuming an accelerated approval, or is that the standard timeline?

I'll take the first one, and Pat can take the second question. As far as the impact Fidelis had on our Q2, and how much of that might come back in Q3 -- in Q4 with the full supply of Quattro, we really don't know for sure. Obviously, as you indicated, some of the product returns that we received on the Fidelis leads, we would expect that a good portion of that would be completed once we can supply the Quattro to those customers, and basically make a replacement for the Fidelis inventory they had. How much of the orders that we had at the end of the quarter will still be there once we have the full Quattro supply as you get to (inaudible) Q3, Q4, we just don't know at this point in time. That's hard to estimate. So it would be too -- I would be guessing right now to give you any kind of an estimate on that number. We would expect some of it to come back, but how much we just don't know at this point.

Let me just add one comment to Gary. One thing that we have done a very good job, and that is continue to support implants. Even though we had to do a quick turnaround, we were able to re-engineer our supply chain to make sure that we could cover most of the implants. So we didn't lose as many as -- as much as you may have thought in terms of customers fulfilling what they thought were needs because of us not having a product to support a new implant. We had Quattro available to support those customers' implants. Pat, do you want to address the issue on the Japan?

On Japan, the timeframe Bill commented on the call was in the fourth quarter of our fiscal year. And that is consistent with kind of a normal approval timeframe.

Did you try for the accelerated approval?

I'm not going to get into the details around how we're (inaudible) Q4 is the timeframe.

Tao Levy, Deutsche Bank.

Just a quick follow-up. On the lost ICD sales, how do we know that's the right number? Is it -- again, kind of on the back of Matt's question. Is it again sales that didn't happen, or implants that didn't take place? I'm just trying to figure out what the overall market has done.

Let me try to again clarify. As Gary said, part of what we indicated in terms of the $80 million that were lost sales that we couldn't supply it in the quarter, as you know, at the end of the quarter we typically fulfill customer's larger orders that sometimes they save up for the end of the quarter. We didn't have the inventory to be able to supply, if you will, end-of-quarter purchases. But that's different from being able to -- missing the implants that were taking place with customers. And in that case, we really did not miss very many, if any, implants because we didn't have the product. So, if you will, the amount of inventory that our customers have on the shelves has come down. So that's a little bit -- Pat, you may want to clarify.

If I can just add some color, (inaudible) think about it in a couple of different ways. In the comments Bill made, 35 million in product returns -- those are leads that were on customer shelves that came back. So, clearly, that's something as we get more supply of Quattro, we're going have to restock customer shelves of inventory. The other comment was 70 million that's left over, and 10 of that is in Japan. And obviously, Japan is a different situation. We didn't have any leads to sell in the last two weeks of the quarter. And similar to the US, most of the end of the quarter processing of sales that we do is a combined lead and device, if you will. And without the lead, it's hard to put those two together. So I think that's basically -- when you put those two together, that's what you come up with.

That's very helpful. Also, two quick questions. Do you have a number for the backlog of Physio-Control orders that's remaining? My last question -- on the Fidelis lead, obviously, it's off the market, but is there any new data in terms of how that lead is performing in patients that have it? And with the fracture issue, is that the only problem that you guys were seeing in the marketplace, or were there other problems with that lead that could come back and be an issue in the patients that still have a Fidelis? Thanks.

Just real quickly, on the Physio question, we're not going to -- we don't report on the backorder numbers here. But, Pat, you may want to talk about --

We mentioned this on the October 15th call on Fidelis. Number one, we haven't released more data; the data that we released and made our decision on was our six-month update that was about to come out in the product performance report. So there is no new data. And we'll continue to update the market as we've always done in each six-month period.

I think it's also important to remind people that the current industry reporting standards for device performance is returned product analysis. And Fidelis in that category is 99.1% at 30 months. The only reason we were able to make the decision we made is because we have two other data sources -- our system longevity clinical trial and our (inaudible) data, which both showed 97.7. And remind people, that was not statistically different. So we made a very conservative call with this lead. There is no statistically significant difference between Fidelis and Quattro, but we felt with a constant fracture rate that it probably would become so over time, which is why we made the action we did. So, I think the point here is that we have been very conservative in the action, there's no new data, and we'll update the market as we get more data in the future.

Michael Weinstein, JPMorgan.

Gary, first to clarify. On Kyphon, you had it being a little bit more dilutive than we do, but it sounds like the difference is -- I'm talking about in fiscal '08 -- sounds like the difference is that you have an inventory step-up over the next couple of quarters, which we did not have in the model. How much is that?

I think you're absolutely right. (inaudible) for those of you who have put a Kyphon impact in, I think that's where there has been a little bit of a disconnect from the numbers I (inaudible). As I indicated, we think it's going to be somewhere in the $0.06 to $0.08 for the last six months of the year here. The impact on the inventory, the inventory write-up that we have to do in purchase accounting that purchase accounting requires, is 40 to $60 million is our current estimate on what amount the inventory will be written up that increases the cost of sales that I have to pull through in the last six months. So I think that's the major difference from what most of you have estimated.

It sounds like the rest of it was in line. We had $0.05 diluted. Let me ask a couple of items. First, Bill, I want to gauge your visibility and level of confidence here on two key upcoming items. One is you basically guided to a six-month turnaround on the Quattro lead submission in Japan. How good is your visibility around that to say if that's a good estimate for a timeline? And the same question, if you would, on the Physio-Control [resumption] of shipments. How good is your visibility at this point in November on the timing of that event?

I feel good on both accounts. We've got a very strong organization in Japan, and we've been working very collaboratively with the authorities when this -- the news occurred, and we recognized that we did not have the Quattro available. So we have been working very well with authorities there, and it's up to their ultimate discretion. But we wouldn't be giving the numbers that we gave if we didn't feel that they were -- that was an appropriate timeframe. And same thing on Physio-Control. I think on Physio, we've made very good progress there. We're on track with where we had hoped to be, and we're working well with the FDA. Again, at the end of the day, the FDA will have to complete their review. And then I hope that they will find that we've made some very, very important improvements, and that we'll be able to resume shipments. So I feel very good about the guidance that we've given you on both accounts.

Gary, let me ask you one more question, just on the cost-cutting. Bill, you can chime in here. One thought that we've had in the wake of what's happened with Fidelis is that, obviously, you guys, Pat, announced -- implemented some cost-cutting in the first half of this fiscal year in the CRDM business. This might give you an opportunity, to use that word, to maybe do some more cost-cutting in that business. And we saw here -- and you commented on the fact that R&D was down 7% this quarter, which I'm sure wasn't what the Street was modeling. Can you just talk about where you think you are going at this -- where you are at this point, where you think you're going with the expense structure of the Cardiac Rhythm Management business over the short-term and longer-term?

As you said, we made a significant change and reduction in the force back in the earlier part -- late last fiscal year and early part of our fiscal year. And you're starting to see that impact now. And we did that based on what we felt was kind of more of a slower growth market (inaudible) here in the US. And we continue to also take a look at ways to reduce the overall cost structure in that business, especially with what's been going on, and obviously with Fidelis. And we're always constantly, obviously, adjusting the employee base and taking a look at our overall cost structure as we go forward. (inaudible) not even CRDM, but all our businesses; we're constantly shifting that.

So at this point, I think, we feel pretty comfortable about where we're at. But we'll have to continue to watch what happens in the market and what happens with our overall market share. And if additional changes are necessary, whether it's investments or cost reductions we'll have to make, we will make those choices. That's what we have done historically, and you can assume we will do that going forward.

Outside of CRDM, as we've talked about, we have continued to focus on ways to leverage the rest of our infrastructure, not just within CRDM, but the rest of our infrastructure to reduce our overall cost and improve overall profitability. So, actions are still in place and will continue to be in place even outside of what's happening here within CRDM.

Rick Wise, Bear Stearns.

A couple things. You talked about the impact on the ICD market outlook, and the likelihood that your ability -- the industry's ability to impact primary prevention is likely diminished. Maybe Pat would like to comment on just in general -- is the rational thing to assume the ICD market is basically flat for the next (inaudible) year or (inaudible) couple of years, do you think, Pat, to recover from this, in broad terms?

I think you're (inaudible) I looked at, obviously, the industry data; the market has been flat in the US for about 18 months. It moves a little bit here and there, but it's basically been flat. I think short-term, obviously, these things can have a slight negative impact. But frankly, the types of patients that are getting devices today have multiple core comorbidities, secondary prevention and heart failure patients with multiple comorbidities. So that's probably one of the reasons you haven't seen the market move a lot is basically patients who need to get them are getting them.

As far as the primary prevention market, obviously, what's happened with Fidelis probably hasn't helped us in developing the market. So we're going to have to work harder. But I've got to tell you, we just published a bunch of abstracts that were presented at the American Heart Association meeting. A trial called IMPROVE HF was presented there. That's the largest outpatient study of heart failure patients to be done to date. 15,000 patients out of 150 centers. And what was really interesting in this -- we talk about getting with the guidelines and compliance to guidelines, and that's where our big effort has been. Well, in fact, when you look at the data out of that trial, 20% of the patients in that trial don't even have an ejection fraction to make a determination of whether or not they need an ICD. Only a third of the patients in that whole cohort actually had a (inaudible) heart class. So how do you decide if somebody needs an ICD or not if you don't even know what their New York heart class is?

Third, even with that -- so when you kick out all the people that don't have an ejection fraction, the people that don't have a New York heart class -- only 50% of patients who need them are getting an ICD. Only 39% of the patients who need a CRT are getting a CRT. And I think actually most surprising in this whole thing was the disparity between men and women. At a P 0.001, women who are indicated for ICD only get it 43% of the time, whereas men get it 53% of the time. That's been published in multiple papers. So I think the bottom-line here is that this is a serious disease. There's a lot of data that's coming out on areas that we've worked on, and we think that the patient population is there. We will have to work hard to get at it. But as the data comes out and we work on the protocols, I think, we will be able to get this market growing down the road.

A couple of other quick ones. OUS (inaudible) were lighter than we looked for. What happened there? Is this related to the US issues, do you think, [past] Japan, or is this the Japan effect?

I think you heard in Bill's comments that Europe was a little bit softer than we had anticipated. And frankly, there's been some very good news that came out of ESC in September, where CRT was given -- raised from a [2A] indication for guidelines up to a level 1 evidence, which is the highest level of evidence you can get. There was also some very good cost-effectiveness data published on CRT devices. So the guidelines are there. I think this is one of those things in the European market, having spent a few years there, you can get some kind of starts and stops from a budgeting standpoint in various geographies. But I don't think it changes the underlying potential of those markets, and we're very committed and have put lots of actions in place to drive the growth, and it's one of our top priorities.

(multiple speakers) to what Pat said, obviously, Fidelis, the impact that we talked about with Fidelis impacted both the US and OUS, because, obviously, we were not in a situation of meeting the demand OUS both in Japan, as we mentioned, but clearly also in the rest of the world.

(inaudible) you provocatively said the Board gave you a "broad mandate to be bold." Maybe you could give us a little more color on that statement. What should we expect -- what's going to be different as a result of that mandate?

Thanks for the question. As I mentioned, we presented our strategic plan to the Board. I think in general the Board was excited about the possibilities they saw with the broadening and diversifying portfolio that we have in most of the right areas, whether it's diabetes, neuromodulation, the opportunities that we presented to further expand our business in the overall degenerative disc disease in the spine world, and some of the things that we've got going on in broadening the way we think about cardiovascular, and being very candid about some of the issues we're facing in the cardiac rhythm disease management space. But in total, I think, the Board came away confident that we are in the right businesses, we have the right things going on, and that they share with us the common view that we have lots of opportunities to grow this business. And they also agree with us that there's more that we can do to look across the enterprise to be able to drive operating leverage to be able to generate improved overall returns. So, I think it wasn't anything revolutionary; it was more the confirmation from the Board about the opportunities that they see -- that we see for continuing by sticking to our plans of diversifying the portfolio, and then both working across as well as up and down the enterprise to get (inaudible) create shareholder value.

Thank you.

Larry Biegelson, Wachovia.

First a clarification. Bill, earlier you mentioned that the OUS market was growing in the mid-teens. Was that on a reported or a constant currency basis?

That's on a reported basis.

So on a constant currency basis, we should just make -- we can just calculate what that is. But that was lower than we've probably ever seen it. Is that a fair statement?

The answer to that would be yes; I think this is lower than what we've seen the last several quarters. But as Bill mentioned in his comments, there was two factors. As I mentioned, obviously, Fidelis impacted OUS like it did the US. Secondly, obviously, DES -- the DES market outside the US, especially in Western Europe, we've seen some [retraction] there. And as Bill mentioned, those were two factors that clearly impacted it overall. We saw strong growth continuing in spine and diabetes. But those two markets -- those two businesses probably had a larger impact than we've seen previously. But a lot of that is due to Fidelis.

Sorry, Gary; I was asking about the OUS ICD market pre the Fidelis recall. Bill mentioned that it was growing at a mid-teens rate, and I was just (multiple speakers)

I guess that mid-teens rate (inaudible) I don't know whether that was currency or not.

It was directional in nature before the decision in mid-October. As I said, we saw a little bit of a softening. But I think Pat answered the question. None of these businesses are linear; there are some fits and starts and stops, basically due to purchasing cycles. And at the end of the year in many of these European markets, sometimes they run out of budget. So I wouldn't necessarily put too much on that. As Pat said, we still see very strong underlying fundamental opportunities for ICD growth outside the US.

When is the next time we're going to see data on the fracture rates of Fidelis from the SLS Registry, the CareLink study, and the return product analysis? I know you mentioned earlier it's every -- is it six-month intervals? So is six months from October the next time there we will be new data presented publicly?

Yes. Every six months.

And then, is REVERSE heart failure still going to be presented at ACC 2008, and is BLOCK HF still an '08 event? And then I'll drop.

We'll check on the reverse. Let me just make -- I want to make one point regarding the expectation that we're going to -- in six months we'll get more data. I want to draw a little bit of a parallel. Many of you may remember the Marquee situation when three years ago we had an issue where we and our internal testing had determined that the battery could prematurely deplete, so we made a very conservative action based on some statistics. And it's very interesting. As we have looked -- as we now look back, and look at where we are, in fact, the performance of the Marquee has probably been one of the best-performing products. In fact, the numbers that we -- the rates that we thought could occur actually did not occur. And in fact, that product has performed exceedingly well. I guess I don't know what is going to happen necessarily with Fidelis, but I don't think you should assume that just because we did what we did, that we think this thing is going to just have a precipitous drop. We took what we thought was the right decision for our customers and for our patients. Without -- again, (inaudible) that would say that this is in anyway different or inferior than other leads in the marketplace. So we will continue, as we have with our product performance data, and we'll now supplement that with SLS data, as well as with CareLink data, and provide our customers with complete transparency on the performance of this product.

To answer your other question, REVERSE is going to be presented at ACC 2008, and BLOCK HF has not been announced as when that's going to be presented.

Thank you very much.

Bob Hopkins, Lehman Brothers.

A couple of questions for Bill and Pat. First, on the fracture rates -- so, today, this afternoon, you don't have an update for us on how many fractures are out there? You said 665 previously (inaudible) the fracture rate (inaudible) that comes again in another six months or so?

Correct.

Back to the issue that was discussed at the beginning of the Q&A on the $80 million in lost sales, I think what you're saying is that you're not seeing a significant change in your share of the implants that are happening out there since the recall was announced.

We're not seeing what, I think, some people have estimated to see. There has been a minimal impact in part due to the fact that we don't have the complete set of leads. The one lead we don't have is a single-coil lead right now, which we will have by the end of the fourth quarter of this fiscal year. So I'm not saying there was zero impact, but there's been a minimal impact.

In terms of the sales that normally happen towards the end of the quarter, in terms of hospitals building inventories, that, obviously, didn't happen this time because you didn't have the inventory. Do those sales just not happen, or do they go to competitors?

That's the big question. We don't know what will happen there. Obviously, you're in a situation of the hospitals not having built up their inventory in some ways which they would be normally working off, obviously, as they go into the following quarter. Will we see those just basically one-off orders that we get from those hospitals versus the bulk orders? We'll have to wait and see. Could you as we get to the -- as we go through this quarter and we deal with the bulk purchase orders that these hospitals normally do, will they have the same level? Will they increase it to replenish those inventories? That will, obviously, have to be their decision. We don't know where they will be at going forward. So, we really don't have an estimate on what they're going to do on that piece of it.

One thing for sure is that they have less inventory now than they did a few weeks ago.

Pat, one follow-up for you is, before the recall, the second calendar quarter, the worldwide ICD market was annualizing at about $5.7 billion. And you guys made some comments about near-term effect and long-term effect. But I was wondering if I could ask you for calendar 2008, do you think that we'll be on a worldwide basis flat with that $5.7 billion, a little bit above, a little bit below? Any thoughts there would be helpful for the market.

US, I think, we're basically looking at a flat to low single-digits, and we still expect mid to upper single-digit growth outside the US. I think long-term we've got double-digit growth opportunities in this marketplace.

So you think we'll see growth from pre-recall levels in calendar 2008 in the ICD market on a worldwide basis, from where you stand right now?

Yes.

And then, just to reconfirm on Kyphon, I think I misheard this. Are you using any debt?

Obviously, in the US, we have a little bit of commercial paper that we've used just on a short-term basis. But otherwise, there will be no long-term debt issued with respect to the transaction.

Thank you very much.

Glen Reicin, Morgan Stanley.

Two questions. First, again, on this -- the ICD sales and the outlook. We've danced around the issue here many times. Can you just give us what the growth in the implant rate was, what the decline was in the quarter, so we can at least see the difference?

We're not going to report on implant rates.

I think we've tried -- as you said, we have answered the question several different ways here. We're not going to get into the various specifics on implant rates and where things are at from that side of it. As we indicated, we have the product return piece. We have a situation where we clearly had the normal -- both purchase orders that we couldn't fill. We've given you kind of the breakout of what that would have normally been. And then, obviously, going forward, (inaudible) (multiple speakers)

As I said earlier in the comment about market growth, when you look back over the last 18 months, last six quarters, the US market from an implant basis has not changed much. It's changed -- from an implant per day, it has not changed very much. It's up a little here; it's down a little the next quarter. Frankly, neither has our Medtronic implants. We've been maintaining pretty stable share. We do not see a significant change in the last four weeks.

But we don't -- the problem is we don't have the data on the lost bulk sales in the quarter, so it's a little bit hard to figure out what the lost share was versus where it's going to come back immediately.

I understand, but I think the point is (inaudible) the fundamental -- the foundation of this business is implants. So, customers are going to put more inventory (inaudible) inventory. What I watch mostly is the implants. That's what's happening in the marketplace from a market share standpoint. Again, I'm trying to give you some clarity around what's going on from an implant standpoint to give you a sense of how the business is going. It's been very stable over the last 18 months. We haven't seen a big drop-off in the last four weeks since the news went out. How customers respond in -- kind of at the end of the quarters and stuff, we'll have to, obviously, work on that.

One spinal question. Can you give us an update on Prestige, and maybe give us some sort of estimate what you think cervical cages are going to generate for you in the United States this year?

Prestige is doing well. We are going through, I think, what we go through with every new-to-the-world technology, and that is hand-to-hand combat on the reimbursement front. I would say that in general, those battles are going well. We've won a bunch of them and lost a few. So in general, I think -- and I think you're familiar with the data. We do have superiority data there. So the database is strong, and it's just hard slogging doing it one by one and getting the reimbursement. So I would say the momentum is building there, and the users of the products are quite happy with them. So we're very optimistic. I'm sorry; the second part of your question?

I just was wondering if you can -- maybe I'll give you a multiple-choice question. Are we talking about sales this year in the United States of 20, 40, 60, 80 million? Give us a range what we're talking about in terms of the contribution from Prestige.

Those are all within range. We're not getting specific about what we think the revenue (multiple speakers)

Then is it -- can you give us an idea what the growth in lumbar versus total cervical was in the quarter?

I don't know that information.

(multiple speakers) (inaudible) do not have that information. I don't know what the answer to that is.

Thank you.

Tim Lee, Caris Company.

Bill, in terms of your comments on the short wire sales (inaudible) bare metal stents, what percentage of your bare metal stent sales are now going out on short wire, and how has that been trending? Could we use your market share in that segment as a proxy of what we could see for Endeavor post-launch?

The number is probably less than 10%. But the truth of the matter is we have not launch the short wire to all accounts. We've only been into really a sampling of accounts. We will -- when we get Endeavor approved, we will roll it out across the board. But we made a decision with Driver not to make it available but to a very limited number of accounts. So I don't think you can really take anything away from our sales so far on the short wire.

One quick follow-up. Given the stock price, where it's at, is there any thought to step up your share buyback program? Thank you.

Let me respond to that. Obviously, during the quiet period here, as we -- again, we announced this on October 15th right as we went into a period of time that it was not possible for us to really be out buying back stock, obviously, after the earnings, we will evaluate this. As I mentioned, we will be opportunistic. We will continue that process. Obviously, this is a very opportunistic time, from our perspective, looking at where the stock price is at. That's all I will say at this point.

Thank you.

I think we have maybe a couple more, and then we'll need to wrap it up. So, next caller?

Jason Wittes, Leerink Swann.

I just want to know if I'm thinking about this correctly. In terms of the Fidelis potential explanted patients, we've talked to a few docs, and if you are a pacemaker-dependent patient, can we expect that those patients will be explanted or get new leads?

We have run down the data on that, and the risk is like 0.1%. It's extremely low-risk when we look at that from a data standpoint. So our advice still holds consistent with the FDA, with HRS, with our independent panel, which is do not explant these devices. Again, ultimately the physician is going to have to do what they think they need to do. But the risk in pacemaker-dependent patients is extremely low. But ultimately that's a decision the physician has to make.

Is Medtronic going to support the physicians, in other words, reimburse, if the doctor decides he wants to explant that patient?

We basically have our normal warranty program that we would work forward with the docs with respect to that. And so, from that standpoint, that would be our normal financial (multiple speakers)

It's a good question. This is something -- Gary's correct -- that is our normal warranty. The lead has to be fractured. We then basically provide a lead at no charge to the hospital, and then we pay [up to $800] for the [other reimbursed] medical for the patient. Under the special circumstances, basically, because of the media hype that surrounded what happened with Fidelis, if a physician chooses to do something like you described in a pacemaker-dependent patient, we try to get them the data. But ultimately, they need to decide what they think is the best for the patient. We have opened up for a limited period of time a window for physicians to be able to do that, and we'll support them like we do on our warranty basis.

So that will be accounted for under warranty on the balance sheet?

That is correct.

And I guess you guys feel that you've got a good handle on it with that, in terms of what the potential expenses are going to be. Or should we expect these expenses to trail throughout the year?

I think we're reserved for it to what we think is going to happen. One thing that's been consistent through all of the conversations is most physicians do not think you should be explanting these. So I don't think this is going to be a big issue. But we have tried to be flexible for the customers.

One last question. Could you remind us what the reserve you've taken is?

What we mentioned was that the $31 million that was -- included scrap and warranty costs would have been (inaudible) the direct costs that I discussed (inaudible) $31 million included inventory write-offs, scrap and warranty costs.

Thank you.

I think we have time for one more question, and then we'll -- I'll make a couple of closing remarks.

Ben Andrew, William Blair.

Just briefly on the CareLink, maybe a question for Pat. Can you comment how customers have looked at the technology in terms of the ability to get new customers involved, or broader utilization by existing customers, and how that may become a revenue opportunity for you?

I've got to be honest; it's been a bit of a silver lining. (inaudible) ever wish for. But I can tell you we've been trying to push the CareLink product uphill for five years, and I think we've been fairly successful. In fact, about 70% of our new implants, high-power implants before Fidelis, were getting CareLink on board. I can tell you that I've personally been to centers that were not interested in CareLink, and they want to put every single patient on it. CareLink will become, I believe, the standard of care from a device follow-up. This, obviously, made people well aware of why it's so important, and we have a big effort behind getting all the patients with Fidelis on CareLink and really pushing that program forward. I do think this is going to be a major opportunity for us in the future.

How does that translate into revenues, Pat, in terms of specific patients.

As you well know, we stopped charging for CareLink about six or nine months ago. But it's part of our overall product, the features of the system. We have a unique algorithm for monitoring lead performance. We've got also some unique capabilities on the CareLink system. So it's a part of the overall system that we sell as the benefits of the whole system.

You said it was about 70% before the recall?

That was on new implants, on new ICD and CRT-D implants. Obviously, there's a lot of legacy patients out there that are not. But we've got (inaudible) we want to put all their legacy patients on as well.

Thank you.

Let me just make a couple of closing remarks. There are really two points I want to make. First, obviously, the Fidelis situation has been a lot of work for the organization, but we continue to feel very, very strong about the fact that we did the right thing here. And the good news is that we're in good shape with regard to the Quattro manufacturing, and we're getting better every day. We have worked tirelessly to support our customers and our patients. And I believe that this will -- once again reflects very well on just the integrity of this organization. And as you've heard from us, while we're not saying there's not going to be any impact, I think, the impact will -- is more in the short-term, minimal short-term, and we feel confident in the long run we'll be able to restore our competitive position, and focus our efforts on continuing to grow the market.

The second point I would just make is, again, looking ahead, we've got still a lot of good things to feel good about. We've got the Endeavor that we still feel that's going to happen by the end of the fiscal year, the calendar year. We've got Kyphon, and there is some momentum building in the Pacing, the diabetes, the Neuromodulation and ENT businesses. So we look forward to updating you at the next quarterly conference call. But with that I'll close. Thank you.

Ladies and gentlemen, that does conclude your conference for today.