美敦力 (MDT) 2010 Q3 法說會逐字稿

Good morning.

My name is Regina and I will be your conference operator today.

At this time I would like to welcome everyone to the Medtronic third-quarter earnings release conference call.

All lines have been placed on mute to prevent any background noise.

After the speakers' remarks, there will be a question-and-answer session.

(Operator Instructions) Thank you.

I would now like to turn the call over to Jeff Warren, Vice President, Investor Relations.

Mr.

Warren, you may begin the conference.

Thanks, Regina.

Good morning and welcome to Medtronic's third-quarter conference call and webcast.

During the next hour, Bill Hawkins, Medtronic Chairman and Chief Executive Officer, and Gary Ellis, Chief Financial Officer, will provide comments on the results of our fiscal-year 2010 third quarter, which ended January 29, 2010.

After our prepared remarks, we will be happy to take your questions.

A few logistical comments.

Earlier this morning we issued a press release containing our financial statements and a revenue by business summary.

You should also note that some of the statements made during this call may be considered forward-looking statements and that actual results might differ materially from those projected in the forward-looking statement.

Additional information concerning factors that could cause actual results to differ is contained in our periodic reports filed with the SEC; and we do not undertake to update any forward-looking statement.

In addition, the reconciliations of any non-GAAP financial measures are available on the Investor Relations portion of the Medtronic website.

Finally, unless we say otherwise, references to quarterly results increasing or decreasing are in comparison to the third quarter of fiscal-year 2009; and all growth rates are given on a constant currency basis.

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

Good morning and thank you, Jeff.

Q3 was another solid quarter.

This morning we reported third-quarter revenue of $3.851 billion, which represents a 10% increase over the prior year as reported, or a 6% increase on a constant currency basis.

Q3 non-GAAP earnings of $857 million and diluted earnings per share of $0.77 both increased 8%.

Our performance this quarter underscores the strength of our globally diversified portfolio.

CardioVascular, Neuromodulation, Diabetes, and Surgical Technologies all posted strong global results.

International continued to perform well across-the-board.

In CRDM, high-power results were particularly strong, with our share remaining stable.

I was pleased by our solid operating results, which included strong gross margins, SG&A leverage, and free cash flow that once again exceeded $1 billion.

Our operating income and earnings growth today are the results of tough decisions we made a couple of years ago to align the organization to the changing market environment.

As I look at the highlights in the quarter, strong results from our International operations clearly stand out.

International revenue grew 11% in Q3.

China, Japan, Western Europe, and Middle East and Africa all grew double digits.

Looking at it by business segment, five out of seven segments grew at or near double digits.

International CardioVascular revenue grew 30%, with all three businesses in that segment growing greater than 25%.

International Diabetes had solid double-digit revenue growth in continuous glucose monitoring and consumables.

Neuromodulation continued to deliver strong mid-to high teens growth in Europe and Central Asia in pain stim, deep brain stimulation, and InterStim.

Finally, we saw strong growth outside the US from our recent acquisitions of CoreValve, Ablation Frontiers, and CryoCath.

The integration of all these businesses are going very well.

Looking ahead, we expect the opportunities in International markets to set the pace for our growth.

We expect to receive CE Mark approval soon for Restore Sensor, the world's first pain stim device that automatically adjusts stimulation based on a person's body position.

We recently launched Veo, the world's first sensor-augmented pump, offering Low Glucose Suspend technology, a first step toward closing the loop for people with diabetes.

This summer, we expect to launch the Advisa MRI pacemaker outside the US; balloon kyphoplasty in Japan; a new stent platform in Europe called Integrity; and many more new products.

We are well positioned to continue driving market-leading growth in International markets.

Turning from International to our Group highlights, let me begin by noting that the new Group structure we announced last fall is working extremely well.

I am pleased with the progress that both Mike Coyle and Chris O'Connell are making in driving execution and developing sustainable growth plans, as well as unlocking valuable synergies across our segments in customer channels, product development, and operations.

In our Cardiac group I was pleased with the results in both CRDM and CardioVascular.

In CRDM, we saw further strengthening in our US high-power business, particularly with CRT, as our new Attain leads and delivery systems, combined with our market-leading Vision 3D devices showed themselves to be superior in many ways.

Even more encouraging is our product pipeline going forward.

We continue to prepare for the expected launch of the Protecta SMARTSHOCK family of devices this summer.

This new platform represents a significant new advance in providing a meaningful reduction in shocks, the number-one unmet physician and patients need.

In pacing, we are excited about bringing our differentiated MRI-compatible technology to the market.

In the US, our first-generation MRI pacemaker, which will be called REVO MRI, is scheduled for FDA panel on March 19.

We anticipate launching REVO MRI this summer in the US.

In addition, we plan to launch Advisa MRI SureScan, our next-generation MRI pacemaker, in international markets this summer.

Upon launch, we will be the only Company with MRI-compatible technology on the market.

Our AF Solutions business continues to perform well in markets outside the US.

We're very excited about the potential to bring our two novel AF ablation technology platforms to the US market in FY11.

We look forward to the STOP AF Cryo data being presented at Late-breaking Clinicals at ACC in March.

We also continue to make progress on our PMA for Ablation Frontiers catheters.

When approved, these two technology platforms will position Medtronic to become the undisputed leader in one of the fastest-growing markets in med tech.

In addition, we expect to become the first Company to have labeled indications for all stages of AF in the US.

Our CardioVascular segment delivered another exceptional quarter.

As I mentioned previously, growth was broad-based with Coronary, Structural Heart, and Endovascular all contributing strong double-digit growth.

In Coronary, Endeavor continues to perform well in markets around the world.

In Endovascular, we attained the number-one position in the US thoracic market this quarter and now estimate that we have market-leading positions in the triple-A and thoracic markets in both the US and Western Europe.

In Structural Heart, our integration of CoreValve is going very well.

CoreValve is the leading transcatheter valve on the market, with approximately 75% share in trans-femoral, the most preferred method for transcatheter aortic valve replacement.

We were also pleased by the recent Appeals Court decision in Germany holding that our technology does not infringe a competitor's patents.

We remain on track to start the US IDE clinical study this summer.

In late January, we announced the pending acquisition of Invatec.

This is another example of a strategic tuck-in that leverages our global footprint, regulatory expertise, and customer relationships to create long-term value.

This acquisition will increase our competitive position in the $2 billion peripheral vascular market.

In addition, Invatec has exciting new drug-eluting balloon technology that is used in both the peripheral and coronary vasculature.

Turning to Physio-Control, I was pleased by the news last week that we have received notice from the FDA to resume unrestricted global shipments.

Although it took longer than we expected, our investments have significantly raised the bar on quality.

We appreciate the loyalty that our customers have shown us during this challenging time, and we look forward to fully serving them as well as gaining new customers going forward.

Turning to our noncardiac group.

Neuromodulation and Diabetes delivered high single-digit growth, and Surgical Technologies posted solid double-digit growth.

These segments offset a slight year-over-year decline in Spine.

In Neuromodulation, DBS and InterStim continued to deliver solid double-digit growth.

Diabetes results continue to be driven by the worldwide acceptance of CGM, or continuous glucose monitoring.

While the market has slowed a bit, the good news is that overall it remains a healthy market.

We continue to focus on strengthening our product portfolio.

We also continue to invest in clinical evidence to expand the market and improve our strong competitive position.

We remain committed to returning this segment to market growth by the end of the next fiscal year.

Core Spine constructs saw modest growth in Q3, and this business continues to track to our expectations at this point in our turnaround plan.

Our launch of the TSRH 3Dx Spinal System is off to a good start.

I'm also excited about the positive customer response to the limited launch in the select account of the first phase of our Solera platform, a next-generation posterior fixation system that will replace our industry-leading legacy system.

While we are pleased with this initial phase, it's important to note that the full impact of the Solera launch will build over the next six quarters.

In Biologics, modest growth in Infuse was bolstered by our strategy to expand the business beyond BMP into ceramics and demineralized bone matrixes.

We continue to work on eight clinical trials designed to generate appropriate clinical evidence for expanded indications.

Our next near-term opportunity is with Amplify, which we expect to be approved in FY11.

Finally, on Kyphon.

Work continues.

In regard to a recent announcement of a potential new US competitor, we are very confident in our current family of BKP intellectual property and the protection it gives to our innovative products.

We will vigorously defend it against any competitive product that infringes on our technology.

Before turning the call over to Gary, let me make a few general comments regarding our overall position in the market and the outlook going forward.

As our industry moves beyond the economic turmoil and uncertain of the past year, Medtronic has never been better positioned to deliver market-leading performance.

We have weathered the storm better than most and are a stronger Company today, in large part due to the proactive changes we began to implement nearly two years ago.

We have changed the way we pursue innovation both internally and externally.

We have been disciplined about optimizing our portfolio through more efficient and effective resource allocation.

We had the courage to make tough restructuring calls over the past two years, including delayering the organization and increasing span of control.

We have made prudent investments in our International markets.

We boldly altered our business model for returning value to shareholders by increasing the dividend and continuing to repurchase shares while other companies went the other opposite direction.

Through all of this we remained steadfast to the Medtronic mission.

We are seeing today how One Medtronic is unlocking the full potential of our diversified portfolio of businesses to create value through common technologies, cost savings, and better alignment with our customers.

I truly believe we are a stronger Company today than we were in the past, and we will endeavor to push ourselves to be even better going forward.

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

Thanks, Bill.

Third-quarter revenue of $3.851 billion grew 6% after adjusting for a $144 million favorable impact of foreign currency.

Breaking this out geographically, revenue in the US was $2.236 billion, up 3%, while sales outside the US were $1.615 billion, increasing 11%.

After adjusting for the non-cash charge to interest expense due to the change in accounting rules governing convertible debt, third-quarter earnings and diluted earnings-per-share on a non-GAAP basis were $857 million and $0.77, respectively.

GAAP earnings and diluted earnings-per-share were $831 million and $0.75, respectively.

Moving on to a more detailed analysis of our results, CRDM revenue of $1.243 billion increased 2%.

Worldwide ICD revenue of $756 million grew 5%.

After adjusting for our competitor's extra week in the comparable period, the US ICD market continued to grow in the low to mid single digits; and the global ICD market grew in the mid-single digits.

Our market share continues to be stable both year-over-year and sequentially.

We've continued to see a shift in mix towards CRT-D, which has become an advantage for us due to our Attain family of left heart leads and our proprietary OptiVol Fluid Status Monitoring technology.

We saw a solid increase in high-power volume in the quarter, offsetting modest price declines.

ASP pressure remained in the low single digits, although perhaps more in the 2% to 4% range versus the historical 1% to 2%.

It's not unusual to see increased pricing pressure ahead of new product launches, and we anticipate this trend reversing when we launch our new Protecta family this summer.

Pacing revenue of $459 million declined 5%.

We continue to feel pressure in Japan from the previously announced Kappa/Sigma field action.

Our global decline was due to a combination of share decline and price erosion, which should be addressed with the launching of our MRI-compatible technology this summer.

CardioVascular revenue of $722 million grew 21%, driven by balanced growth across all businesses.

Coronary revenue of $386 million increased 23%, and the International Coronary grew (technical difficulty) reflecting the continued momentum of our Endeavor launch in Japan, which contributed over $40 million in revenue this quarter.

We now estimate that our worldwide unit share for all coronary stents is 20%, up over 300 basis points year-over-year.

In the quarter we also announced the acquisition of Invatec.

We expect to close this transaction in Q4.

While we don't expect any material financial impact in Q4, we do expect it to be $0.03 dilutive in FY11 and accretive thereafter.

Structural Heart revenue of $216 million grew 20%, driven by 39% growth in International markets on the strength of our CoreValve transcatheter valve and above-market growth in tissue valve.

Transcatheter valve therapy continues to gain acceptance in major markets; and Germany and France have approved reimbursement.

We continue to achieve our key objectives related to the integration of CoreValve.

We have completed our distributor integrations, and the expansion of US and international manufacturing operations remain on track.

Endovascular revenue of $120 million grew 15%, driven by the ongoing success of our next-generation Endurant Abdominal Stent Graft in International markets and our Talent abdominal and thoracic stent grafts in the US.

Spinal revenue of $842 million declined 1%.

Core Spinal revenue of $630 million declined 2%.

Core Metal constructs grew in the low single digits, while Kyphon results had a year-over-year decline as the perception of referring physicians continues to be negatively impacted by the New England Journal articles on vertebroplasty.

Looking at the worldwide Spine market in Q3, although it has slowed a bit, growth remains in the upper single digits.

Our primarily analysis suggests that the market deceleration is primarily attributable to a slowdown in contribution from mix, as procedure growth and pricing trends remain stable.

Biologics revenue of $212 million grew 2%, reflecting growth from MASTERGRAFT Strips and PROGENIX Plus, as this business expands beyond BMP.

Infuse unit growth in the quarter was offset by negative mix due to a growth in smaller tips.

Neuromodulation revenue of $394 million increased 8%, driven by continued strength in deep brain stimulation and gastro-uro.

Our DBS business saw strong growth in Q3, driven by the continued US adoption of Activa RC and PC.

Feedback for these neurostimulators has been very positive, based on their size reduction over the previous generation and the new programming system.

Gastro-uro revenue continued to grow above the 20% level, driven by another strong quarter from InterStim therapy.

Our pain stim business grew in the mid-single digits, and our infusion pump business experienced a year-over-year decline due to difficult comparisons versus Q3 last year.

Diabetes revenue of $311 million grew 8%, driven by very strong growth in our CGM franchise, which is now annualizing at over $125 million.

Insulin pumps had mid-single digit growth in the quarter, driven by the growth in the US and Western Europe.

Surgical Technologies revenue of $239 million grew 12%, driven by growth in monitoring, ENT image guidance systems, and power and related service.

Our nerve monitoring business continues to be very strong as customers upgrade to our Nerve Integrity Monitor 3.0.

Navigation in the US came back strong after a weak Q2, and we continue to see O-arm adoption in International markets.

While capital equipment has been a tough market over the past year, we have performed well due to our quick reaction to modify our customer payment options.

Finally, Physio-Control revenue of $100 million increased 8%, driven by the LIFEPAK 15 monitor/defibrillator.

We were pleased to receive notice last week from the FDA to resume unrestricted global shipments.

Now turning to the rest of the income statement, the gross profit margin was 76.3%.

Gross margin in the third quarter of last year was 75.7%.

In addition to a modest FX benefit in the quarter, 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.

We have maintained industry-leading gross margin in a challenging environment.

In Q4, we would expect our gross margin to be between 75.5% and 76% of revenue due to less benefit from FX and a changing product mix, in part due to the reentrance of Physio-Control.

Third-quarter R&D spending of $344 million represents 8.9% of revenue, but includes a negative 30 basis point impact from foreign currency translation.

In addition to FX, R&D was impacted by timing differences related to clinical spending as well as a focused shifting of resources to address regulatory issues.

We remain committed to investing in new technologies to drive future growth and continue to expect R&D spending to remain in the 9.5% to 10% range over the long term.

In Q4, we would expect R&D spending to be about 9.5% of revenue.

Third-quarter SG&A expenditures of $1.328 billion represented 34.5% of sales, compared to 36% of sales in the third quarter last year.

SG&A expense benefited from our ongoing initiatives to leverage our facilities and IT expenses.

Additionally, our realignment and restructuring efforts from both fiscal-year 2008 and 2009 provided some tailwind in reducing expenditures.

This was partially offset by an increase in legal expenses in this quarter compared to last year, driven by an increasing amount of government scrutiny on the industry.

We expect legal expenses to continue to run high for the remainder of the year.

Overall, I'm very pleased with the leverage we are driving in SG&A, and we expect to deliver on our FY10 commitment of 80 to 100 basis point improvement in SG&A.

Net other expense for the quarter was $148 million compared to $50 million in the prior year.

The year-over-year increased primarily as a result of losses from our hedging programs, which were $29 million during the third quarter compared to $31 million in gains in the comparable period last year.

Because we hedge our operating results during periods when the dollar is weakening, higher translated revenues will for the most part be offset by currency hedging losses.

Looking ahead, based on current FX rates, we anticipate net other expense will be in the range of $120 million to $140 million in Q4.

Net interest expense for the quarter was $56 million.

Excluding the $41 million non-cash charge to interest expense, due to the change in accounting rules governing convertible debt, net interest expense on a non-GAAP basis was $15 million.

At the end of Q3, we had approximately $6 billion in cash and cash investments.

Looking ahead, we expect our cash to continue to increase.

However, low interest rates will negatively impact our return on this cash.

Turning to our tax rate.

Our effective tax rate as reported in the third quarter was 21.8%.

Based on our current geographical earnings mix, we increased our year-to-date fiscal 2010 effective tax rate from 21% to 21.5%, which resulted in a cumulative catch-up expense of $16 million in the quarter.

Also included in the effective tax rate is an offsetting $7 million tax benefit associated with the finalization of certain tax returns, resolution of certain income tax audits, and changes to uncertain tax position reserves.

As I just said, our year-to-date effective tax rate exclusive of one-time adjustments is 21.5%, which we believe is a reasonable estimate for the remainder of the fiscal year.

However, this estimate does not assume that the US R&D tax credit, which expired on December 31, will be reinstated this fiscal year.

Third-quarter weighted average shares outstanding on a diluted basis were 1.109 billion shares.

Fiscal year to date we have repurchased $733 million of our common stock and have remaining capacity to repurchase approximately 57 million shares under our Board-authorized stock repurchase plan.

Through the end of Q3, we have also paid out $681 million in dividends.

As before, we have attached an income statement, balance sheet, and cash flow statement to this quarter's press release.

I direct your attention to these statements for additional financial detail.

Let me conclude by commenting on our outlook for the remaining quarter of fiscal-year 2010.

As you know, we continue to see significant fluctuations in currency exchange rates, and they remain difficult to predict.

Therefore, we continue to provide our revenue growth outlook on a constant currency basis.

Consistent with last quarter's comments, we believe a constant currency revenue growth of 5% to 8% remains reasonable for the fourth quarter.

If the exchange rates remain similar to yesterday for the remainder of the fiscal year, then our Q4 revenue would have an estimated favorable impact from currency of $120 million to $140 million.

Turning to our guidance, we continue to be pleased by our execution.

In our first three quarters we delivered 11% earnings per share growth on a non-GAAP basis, even when including the dilutive impact from acquisitions.

Based upon this solid performance, we are comfortable raising the lower end of our earnings per share guidance for fiscal 2010 to a range of $3.20 to $3.22 per share.

While we do not provide quarterly guidance, this implies Q4 earnings per share of $0.87 to $0.89; and the current Wall Street consensus estimate of $0.87 appears reasonable at this time.

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

This updated guidance represents FY10 earnings per share growth of 12% to 13% after adjusting for our AF and transcatheter valve acquisition dilution.

One housekeeping item before I turn things back over to Bill, who will conclude our prepared remarks.

We will be hosting our annual institutional investors and analysts meeting this year on Monday, June 7.

This year the meeting will be held in New York City.

With that, I'll turn it over to Bill.

Thank you, Gary.

Before we began our Q&A session, let me close by noting that Q3 was another step in building our track record of delivering consistent performance.

We remain committed to our focus on innovation to drive growth, executing to generate efficiency and leverage to fund future opportunity, and in generating returns for our shareholders.

We intend to end FY10 strong.

And looking ahead across all of our businesses, we are poised to deliver on one of the most robust pipelines in our history.

Innovation is the lifeblood of our Company and the foundation on which it was built; and innovation will continue to fuel our success going forward.

I would now like to open things up for Q&A.

In the interest of getting to as many questions as possible, we would respectively request that each caller limit themself to one question and one follow-up.

Operator, first question.

(Operator Instructions) Bob Hopkins, Bank of America.

Hi, good morning.

Can you hear me okay?

Great.

First question I wanted to ask was on the growth you saw outside the United States, specifically in Europe.

Because many of your competitors have reported difficult results again, especially in Europe.

So I was wondering if you could comment on what you are seeing in Europe currently.

What is it your product mix?

Are you taking share?

Just what you see going on in Europe and confidence in that market being a healthy market going forward.

Just kind of want a State of the Union on Europe, if you can.

Yes, Q3 was a good quarter for us in Europe across-the-board.

It's a combination of taking share and it's the combination of continuing to develop markets with new technologies like in the Neuromodulation space.

The Diabetes business did well.

The Neuromodulation did well.

Our CardioVascular business with Endeavor, with CoreValve, with the CRDM, with the atrial fibrillation products.

Our constant currency for Europe end Q3 was around 12%.

So it was a good, solid quarter for us, balanced across the enterprise.

And again I think it speaks to the strength of a diversified portfolio.

On the CRDM side, can you just go into a little bit more detail in terms of what you are seeing on the pricing front, both in terms in ICDs and pacemakers?

Then maybe within those comments, talk just in a little bit more detail on why pacers were weak in the quarter and what you expect going forward.

Thank you.

All right.

First of all, let me talk -- start with pacers.

ASPs were a little soft this quarter, and I think you see this often in front of a new cycle of innovation.

As we have been saying we're very excited about our MRI pacemakers which will be coming in the US in FY11.

And we will be introducing Advisa outside the US in early FY11.

But this quarter we did see a little bit more price impact than we have seen in recent quarters.

But again, you've got to look at the pacing industry over the last 50 years.

There are little cycles that we go through.

But this is a business that we continue to think it will be a very solid low single-digit kind of a growth business over time.

On the ICD side, again, we didn't see anything really unusual this quarter.

We've seen -- if you look at this year versus last year, I would say that it's sort of in general maybe a year ago we saw 50 to 100 basis points, maybe this year it's close to 100 to 200 basis points.

But we've been successful in managing through that because of the mix with new technologies.

We are still seeing a benefit from the launch a year ago of the Attain family up left-sided heart leads.

Then as we get ready to launch Protecta we think that that is going to give us the opportunity to offset perhaps some overall price pressure.

So is your opinion of the CRDM and especially ICD market growth outlook changed at all by what you are seeing this quarter?

No.

We continue to see the ICD market in that mid-single digits.

Outside the US this quarter was a little bit lighter than what we've seen, but high single-digits, low double digits for outside the US.

And the low to mid single digits in the US.

So we continue to see the ICD market in that sort of mid-single digits, if you will.

Great.

Thanks so much.

Mike Weinstein, JPMorgan.

Thanks, good morning, guys.

Can we dive into the spine market a little bit?

It would probably be helpful to get a better read on your Core Spinal business first.

Could you tease out Kyphon's performance from that, the down 2% Core Spine.

How tough was it in Kyphon?

And then talk about the market, because the market did seem to step down this quarter.

You suggested that you thought the stepdown was related to mix.

But we are seeing more pushback in spine from the payors.

So we would appreciate your insights into the health of the market.

Thanks.

Yes, okay.

Well, first, as you can imagine, I'm not happy about our Spine performance, but it's not a big surprise.

We knew we were going to be in this rebuilding mode.

Probably the biggest disappointment for me has been Kyphon.

Okay?

Kyphon, just for your information, what we saw for Kyphon is close to what we saw last quarter.

Okay?

In Q2.

We've seen a decline year-on-year with Kyphon, and it's multifactorial.

The New England Journal of Medicine article didn't help us.

We do have competition, not necessarily people who have on-label indications for kyphoplasty; but there are people that are positioning products sort of kyphoplasty-like.

And that has had an impact.

We are investing in our pipeline and we will be bringing out next year, we think, a whole range of new products in Kyphon that will further strengthen our overall position in that marketplace.

But Kyphon is -- Kyphon continues to be an issue for us.

And it's not just the BKP; it's also the X-STOP.

So we have a number of things internally that we are doing that we will give you more visibility to at the analyst meeting in June, which we think will enable us to maybe organizationally put some more focus on the right areas to be able to re-accelerate growth there.

But Kyphon has been the -- was the biggest impact on the performance this quarter.

The overall Spine business, as you heard me say, yes, it is -- we saw a little softening.

And you saw that in other companies as they reported.

I don't -- our view is that this is still a very healthy market.

The fundamentals are still strong.

The procedure volumes are strong.

We saw this quarter perhaps a little bit of an impact because of the fact that we have not brought out as much new products; and that's where we get the opportunity to, if you will, influence the value through mix.

But as we bring out next year things like Solera and as we continue to drive the TSRH 3Dx and VERTEX SELECT, I think that's going to help us to drive the market.

And we still are close to 40% of the market.

So as kind of Medtronic goes, sort of the market goes.

Okay.

I need to make sure I'm following you.

So on the Spine market, you think a stepdown to high single digit growth this quarter; but you think that that rebounds with new product launches.

Is that the picture?

I don't have a crystal ball, but we aren't hearing anything that is fundamentally different.

There is still -- if you think about the need and the unmet clinical need for people with degenerative disc disease or people with deformity or people with trauma, I mean this is -- we're still scratching the surface.

Reimbursement is still solid.

The pipeline, our pipeline is solid.

So I think you put it all together, we don't -- there is nothing that would tell us that this market is kind of taking a step down.

But this quarter, there is no question.

We saw a bit of softening.

I think that's been -- at least the checks that I'm getting from being out in the field and talking to hospital CEOs, is that I think we've seen, because of what's happened in the economy overall, kind of an impact on just general procedures.

Because people's insurance is -- they're without insurance, and there's other factors which I think are putting a little bit of an interim damper on the overall healthcare market.

Okay.

Let me just ask Gary one quick financial question and I will let others jump in.

It looks like, Gary, your FX hedges are playing out favorably to what you thought they would a quarter ago.

If you look at your other expense line, it came in lower this quarter than what you thought.

And it's obvious you are guiding to a lower level for the fourth quarter than what you were thinking a quarter ago.

Is that just because of the strengthening of the dollar?

It is, Mike, and the answer -- it's the strengthening of the dollar and it's versus various currencies.

Obviously, it's probably more important that the euro is the weaker part.

And the reality is even on, for example, revenue we were a little softer on the FX benefit from revenue in the quarter than we expected.

But interestingly enough, we are much softer from what we predicted at the beginning of the quarter on the euro; but actually saw benefit, for example, in some of the other currencies that we don't hedge.

So the reality is my hedging losses ended up being less than we expected at the beginning of the quarter because the euro did weaken so much.

But the fact of the matter is it didn't have as large of an impact on the revenue line.

So that's what we saw.

As you said, we saw a little benefit on the other income expense line from that.

And obviously we saw a benefit just from the fact that we didn't get as much revenue benefit as we had originally expected at the beginning of the quarter.

But part of it is just the mix on what currencies we hedge.

Got you.

Thank you.

Matthew Dodds, Citigroup.

Good morning.

Just a couple questions.

First, Bill, your comments on CRDM with the pricing, can you comment at all about whether that is a US trend, or you are seeing pricing pressure O-US as well for pacers and ICDs?

I would say, Matt, it's really a global phenomenon.

It's not just US or just O-US.

We see it really in markets around the world.

And the second question is now that Visao, a lot of the FDA issues are behind you, is a spinoff now a possibility going forward?

Have you revisited that?

Our focus right now is in gearing manufacturing back up and working to serve the customers that have waited so patiently.

We have, we think, the opportunity to drive this business in the near term.

But once we get through that, we will take a step back and reevaluate our strategic alternatives and go from there.

Thanks, Bill.

David Lewis, Morgan Stanley.

Good morning.

Gary, just a quick follow-up on Mike's question here.

Just given the other income, even with the FX hedges it looks like the other income coming in better than we would have expected.

Are you still committed to year-over-year at least an 80 basis point improvement in operating income?

For FY10, the answer is for operating income obviously we've seen that 80 to 100 basis point year-to-date, both in higher gross margin and improved SG&A.

So on the operating margin line the answer is yes.

But as we have said before, it's both.

It is related to what we're seeing in gross margins, where we are real pleased on the gross margin line.

Because the reality is with some of the pricing pressures Bill just has mentioned, we have been able to basically offset that and actually see our margins increase slightly, where a lot of companies are struggling on the gross margin line.

And at the same time on the SG&A line, we have seen already year to date about 100 basis points of improvement on the SG&A line itself.

So we are focusing on numerous areas.

But as a result, we remain committed that that operating margin improvement that we have been talking about will be there for the full year.

So we've executed on that so far, and we don't see any reason to say that we are going to fall back on that in Q4.

Great.

Very helpful.

Then, Bill, just a strategic question on CRM here.

You've got competitors talking more about the potential to integrate sales forces, perhaps [suddenly increasing bundling] in the industry.

You have also seen your [ICGR] become a little more stable and perhaps you're anniversarying some of the more serious perception issues around Fidelis.

So I wonder, thinking out over the next four to six quarters and given that you have new management, do you see any kind of fundamental change or any changes at all in terms of how you manage this business?

Do you get more conservative?

Do you get more aggressive?

Do you increase your level of spending?

Maybe help us understand how the next four to six quarters could go.

Well, I like my position right now with my overall cardiac franchise, with CRDM and CV and with the recent restructuring and bringing in Mike Coyle.

As I think I referenced in my remarks, very pleased so far with what Mike and Pat and Scott are doing to really position us as a Company that truly covers the gamut in the whole area of cardiac disease management.

So it's interesting.

I mean seeing what some of the people have done, really to some degree following some of the announcements that we made.

But we're looking at what we can do to better serve customers.

And, by the way, customers -- the definition of customers is changing.

I mean it's not just the clinical customer.

There are now economic buyers that are becoming more and more important.

So I think we're very well positioned to be able to serve customers in that broad term with a broad range of technologies that really there is very little, if any, kind of shortfall.

Okay, Bill, just maybe one last quick pipeline question and I'll jump back in queue.

The timing for CoreValve ID has shifted a little bit here over the last three to four quarters.

Now we are sort of saying late summer.

Would you say that given your conversations with the FDA, even though that has maybe pushed incrementally to late summer, your visibility on that timing has gone up?

Or is it relatively similar to where it was six months ago?

Thank you.

Well, David, I'm not sure where you are coming from in terms of that, with our timing shifting.

It really hasn't shifted.

We said this summer, and we're still comfortable with that.

So there is nothing that has happened that would in any way change our view on when we think we can begin the IDE.

We've obviously been in discussions with the FDA over that six-month period of time.

So do we have better visibility on where that is now versus even six months ago?

The answer is yes; but as Bill said, we are still comfortable with that, this summer on starting the IDE.

Thank you very much.

Kristen Stewart, Credit Suisse.

Thanks for taking my questions.

I was just wondering if we could look out to March.

Obviously, you have a lot of dates coming up with the AF data coming out of ACC, and then the panel meeting.

With respect to the AF business, can you just maybe talk about what your plans are to further support that franchise in terms of building out a sales force?

Then on the panel for the MRI-safe pacemaker, can you just comment on what level of data should we be expecting to be released to support that panel review?

Well, first of all, on the Cryo, again, we continue to be very excited about the opportunities here.

This is sort of a new market for us.

It's all upside.

We will be presenting at the panel and the STOP AF data will be presented at the ACC.

We again remain cautiously optimistic that things will go well and we will be in the market in the first half of FY11 with our CryoCath Technologies, and a little bit later in the year with the Ablation Frontiers technology.

We are building now a focused field effort to take all of our atrial fibrillation technologies -- the Reveal technology, the CryoCath, the Ablation Frontiers, and the other EP diagnostics that we have -- and really coming out of the blocks with a pretty formidable critical mass in the AF space.

So we are excited about that.

In terms of the -- on the MRI, yes, there is really no specifics here other than we are well prepared.

We will present at the panel; and we are, again, I would say cautiously optimistic that this will go very well for us.

Then just I guess real quickly on -- Boston obviously has their panel date the prior day for MADIT-CRT.

Did you guys ever submit some of the data from your studies to further expand the label on your devices?

No, not yet, not yet.

Okay.

Thank you.

Ben Andrew, William Blair.

Good morning.

Can you talk a little bit more about the Spine space?

With the recent announcement from some competitors of targeting the kyphoplasty space particularly, what is your strategy there from a competitive standpoint?

It sounds like you had some new products coming next year.

But from a litigation standpoint, do you see the need to go down that path with multiple competitors seemingly targeting that space in the next several quarters?

Well, as I said, we first of all are very confident in the strong strength of our IP; and as I said, we will vigorously defend and assert our IP against any of those that we have reason to believe are infringing our intellectual property.

We have a number of patents which protect that space that we really have, if you will, brought to the market and developed.

From a -- again, if you look at where we are today in regards to some of the competitors that are in the space, look at the technology that we have and still feel extremely confident that we have market-leading technology in many different dimensions.

At the end of the day, we know that technology makes a difference.

Innovation sells.

So we will compete vigorously with the technology.

We will compete with the strength of our distribution and the strength of our evidence.

Bill, what is the situation now in Japan?

Has the timing there changed for approval and reimbursement?

No, no.

The timing is -- we're on track.

We believe that we'll have -- in early FY11, we will be beginning to develop the market in Japan.

Okay.

Then last question on the construct side within Spine.

You talked about maybe the market slowing due to reduced opportunity with mix.

Do you see the new-generation products you are bringing out over the next five, six quarters and rolling out offsetting that?

Or are we looking at kind of a new normal, with a little bit slower rate of growth sustainably for Spine?

No, I think we believe we will be able to offset that with the Solera and with the TSRH 3Dx that we are bringing out, and the [X-CBR] that we just recently launched, and some of the things that we're doing in the defib space.

So the whole formula here, it's price, volume, it's mix, and we look at what's happened the last quarter or so, we haven't had much benefit from mix.

In fact, it has gone the other way.

So we think that once we bring out new products and we can demonstrate the value, that will help lift the market.

Thank you.

Bruce Nudell, UBS.

Good morning.

Thanks.

I have a spine question and then a reform question.

Bill, it looks to us like the US fusion market has about 5% procedure growth, maybe 5.5%.

And the market's clearly has been low double digits for a long time.

Is there anything -- but reimbursement is great.

So is there anything structurally that is going on now where that ASP inflation contribution could go down in the low single digits?

Or do you expect that you'd be able to maintain mid-single digit ASP with innovation?

Yes, Bruce, I tried to answer this.

I do think that we're -- I don't see anything structurally changed.

I don't see anything that would suggest the fundamentals are any different.

In fact, if anything, it's the other way.

The prevalence of degenerative disc disease and deformity and trauma is only increasing.

So we remain very bullish on the overall Spine market.

I do think -- again, it's hard to quantify.

But I do think what we had seen in the last maybe six months to a year, with the impact of the economy and with the increasing unemployment rate, it has had I think a bit of an impact across-the-board.

Perhaps that's part of what we're seeing, but I think that will ultimately resolve itself.

And my follow-up is --

Bruce, just to add to Bill's comments, the only other thing I would say is the reason that we think that the fundamentals are so strong is we know that we're still just touching -- we haven't got full penetration in [leads] markets, not only in the US but even internationally as far as people with back pain.

As we continue to develop products that are minimally invasive in helping people really deal with that back pain and moving up that continuum of care, that's where we continue to see this market growth potential.

So it's not just even on the fusion side; it's clearly even just broader than that.

But we still see tremendous opportunities for these procedures to continue to increase.

Then, Bill, I noticed in the President's language yesterday the change of the definition of the med tech tax.

It's delayed till 2013 in his proposal; but it's also an excise tax.

When you buy a car you have these federal and local taxes, and nobody gripes about them, and you don't try to negotiate the federal tax down.

Is the change of the presentation of that fee going to be helpful in terms of the industry being able to pass that along to hospitals?

I don't know, Bruce.

I think you know our position.

All along we have been -- really questioned why you would tax an industry that has so much to offer in terms of just economic growth, if nothing else; and just the contributions that we are making to overall healthcare.

But the language was better.

I mean the fact that it's pushed out to 2013.

The fact that it's an excise tax and it's tax-deductible.

I mean, it's better.

But the idea that we could pass it on, it's -- again, we sell through hospitals.

It's not obvious that we could pass this on.

Thanks so much.

Tao Levy, Deutsche Bank.

Hi, good morning.

I was wondering if maybe you could comment a little bit more on the slowdown that we're seeing in the US pacemaker market.

I know you mentioned you had some field action stuff.

But also the whole market seems to have really slowed down this past quarter.

Is there anything specific going on there?

No, I don't think so.

I did mention that we've seen a little bit more ASP pressure.

But with the introduction of MRI-safe pacemakers in the not too distant future, I think that will help to reaccelerate the growth a bit in the overall market.

But there is nothing that would suggest that there is a declining demand for pacemakers.

The fact is that with the changing of the demographics and the aging of population, the fundamentals here are still very solid.

So I think we have seen a little bit of the impact of price, I think has weighed in on the market.

But that we believe will change as we continue to innovate.

If you look at Physio-Control, with the FDA news last week and say this quarter's performance, how much was Q3 limited by what was going on at the FDA?

And as we go forward, should we expect significant increases from these levels?

Or you didn't think it really had too much of a headwind on sales?

Thanks.

No, it's not a headwind.

It's been -- it's had a headwind.

So we -- it's hard to quantify exactly what that has been.

But we have been restricted from shipping certain products, and now that restriction is limited.

So we will clearly see an increase in Q4 and going into next year because of the restrictions being limited.

Thanks.

You know, Tao, basically the revenue for the last several quarters when we have been restricted have been in that $90 million to $100 million range.

So Q3 was right in that line.

As Bill said, we don't know exactly what we are going to expect as we full launch on all the products.

We have been very happy with obviously how customers have stuck with us; but we will have to see how they respond now with our ability to really launch everything.

If you go back prior to that whole activity really happened, we were probably in that more around $120 million, $125 million range.

So will we be able to get back up to that [first] quarter, we will have to wait and see as we get back in full marketed sell.

Great.

Thanks.

Very helpful.

Larry Biegelsen, Wells Fargo.

Good morning.

Thanks for taking my call.

Two questions.

First, Bill, maybe on -- I know it's early days -- but the potential impact of 510(k) reform.

Do you still think that 10% of sales as a percent of sales for R&D is a realistic target, or could it go higher?

And the other implications for a large company like Medtronic, which obviously has a lot of resources, is this potentially an advantage for Medtronic?

That's my first question.

Yes.

This is -- there was the meeting this week or last week with the FDA on the whole 510(k) process.

So this is still a lot of discussion going on with the FDA on what is the right way to address some of the concerns that have been expressed.

So it's not there what will be the ultimate outcome.

But as it relates to Medtronic, as we commented before, most of the products that we sell are PMA products.

So if there was a change in 510(k) it's not really going to impact us necessarily as much as it may others.

Yes, to your point, it could have an impact on smaller companies and just the appetite for venture financing if the timelines are going to be drawn out.

So I do worry about this as it relates to just our country's ability to continue to have leadership and innovation in medical devices.

Back on pacemakers, the MRI-safe pacemakers, if you sounds like you expect those pacemakers to help you take share in the US and internationally.

On that same subject, the Kappa/Sigma warning letter status, could that potentially impact the approval in the US of the MRI-safe pacemaker?

And lastly, on the same topic, are you trying to remove the limitation for chest scans for the Advisa outside the US?

Thanks.

Well, when we talk to physicians in regards to what they see in terms of the importance of MRI, to a person they say this is critical.

70% of people who get pacemakers need at some point to have an MRI.

So we are obviously very excited and bullish that this will enable us to gain share as we bring forth the Advisa outside the US and when we bring REVO here in the US.

So yes, we think this is going to be a very important introduction around the world.

In terms of -- there are no restrictions with Advisa outside the US, so that's not an issue for us as it relates to chest scans.

And the Kappa/Sigma warning letter, Bill?

I'm sorry.

Oh, sorry.

Kappa/Sigma.

We have -- we're waiting for the FDA to come in.

We have corrected the things that they identified.

We are hopeful that the FDA will be in sooner rather than later and this won't be an issue.

Thank you.

Okay.

Why don't we do, I think, two more questions?

Rick Wise, Leerink Swann.

Good morning, everyone.

This is Danielle in for Rick.

First question, broadly speaking, can you talk about now you have made quite a few acquisitions over the last 12 to 18 months.

Can you talk about your use of cash and priorities as it relates to future acquisitions, share buybacks, etc.?

This is Gary.

As we've indicated, we continue to buy back obviously stock and dividends.

So 40% to 50% of our free cash flow we still are continuing to remain committed to returning that to shareholders in the form of share buyback and dividend.

But we also feel that that gives us adequate ability to make acquisitions.

And as you said, we have made several over the last 18 months; but they have been smaller size obviously, more the tuck-in type of acquisitions that we feel have performed very, very well.

So we're pleased by that.

And we still have the financial flexibility with the cash we are generating to allow us to make those types of acquisitions of technology and product lines.

So overall, the strong cash flow this Company continues to generate gives us the flexibility we believe to actually add to our product portfolio through acquisition and to make sure we are returning the appropriate amount to our shareholders.

Okay.

Then just following up on the acquisition front, do you see any maybe white spaces in your business that you would like to fill on that front?

Well, we obviously can't comment on that question specifically.

But no; as we said, we like our portfolio.

We have a very broad, diversified portfolio.

Again I think that is in part how we have been able to manage through a lot of the turbulence in the economy, by having a diversified group of businesses.

We're in most of the spaces that we think are important, with the aging of the population and as it relates to chronic disease.

So our focus -- and you've seen this the last 18 months -- has been more on the tuck-ins.

It's how do we leverage this global footprint that we have, with close to 9,000 people in the field?

So our first sort of priority is if we can feed that distribution with more technologies.

So that's really where we are focused.

Okay, great.

Then one more question.

Japan, I believe we're coming up on a reimbursement review there for medical devices.

How could this impact Medtronic's sales, what your exposure in Japan across your business is?

And does this change your strategy in Japan?

Thanks so much.

Yes, just quickly on that, this is an industry; this is not just a Medtronic.

Every other year Japan goes through a foreign average pricing review and an R-Zone review.

We have just completed the negotiations there.

So we are -- it will impact us going into FY11.

We will see an impact in April.

It is in that 5% to 6% of revenue in Japan.

Okay.

Last question.

David Roman, Goldman Sachs.

Good morning, and thank you for taking my question.

Just two quick follow-ups.

Bill, when you first set out the goal to return the Spine business to market growth by FY12, the market was growing in the 10% to 12% range.

And now at lease for calendar Q4, it looks like it probably grew more like 7% to 8%.

Should we think about the 7% to 8% number is now the long-term bogey implied and then also for your growth rate, and then that gets us to the 5% growth for you?

Or should we think about the market accelerating as some of the pressures you talked about abate over the next couple quarters?

That's a good question, David.

No, you should think about it in terms of what the market is growing at.

If the market is growing at 7% to 8%, what we have said is that we are going to return to market growth; so it's in that 7% to 8% growth range versus back up to 11% to 12% growth rate.

Then --?

If we are successful with the new products and the market accelerates, then, yes, we could see some more.

But right now, based on -- as Bill said -- based on where the market is I wouldn't do any more than what the current market is indicating at this point.

Then if we look at this as 20-ish-% of sales and that's a 4-point delta in market growth, first of all you expected what?

Why wouldn't that have an impact on your long-term growth rate or other businesses making up the difference?

Well, I'm not sure I understand the question.

I mean we haven't really given long-term guidance.

But again this comes back to the overall portfolio.

We generated 6% constant currency, 10% as-reported growth this quarter with Spine sales that were flat to negative.

So this is, again, the whole value of having a broad-based portfolio.

We think CRDM is ticking back up.

We believe Spine will tick back up.

We continue to feel good about the Neuromodulation business, the Diabetes business.

CardioVascular we had -- this year we know was sort of an extraordinary year because of being in Japan with Endeavor; and next year that will come down a little bit.

But again, when I look at our portfolio with all the puts and takes, we feel very good that we can continue to deliver market-leading performance.

Maybe that's a good way to summarize the call here.

Because if you look at just again this quarter, again, 6% constant currency is arguably at the very high end of what we saw the med tech industry this last quarter.

I think it speaks to the strength of our overall portfolio.

So that is how we are playing it going forward.

We know we have got some challenges with Spine.

I am confident we are doing the right things to re-accelerate this going forward.

So maybe in summary, I think it was a good quarter for us.

We continue to demonstrate our ability to make the tough decisions and to deliver.

I think we are well positioned from a portfolio as well as geographically.

We continue to see opportunities to grow faster outside the US.

We are investing disproportionately out there.

And so I remain optimistic about the outlook going forward.

Then can I just ask one last quick question on gross margin?

I think you are at the highest gross margins of all large cap med tech this quarter so far, those that have reported.

Can you just maybe talk about how -- I think you told us in the past, your ability to use your scale to offset some of the pricing pressures that are happening in the end-user markets.

Well, David, this is Gary.

As we've talked about, we started a process over two years ago.

Now we're in our third year of this process, where we saw a couple years ago that we were going to see increasing pricing pressures.

And we had a program underway to take $1 billion in cost out of our products.

That was when we were still at the point in time, even two or three years ago, had market-leading gross margin.

So we're never happy with where we are at and continue to challenge the organization to continue to do better.

As a result of that, we have taken already out -- in the third year we will have taken over $600 million out.

Almost $700 million of cost of our products.

That is how we are able to offset pricing pressure.

The industry I would say is just starting to realize that maybe they need to be addressing that, and as a result I think you are seeing gross margin pressures from some of the competition and some people in the industry, where Medtronic has already taken the steps to make sure that that is not affecting us at this point.

Okay, that's very helpful.

Thank you.

Okay.

Well again on behalf of the entire management team, I want to thank you for your interest in Medtronic and continued support; and we look forward to seeing you in June in New York.

Thank you.

Ladies and gentlemen, this does conclude today's conference.

Thank you for participating.

You may now disconnect.